Are Aggressive Buyers Stupid or Guilty of Segmentation Errors?

200938132350607This blog by Andrew Cox (originally posted on Spend Matters) continues the debate on procurement practices in the retail industry that have come under recent scrutiny and criticism.

In a recent blog (Spend Matters, 21st January) I explained why I disagree with Peter Smith’s view (Spend Matters, 12th January) that food companies should be condemned as ‘unethical’. I also do not think food companies have been ‘stupid’.

Nevertheless, I do agree with him (and with David Atkinson) that, when developing more aggressive sourcing strategies to extract extra value for themselves, these companies—in the face of increased competition and declining profitability—may have been guilty of some serious power and leverage segmentation errors.

It would appear that the some food companies may have rushed into decisions without fully segmenting their power and leverage positions across their entire supply base. By doing so they have appear to have developed a ‘knee-jerk’ and ‘one size fits all’ approach to sourcing.

Perhaps the gravest error that any buyer can make is to fail to properly segment their supply base, so that they can fully identify the range of power and leverage scenarios that exist (see diagram below), both within their categories of spend, and also in relation to each and every supplier within them—currently and potentially in the future.

The Power Matrix Figure

Only by understanding the current and future potential power position of each and every supplier in a category of spend, does it become possible to identify two things:

  • Which categories are likely to be the most amenable to particular types of sourcing strategies?
  • Which suppliers (if not all) within a particular category are likely to be the most amenable to successful leveraging successfully, given a particular sourcing strategy?

To put it at its simplest, if a supplier is dominant (i.e. they have a monopoly over a product/service which cannot be easily competed away, and this is highly valued by the buying company’s customers) then it is likely to be a serious error to try to leverage them aggressively within a contractual term, or before awarding a new contract. If the dominant supplier has many alternative options they can either walk away or impose unacceptably high costs on the buyer for their aggressive behaviour.

Conversely, if a supplier is operating in the buyer dominance (few buyers/many suppliers/low switching costs) or independence power positions (many buyers/many suppliers/low switching costs) then the scope to use more aggressive leverage successfully within or before contracts are signed is much greater for the buyer. This is because the buyer has many alternative sources of supply and the supplier must continue to pass value to the buyer if they wish to retain the relationship in the future.

It follows from this that buyers must be extremely careful about analysing the power position of each and every potential supplier, both now and in the future. If they do not, then they may well fall into the trap of adopting a ‘one size fits all’ strategy that can lead to serious supply consequences in the future.

In this light, although we cannot know for certain without analysing these sourcing strategies in detail, the adoption of universal approaches that demand more money for simply being a supplier (Premier Foods’ pay and stay approach), or continually asking for increased discounts after agreeing contractual prices (Tesco), are evidence of overly-simplistic sourcing approaches that have not been informed by a sophisticated segmentation of the power and leverage positions of each and every supplier.

That said there is nothing wrong with adopting a universal approach to supplier leverage in the future, but this is only likely to be safe if the power position favours the buyer both now and in the future, and all of the suppliers are operating in a relatively weak bargaining position (which of course never happens).

Given this, it could be that Sainsbury’s strategy of delaying payment terms for all of its construction and fit out contractors is a sensible strategy. But this would only be the case if all of these suppliers are highly dependent on working with Sainsbury’s, with few alternatives, and none are able to use counter leverage in the future.

It is not clear, however, whether or not food companies have fully thought through this last point—namely, the need to fully understand and segment the time dimension in power and leverage.

Obviously, while power can move between buyers and suppliers over time, it is important to recognise that this power shift does not occur in all categories of spend in the same way. Sometimes, buyers may be at risk of it, but at other times they may not. One must be careful, therefore, about claiming that suppliers will always be able to take advantage of buyers in the future if they abuse their power now, and vice versa.

Once again this forces us to recognise that a ‘one size fits all’ strategy is normally an error, and that the sophisticated segmentation of power and leverage scenarios is at the heart of successful sourcing strategy development and subsequent supplier relationship management.

Indeed, it is interesting to conclude with the thought that power segmentation within supply chains also demonstrates that the use of aggressive ‘within-contract’ (this is post-contract if deemed after contract award) and ‘post-contract’ leverage may be much easier for some companies than others.

There is another power-related factor—sourcing strategy brand impact—that buyers have to consider, and one which may be much more problematic for B2C retail companies that sell to end consumers (like Tesco and Sainsbury’s) than for B2B companies (like Premier Foods and 2 Sisters) selling to retailers. Arguably, B2C firms have to be much more aware of the impact of their sourcing strategies on public opinion and customer behaviour than others (and particularly if these are likely to be aired in the press and media).

The problem for Tesco and Sainsbury’s is that their brand reputation is a key factor in their overall business strategy, and this is because they operate in an increasingly competitive market, with new lower cost entrants challenging their historic market shares and profitability. In such a market, where the switching costs for consumers are relatively low, food retailers must jealously protect their brands.

This means that any consumer perception that a sourcing strategy is a form of ‘unethical bullying’ is likely to have a significant impact on customer behaviour, and potentially on market share and profitability. Arguably, this issue is much less likely to be a constraint for B2B companies (and especially multi-product) companies in the food supply chain.

While we have only focused here on a few power resources (and there are many more that need to be considered when developing an effective sourcing strategy), these examples highlight the fact that some food companies are evidently not fully competent in understanding power and leverage when developing their sourcing strategies.

This reinforces the view that one of the greatest weaknesses in the procurement profession today is the lack of competence by buyers in fully analysing their current and future power positions, leading to a failure to fully understand the appropriate sourcing options that are available to them to leverage improved value from suppliers.

How this competence gap can be eradicated will be a subject for the future.

Andrew Cox
Andrew Cox
Vice President,IIAPS
Andrew has undertaken over 25 years research into best practice in purchasing and supply, and was the Founding Professor of the CBSP, University of Birmingham Business School, where he established the world’s first MBA in Strategy & Procurement Management. In 1998 he was awarded the Swinbank Medal for Outstanding Services to UK Purchasing & Supply by CIPS. He is also a founding Director of IIAPS, where he is currently Vice President. Andrew has been a strategic adviser and consultant to a large number of blue chip companies and to major public sector organisations in Europe, Asia and North America, primarily in the area of external resource management and the business process alignment of business strategy with purchasing and supply chain management.

5 thoughts on “Are Aggressive Buyers Stupid or Guilty of Segmentation Errors?”

  1. I think the time horizon point is the key one. Peter can write for himself, but I suspect he thinks these Buyers are thinking of today not tomorrow and that is why they are making a mistake. Perhaps one of the buyers could comment if they read this? Anonymously? If so I think we all agree on the issue, just not whether it is a matter of ethics or practicalities.

    My other concern is the potential abuse of a strong financial position to fight legal challenges for breaking contract – which does not help any of us.

    1. Point well taken about time Paul.

      Of course large companies have more financial muscle, which is always a power lever in their hands, and especially against small suppliers post-contractually.

      There are, of course, ways for small suppliers to deal with this–if brand/reputational issues are not available they can always force the buyer to ‘post a hostage’ (sorry about he academic language). Unfortunately this cannot be done after the contract is signed, only before.

  2. Elegant presentation of the idea of the power matrix between supplier and buyer and the implications of rightly or wrongly considering the segmentation of power and leverage scenarios. Sometime back I crudely tried to apply some of these concepts into a tool that category managers could use to predict costs in the future. Where it worked I now realized it was because people really did have a clear view of the power matrix. In practice it has been modestly successful although every one that used it modified portions to their taste.http://www.slideshare.net/wkohnen/purchasing-predictive-tool-for-category-cost

  3. Nice information, many thanks to the author. It is incomprehensible to me now, but in general, the usefulness and significance is overwhelming. Thanks again for this and your other blogs!

  4. Thanks for sharing, this is a fantastic post and covers very important issues for buyers in retail (and other industries). Really looking forward to read more.

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