How to Best Improve Supplier Segmentation

Supplier relationships are a lot like personal relationships. Each is individual, enriches daily life, and requires different levels of attention to keep strong. Just like best friends, there are a few suppliers your business simply couldn’t live without.

Businesses rate the characteristics of their supplier relationships using supplier segmentation. Evaluating your supply chain relationships with a supplier segmentation model reveals important information about your supply partners. It reveals how much you spend, how closely you rely on each supplier, and how much they support your strategic sourcing goals.

In this post, we'll cover the basics of supplier segmentation:

What is supplier segmentation?
The benefits of supplier segmentation
Steps involved in supplier segmentation
Best practices for implementing supplier segmentation
How a Kraljic Matrix creates supplier segmentation
How software improves supplier segmentation

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What is supplier segmentation?

Supplier segmentation is the process of dividing suppliers into groups based on criteria such as spend, supplier risk, or strategic value to the business. By grouping suppliers, companies can effectively manage their relationships and spending.

Segmenting suppliers helps companies improve supplier development for high-value relationships. At the same time, it avoids wasting limited resources on low-value partnerships.

What are the benefits of supplier segmentation?

Supplier segmentation helps procurement professionals and finance teams contextualize their spend with each supplier.

Using a supplier segmentation approach offers various organizational benefits:

Procurement teams focus on specific suppliers and categories, improving efficiency.
Buyers have access to data for better price negotiation and risk management.
Finance teams track spending by supplier type, making it easier to identify cost drivers.
Procurement adopts a continuous improvement approach to their supplier practice.
Organizations maintain business continuity in the face of supply chain disruptions.

What are the steps to supplier segmentation?

Building a segmented supplier list to help evaluate partnerships takes time and attention. It relies on quantitative and qualitative data about each supplier relationship. Depending on the number of suppliers in your supply base, beginning the segmentation process may take some time.

Consider breaking segmentation into stages, focusing on the areas of most significant spend or known important suppliers. These are often the same areas that offer big wins regarding cost reduction and optimized resource allocation.

There are four steps to effective supplier segmentation: data collection, data analysis, criteria selection, and implementation.

Data collection: Pull together information on all your suppliers. This data should include financial information, such as spend levels and payment history, as well as qualitative information, such as the quality of goods and services provided.
Data analysis: Once you collect the data, analyze it to identify patterns and trends. This step will help you understand where your current spending is going and where there may be opportunities for savings. It will also help you identify which suppliers provide the most mission-critical services to the organization for the best value.
Criteria selection: After you've analyzed the data, it's time to select the criteria you'll use to group your suppliers. Spend levels, risk factors, and strategic importance are all common criteria used in supplier segmentation. Once you've selected your criteria, begin grouping your suppliers accordingly.
Implementation: Put your supplier segments to work. This means updating your sourcing and procurement approach to reflect the new supplier categories. You should also develop clear communication plans for each supplier segment so everyone in your organization knows how to interact with each group of suppliers.

Supplier segmentation best practices

To further enhance your supplier segmentation initiative, adhere to the following best practices when collecting and analyzing supplier spend data:

Consider the Pareto Principle: This business rule (sometimes called the 80/20 rule) estimates that 80% of your spend comes from just 20% of suppliers. Look at big-ticket vendors first when tackling a supplier segmentation project from the ground up. These few critical suppliers probably represent the bulk of the segmentation work. They may also offer the most cost optimization opportunities.

Take a holistic approach: Sometimes, looking solely at the bottom dollar leaves out important context in supply management. Understand the total value of each supplier, including features like delivery timing, contract compliance levels, quality, and response to issues or challenges.

Review performance regularly: Segmentation isn’t a one-and-done exercise. Instead, treat segmentation and supplier performance management as ongoing processes that yield continual results. Supplier usage, terms, and total value change over time, so be sure to reflect this reality in your supplier management program.

Using a Kraljic Matrix for supplier segmentation

A well-informed procurement practice is vital to optimizing your supply chain. To better understand a company’s constellation of supplier relationships, many procurement teams use a Kraljic Matrix.

Developed in 1983 by Peter Kraljic, this tool helps procurement identify key suppliers, evaluate current supplier performance, and assist in the wider supply relationship management (SRM) process.

The Kraljic Matrix is a grid that helps businesses understand and manage supplier relationships by dividing them into four categories. Then, those four categories are used to create a matrix. The matrix contextualizes suppliers based on two key factors: business impact and supply risk.

To do this, segment every vendor in your supplier base into one of four categories. The matrix reveals the critical suppliers in your vendor pool as well as those who may benefit from better negotiation and performance management.

The management strategies for each category vary depending on its criticality and accessibility:

Leverage: These suppliers offer impactful but low-risk goods and services for your organization. Leverage items or supplies are available from other providers, which increases the opportunity for negotiation to receive better pricing.
Strategic: Strategic items are the components and supplies with the potential to disrupt business operations. They may come from a single source or have a complexity level that makes them difficult to fulfill. Strategic supplier relationships should receive the most attention from your organization and may require attention from upper management.
Non-critical: For non-critical items, Risk and impact are both low. Focus on price optimization and effective demand management to reduce the burden of acquiring these transactional goods. Different suppliers may be able to offer new product options or negotiate for a better profit impact.
Bottleneck: Bottleneck items have low business impact but less-reliable supply availability. Demand for bottleneck items typically fluctuates, so focus on effectively managing short-term supply and eliminating long-term needs where practical.

Improve supplier segmentation with Order.co

Supplier segmentation is a key component of procurement and supply chain management. Segmenting suppliers into categories can be done manually, but this process is time-consuming and difficult to maintain.

Software that automates the supplier segmentation process improves procurement efficiency. Such software analyzes supplier data to identify patterns and relationships between suppliers, products, and geographies. This information creates supplier segments that accurately reflect the organization's procurement needs.

Organizations that use vendor management software tools to automate supplier segmentation also benefit from improved visibility into their procurement processes. They more easily identify and mitigate supplier risk to help protect the organization's bottom line.

Using spend management tools like Order.co can improve the segmentation process while offering many other benefits:

A robust platform provides access to a network of 15,000+ high-quality, pre-approved suppliers.
Streamlined ordering allows stakeholders to get the supplies they need quickly and easily.
Spend visibility helps finance contextualize spend with your most important suppliers.
Invoice and payment automation enhances cost savings and cost avoidance practices for better cash optimization.

Schedule a demo of Order.co to see the platform in action and learn more about improving your supplier segmentation with our first-in-class procurement software.

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