Understanding Supplier Segmentation: A Complete Guide

Ah, suppliers 

They are the flesh and bones of procurement right?

That doesn't mean however that managing them is a walk in the park. 

There's just so much to be done, finding potential options for your company are only a quarter of the work. Establishing a good contract that meets your requirements is the next step.

But once the relationship is formed how can you be sure that things are going as expected?

How can you optimize the way you deal with your suppliers?

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Supplier segmentation, that's how.

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What's Supplier Segmentation?

You've heard it before 

If you want to organize something, make categories.

Well, that's pretty much how supply segmentation works. 

It categorizes your company's suppliers based on factors like their relevance, level of risk, or capabilities, or location. 

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Supplier segmentation is usually seen as an important part of any SRM, supplier relationship management, and strategy, and with good reason, as it helps you to understand which suppliers are critical to your company's operations and lets you develop a personalized approach to manage your relationships. 

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Common misconceptions 

• Supplier segmentation is only useful for large businesses: Quite the opposite, knowing where your suppliers stand in terms of importance and risk is fundamental for any company.
• I've already divided my suppliers into categories so the job is done: Not necessarily, supplier segmentation requires constant reviews so you can adapt to changes in your industry.
• It's only about costs: One of the greatest things about supply segmentation is that it not only assesses things like prices or quality but also focuses on risk management and innovation.

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Supplier Segmentation Models 

Depending on what your goals are, there are some models you can choose from.

The most common?

• The Matrix: Ideal if your focus is on risk and profits.
• The Pyramid Approach:  Builds a hierarchy of suppliers based on importance.
• Risk-based segmentation: Let you identify vulnerabilities in your supply chain.

Let's see each one in more detail

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The matrix

You’ll find that this approach is widely used in supplier segmentation. It categorizes suppliers into four quadrants based on two dimensions: supply risk and profit impact. These quadrants are:

• Non-Critical Items: Low risk, low impact. These suppliers are the ones that require minimal management effort.
• Leverage Items: Low risk, high impact. You’ll want to focus here on negotiating favorable terms.
• Bottleneck Items: High risk, low impact. Mitigating risks with these suppliers is key.
• Strategic Items: High risk, high impact. These suppliers demand close partnerships and careful monitoring. They are risky, yes but that doesn’t diminish their relevance. 

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The pyramid approach

Do you want to organize your suppliers according to their strategic value? 

This is how you do it 

At the top are your most critical suppliers, often few but vital to your operations. The middle tier includes suppliers that are important but not essential, while the bottom tier consists of those that provide standardized goods or services.

Pretty simple 

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Risk-based segmentation 

If you don’t know a problem, can you fix it?

No really 

Stick with this approach if you are ready to address potential vulnerabilities in your supply chain. Carrying out this assessment means that you’ll be evaluating factors like geopolitical risks, financial stability, and dependency levels, so you can categorize suppliers based on their risk profiles.

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This approach is particularly useful in industries with complex supply chains or where disruptions can have significant consequences. 

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Strategies for Supplier Segmentation

Begin with the right data 

As you probably already noticed, supplier segmentation implies a lot of analysis, which means that you’ll first need to count on high-quality data regarding your current suppliers and their performance, and of course, let’s not forget about spend analysis. 

Define your criteria 

Yes, supplier segmentation is all about making categories, so be sure to create the segments that matter for your business. It could be quality or it could be potential risk levels, you’ll be the one deciding. 

Build the right groups 

Based on the criteria you have formed, group your suppliers into categories that make sense for your company. 

Communicate 

Before diving into operational mode, share the new approaches with your procurement team so they are prepared to work accordingly. 

Strategic vs Tactical Suppliers

One of the simplest ways to start diving into your suppliers is to determine if they fall under the strategic or tactical category. 

Strategic suppliers are integral to your long-term goals and innovation efforts. Tactical suppliers, on the other hand, provide goods or services that are more transactional.

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How to Use Technology for Supplier Segmentation?

Data is essential for supplier segmentation, but how can you get it right?

Technology is how 

Digital solutions like supplier relationship management  or procurement software and data analytics platforms can help you gather insights, automate classification, and monitor supplier performance.

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Factors Influencing Supplier Segmentation

Several factors influence how you segment your suppliers. These include:

Market conditions

The market is always changing, what happened yesterday, might not necessarily be there today, for your company this means that you could see a sudden variation in your levels of supply and demand without notice. Using what-if analysis and predictive analytics to be as prepared as possible. 

Supplier capabilities

Ideally, you would have done this before getting into a contract, determine what kind of service that potential supplier is going to offer you. Assess their production capacity, technological expertise, and ability to adapt to your needs.

Internal priorities

Align segmentation with your strategic objectives, whether it’s innovation, cost reduction, or risk mitigation.

Challenges and Solutions in Supplier Segmentation

Supplier segmentation isn’t without its challenges. Common problems you could face include data accuracy, resistance to change, and resource constraints. To address these issues:

• Invest in Technology: Use tools to improve data accuracy and efficiency.
• Provide Training: Educate your team on the benefits and processes of segmentation.
• Start Small: Pilot your segmentation strategy on a subset of suppliers before scaling up.

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