Imagine you could sit and listen to conversations in your customer's procurement department. What would they say? Typically, procurement would divide their suppliers into at least four groups using a method that asks two questions like this:
- How difficult is it to switch suppliers? (Is it hard to do or risky to do?)
- How important to us is our spend on this supplier? (Is it a big portion of spend or is it important strategically?)
How Hard is it to Switch Suppliers?
How hard it is to switch suppliers depends on several factors. First, is there another supplier? Probably. So, is the other supplier the same? Again, in mature markets services and products are often similar. Here procurement ask the killer question: how hard is it to change?
How Important is Spend?
The importance of spend depends on several factors too. The easiest question is what portion of our spend is this supplier? If they are less than 10%, they are a low portion of spend (and your cost structure); if they are more than 30%, they are a high portion of spend (and your cost structure).
A trickier question can be how important is this supplier strategically? In a project, we found a small supplier which was a small percentage of spend: less than 5%. Was this supplier important strategically?
What we mean by strategically important can be found by asking these questions. If the supplier suddenly went out of business tomorrow:
- Customers: Would this affect any customers?
- Competitors: Would this affect how we compete?
- Employees: Would this affect any important groups of employees?
- Suppliers: Would this affect any of our suppliers?
- Regulators: Would this affect any of our regulators?
In the project, our client discovered there were no alternatives to this software. That was frightening. But if the company were to go out of business, then they could not deliver a critical service to some of their biggest customers, for months. This small supplier was strategic!
As shown in the diagram below, using these two questions (switching and importance), procurement can divide suppliers into four segments: Major Supplier, Commodity, Strategic Partner and Niche Supplier. Let's look at these two at a time: easy-to-switch and hard-to-switch.
For easy-to-switch suppliers - Major Suppliers and Commodity - procurement is in a strong position and will make good use of competition in the marketplace to drive down your prices. Typically, they offer the incentive of short contracts, like one year, to drive down prices.
For hard-to-switch suppliers - Strategic Partners and Niche Suppliers - procurement is in a weaker position and will not be able to make good use of competition in the marketplace to drive down your prices. Typically they will look for longer contracts, like three years with options, like two years, to extend contracts without going out to the market.
Well, if you have a choice, then you would always want to be a hard-to-switch supplier. Being hard-to-switch means you and your business can plan with the security of knowing your customers that you can't afford to lose are locked up for years. Also, it should mean that you grow revenue and profit with these customers.
What if you realise that you are an easy-to-switch supplier? Then you have two choices. Cut costs so you will be viable without that customer's business and so you can compete more aggressively on price.
You do have a second choice. Work fast at making it harder for procurement to switch suppliers. How? Listed in order of importance, here are some ways:
- Help your customer grow their revenues.
- Help your customer reduce their costs.
- Build relationships with C-Suite executives.
- Build relationships with more than one influential manager.
- Do business with more than one department.
You need to work fast because most of this list will take more than a financial year and during this time you are vulnerable to losing the customer you can't afford to lose.