Flat pack empire: are you at risk from supplier dependency?
A risky business...
The BBC documentary “Flatpack Empire” aired this week.
This three-part series explores what goes on beyond the showroom floor at the world’s largest furniture retailer, Ikea. As well as showcasing their recruitment, design and retail practices the documentary gave viewers an insight into their supply chain operation by following the story of a Swedish wood mill.
One of the most fascinating aspects was that this supplier has devoted their entire order book to manufacturing Ikea products since it began production. Ikea is, and always has been, their only customer.
Being entirely dependent on only one customer is clearly a risk for the supplier but it is a risk for Ikea too.
Leverage or risk?
Procurement theory tells us that buying a significant proportion of a suppliers’ output creates a good leverage opportunity, resulting in low prices.
We can also look at this from a supplier’s perspective using a model called Supplier Preferencing (shown below). Using this tool, we define a supplier who sees your account as attractive and where you are a significant contributor to their revenue, as “core” – theory says that they will value your business, perform well and strive to keep it.
Certainly, if the loss of a portion of your business to a supplier would result in the elimination of their profitability, then there is a risk. Analysis of a supplier’s accounts will enable you define the risk (your revenue x gross profit margin vs. EBIT). Or a quick rule of thumb is to undertake a deeper analysis with any supplier where you are more than 30% of their revenue.
So, while making up a high proportion of a supplier’s revenue can be considered good from a cost perspective an overly dependent supplier can create risks for your business. This is the Dependent Supplier Danger Zone
Supplier dependency - when does it become a supply chain risk?
There are two key risk factors
- Flexibility: The supplier may manufacture several different product lines for you. Your flexibility is put at risk when removing production of some of these lines puts such pressure on the supplier that effects their ability to produce the remainder of the product range. This can restrict your ability to move product lines to alternative suppliers and may even cause inflexibilities in production planning, particularly if you need to scale back.
- Financial: A cost-cutting drive can cause disaster. Suppliers with a diverse customer base can often squeeze their margins for key clients who buy high volumes by eating into profits from customers with less purchasing power. A supplier with just one customer does not have this option.
These risks intensify if the dependent supplier is “strategic” for example, a creative marketing supplier. An effective cost saving measure in the marketing category is to move more remedial design work from high end agencies who specialise in thought leadership and strategic branding and giving it to lower cost agencies. If the incumbent agency is highly dependent on your business then this course of action could result in the agency collapsing and the loss of your key marketing supplier.
There are several measures to effectively mitigate this risk.
1) Prequalify alternative suppliers: Assess the complexity of the products being produced by the supplier. Can you identify alternative suppliers who can produce this range?
2) Vertical integration: If there are few alternative suppliers of the product you are buying consider the option of buying the means of production through acquisition of the supplier. Even if acquisition is not required today it is certainly worth planning for in order to manage the supply chain risk.
3) Production reorganisation: If reducing the volume that you put through one supplier is going to have detrimental effects on all the products they supply then consider market testing the production of alternative products with the supplier. This is, we believe, the course of action taken by Ikea in the documentary.
Points to consider
When you make up a significant proportion of your supplier's revenue you become exposed to a multitude of risks that can have a negative impact on your supply chain and potentially your profitability.
1) Identification. The starting point for Supplier Relationship Management is to segment your supply base. At risk suppliers should be identified, and a key criteria for segmentation, is the % of business you are to that supplier.
We would recommend you identify your suppliers where you are more than 30% of their revenue.
Undertake supplier financial analysis to understand the impact of your business on their profitability
2) Understand the risk. Analyse the impact and likelihood of risk – in terms of flexibility and financial risk.
3) Manage the supplier. Put in place a Key Supplier Management process to monitor and manage the performance (and risk) of that supplier.
4) Take action. Only in a monopoly supply market are you forced to use a single supplier!
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