Supply base complexity: Finding the right balance

Finding the optimal number of suppliers to form your supply base is not easy — nor is it the only factor buying companies must juggle in order to manage their suppliers effectively. New research from Thomas Choi, professor of supply chain management at the W. P. Carey School of Business, shows that companies need to go beyond just looking at how many suppliers they have in their supply base. They need to consider the three dimensions of supplier complexity, then calculate the impact of each on a variety of supply chain factors.

To reduce supplier complexity or not to reduce supplier complexity? That has been the question lately in supply management circles. And it is a question whose answer is, well complex. Since the early 1990s, large buying companies — manufacturers in industries such as aerospace, automotive, high-tech, and pharmaceuticals — have focused on reducing the number of suppliers they manage in their supply base, primarily in order to cut costs.

This streamlined supplier ideal dovetailed nicely with enterprise-wide "lean" manufacturing efforts that were gaining traction at the same time, and made life a little easier for a lot of supply managers. But fixating solely on the number of suppliers in a supply base without taking into account other aspects of supplier complexity is short-sighted, finds Thomas Choi, professor of supply chain management at the W. P. Carey School of Business, whose recent research on the subject was published in the Journal of Operations Management.

"Most companies will say, 'We have 2,000 suppliers in our supply base, let's get that down to a lower number. We'll be able to spend less energy managing our suppliers; have an easier time building long-term supplier relationships; and we'll have more leverage to obtain better pricing,'" Choi explains. "With that approach, however, companies miss out on other important supplier dimensions, such as how differentiated the players are, and how they are linked up together."

What is complexity?

Choi's research into the implications of supply base complexity on corporations' overall competitiveness suggests that all three dimensions of supply base complexity — the number of suppliers in the supply base, the degree of differentiation between the suppliers, and the level of suppliers' interrelationships — play an equal role in determining supply management success. In other words, if companies are to manage their supply base effectively, they must understand the true complexity of that supply base, as well as its importance to the overall enterprise.

"To tame a beast, you have to know what that beast is like," jokes Choi.

While fine-tuning the number of suppliers in a supply base makes intuitive sense, the importance of the other two dimensions is not always as obvious to supply managers. "Buying companies think if you've seen one supplier, you've seen them all," Choi explains. "But that is a mistake. Suppliers are all different — they have different cultures, they dance to different tunes." This differentiation is important because it increases supply base complexity.

If a buying company has 10 suppliers in its supply base, for example, and each one has different operational practices, varying levels of technical capability, and/or different cultural and language needs, it is harder to coordinate and manage those suppliers efficiently, explains Choi. Likewise, the level of interaction among suppliers, also known as supplier-supplier relationships, is an important aspect of supplier complexity — one that manifests itself in surprising ways.

Choi has studied this particular dimension in detail, and finds that whether suppliers compete or cooperate with one another has a significant impact on the buying company's procurement and manufacturing success — as well as its bottom line. Learning to cultivate the type of supplier interaction that works best for their procurement strategies is another level of complexity supply managers must master.

Why does complexity matter?

In the same way that most companies zero in on reducing the number of suppliers in their base while ignoring the other important dimensions of supplier complexity, buying companies often make the mistake of managing supplier complexity only as a means of cutting transaction costs. Though reducing complexity does indeed often reduce those costs, it doesn't tell the whole story — there are other important factors to consider.

"When companies focus only on reducing overhead and the price of supply materials, they miss out on other important aspects that have more significant impact on cost eventually," Choi notes. Buying companies seeking optimal supply performance must also take into account supply base complexity's impact on three other areas: supply risk, supplier responsiveness, and supplier innovation, he finds.

A number of intricate relationships exist between supplier complexity and each of these elements, as seen in both in the scientific literature and in the real business world. Generally speaking, reducing supplier complexity can lead to lower transaction costs and increased supplier responsiveness, because working with a small number of similar suppliers that have minimal interaction with one another gives buying companies greater control.

The buyers have the muscle necessary to get the pricing they want, and the time required to devote to holding suppliers to certain standards of responsiveness. On the flip side, however, reducing supplier complexity can increase supply risk and cause buying companies to give up a degree of supplier innovation. "If a buying company is working with base of 50 suppliers as opposed to 500, they are pulling from a smaller pool of creative ideas," Choi notes.

"Think about how companies such as Toyota and Honda reduce their cost of manufacturing. A lot of their improvement ideas — for example, a different way of configuring sub-assembly, or using less expensive materials that function the same way — most of these ideas came from their suppliers," he adds.

The Goldilocks solution

When it comes to supplier risk, it seems a middle-of-the-road "Goldilocks" approach to reducing complexity is best. Too few suppliers and a company has no depth, exposing it to risks such as material shortages or a lack of recourse if a supplier's factory is damaged; too many suppliers and the company risks losing control of its supply base, allowing unfavorable events to occur.

"There is a quadratic relationship between supplier complexity and supply risk — too little complexity and you increase the risks, but too much complexity also increases risks. Companies need to think about an optimal point where they gain the maximum benefit," explains Choi. He cites Volvo Group as an example. The Swedish diesel engine manufacturer reduced its total number of suppliers from 800 to 50, but found itself facing a new set of problems.

"Volvo underwent an engineering-driven supply base reduction. But now the company realizes it has increased supply chain risk because it is a lot more dependent on these 50 suppliers," Choi says. "It was difficult for this company to figure out how to handle the situation." Indeed, handling the situation and determining both the optimal number of suppliers and the optimal level of complexity for the supply base is exactly what companies must do to effectively manage supply base complexity.

How can companies accomplish this? Very carefully, says Choi. "They need to ask themselves, 'Have we downsized too much? How well do we know our supply base? Do we know what type of culture supplier A has compared to supplier B? Do they talk to each other?' I recommend companies take a close look at all these factors," he says. An exact science it is not.

But companies that take the time to closely evaluate all aspects of supply base complexity and its impact on transaction costs, risks, responsiveness, and innovation are at least on the right track to improving the overall effectiveness of their supply management. "The most important thing for buying companies to take away from this research is the fact that blindly lowering the complexity of a supply base may not always be desirable," explains Choi.

Bottom Line:

• In the 1990s, many companies reduced supplier numbers hoping to reduce costs and reap the benefits of enterprise-wide "lean" manufacturing.
• The number of suppliers is just one component of the complexity of a company's supplier base. Other factors to consider include the degree of differentiation between the suppliers and the level of suppliers' interrelationships.
• Cutting the number of suppliers can chop transaction costs, but there may be other consequences, including an increase in certain kinds of risks.
• Reducing the number of suppliers a company deals with may give the buyer more control over those who remain, but fewer numbers may mean less innovation.
• Beware an easy answer to complexity.