Supplier relationships are frequently damaged as a result of procurement cost-cutting activities during an economic downturn when it should be the ideal time to strengthen key supplier relationships for long-term success.
— By Lena Haram
Cost management is one of the areas of focus for procurement, and some believe it is the most important. This is true especially during normal economic downturns. Often during times of economic stress, cost minimization becomes the over-riding goal at the sake of strategic processes, like supplier relationship management (SRM).
In an economic downturn, the concentration on reducing costs comes with a hefty price: Loss of the full value that SRM offers. When the economy is contracting, SRM is in danger of becoming a cost control process instead of a supply chain system that delivers full value.
Allowing SRM to devolve into a cost control process means the business loses what it needs most – the ability to capture value producing opportunities that help the company remain competitive. In addition, letting key supplier relationships deteriorate has business consequences that are likely to endure long past the economic downturn.
Becoming Transactional Once Again?
Procurement functions have been moving toward implementing an SRM system because of the many advantages SRM brings an organization.
The business case for SRM is clear. SRM can lead to supplier-driven innovation, reduced supply chain risks, greater efficiency, high ROI, and lower costs. Procurement functions with SRM have put strategic plans into place for managing key suppliers to maximize value. Refocusing primarily on costs means the other advantages are not likely to be achieved. It is like taking a step backwards by making procurement primarily a transactional function rather than a strategic one.
The pressure to focus on costs can be immense during an economic downturn, but it is a shortsighted approach to deal with a market condition that will not last.
The pressure to focus on costs can be immense during an economic downturn, but it is a shortsighted approach to deal with a market condition that will not last. It can also negate much of the effort put into developing a diverse supply chain when costs become the sole driver of doing business with suppliers.
For example, studies have shown that diverse suppliers bring innovation to businesses, and innovation is needed to remain competitive. However, most diverse suppliers are small-to-medium-sized businesses and not necessarily able to provide goods and services at the lowest price. The value of innovation is lost in the interest of buying at the lowest prices from larger suppliers.
Dos and Don'ts
During the last recession, many supplier relationships were hurt, providing good lessons on the "dos and don'ts" of supply chain decision-making during an economic downturn.
Many of the decisions made involved consolidating contracts to give more business to fewer suppliers with larger capacity, edging out the smaller suppliers on the belief it costs too much to manage the existing supply chain due to its complexity. In some cases, suppliers found themselves stuck with too much inventory as product orders fell and suppliers were not forewarned or given time to adapt. The lack of transparency and communication hurt suppliers financially, sometimes causing bankruptcy, and damaged the trust level the supplier had in the customer.
When economic uncertainty prevails, supply chain risks increase, meaning it becomes even more important to maintain and manage relationships with key suppliers. On a global basis, governments respond to economic downturns with new laws and regulations and local suppliers suffer financial hardship, causing disruptions in the supply chain.
Strong relationships with key suppliers give procurement professionals two-way communication channels for sharing insights that can reduce risks. Strategic suppliers also may have first-hand knowledge of some upstream and downstream suppliers experiencing financial distress and at risk of going out of business. Suppliers have knowledge of market conditions, customer sentiments, and so on. This knowledge, coupled with the customer's market and supplier tracking, gives procurement the ability to intervene early when risks appear they are becoming reality.
Cost reductions are measured using standard measurements like purchase price variance. Emphasizing year-over-year cost reductions and other traditional KPIs, without considering supplier relationships, drives procurement to ignore other value measures. In fact, focusing mostly on unit costs inhibits the ability of suppliers to contribute to total cost reductions in their customers' operations. For example, a supplier may not be able to drive per-unit costs for deliverables down but can reduce total costs by suggesting substitution of materials somewhere along the supply chain.
Proactively Addressing Signs of an Economic Downturn
Economic downturns like the last major recession usually do not happen overnight. There are warning signs, and that is when procurement professionals should become even more proactive in planning responses to risks.
Technology can play a big role. For example, machine learning technology can enable the generation of more flexible contracts, and good communication can give suppliers the advance warning they need when changes in demand occur. This will help suppliers avoid inventory excesses or shortages and preserve quality customer services. Market analytics can indicate early shifts, enabling customers to work with strategic suppliers to develop risk responses.
The one thing procurement should not do is cut staff and resources in an attempt to save money. Over the long-term, it costs an organization more. SRM requires procurement talent that continues to monitor supplier health, collaborate with suppliers to manage demand uncertainty and risks, and proactively address future needs as the economy improves. Retaining procurement talent enables a firm to bounce back at a much faster rate when the economic picture improves.
Supplier relationships are developed for major reasons that include enhanced competitiveness, cost efficiency, enabling technologies and improving operational effectiveness. These four reasons still apply when the economy goes sour. In fact, when the economy trends down, the supplier relationships become more important, not less.
Procurement needs to make sure it maintains the resources it needs to leverage the supplier relationships to successfully manage the downturn and establish readiness for the upturn when it happens. An economic downturn is an opportunity to strengthen supplier relationships.