Business addiction and purchasing strategy

„Amazon's employees compare trading by independents on the company's site to heroin addiction: when sales of a product suddenly pick up momentum, they get euphoric, then comes the addiction, and then self-destruction as Amazon starts to undercut their margins and price. Sellers „know they shouldn't be using heroin, but they can't stop,” says Kerry Morris, once a salesman at Amazon.” Quoted from the book „JEFF BEZOS AND THE AMAZON ERA. THE STORE WHERE YOU BUY EVERYTHING” by Brad Stone.

In the case of Amazon, or the retail industry in general, the greatest risk arising from dependence on a business partner is usually borne by the supplier. In the aerospace, maritime, automotive or rail industry, the situation is no longer so clear-cut. Dependence on a business partner can be dangerous for both parties, supplier and customer.

From Eveneum's practice, the following reasons for dependence on a single supplier are most commonly encountered:

• the supplier nominated by the customer, the so-called. customer directed buy, customer nominated supplier. It is interesting to note that often such a supplier is not formally imposed by the client but „strongly recommended”.”
• limited market in the region
• specific product or material
• monopolist due to: IP, barriers to entry such as prestige, brand recognition and trust
• the need for early involvement of the supplier in the design process [upstream]
• too high a cost for change and validation
• obsolete technology or material [obsolete technology/material] resulting, in conjunction with low volumes, in a lack of interest from other suppliers
• purchasing strategy, e.g. introducing a distributor who takes on small suppliers. Instead of buying screws from 20 manufacturers, we introduce a supplier who takes over the supply of all the products needed. The supplier takes over some of the responsibility and competence from the customer
• strategic decision to engage more with a supplier. Aerospace is an industry where we often find ourselves setting up JVs with key technology suppliers. An example that gave me a big headache in 2012 was the JV between GE, Snecma and Nippon Carbon, more information at: ge reports and yahoo finance. I was managing the composite materials category at Rolls-Royce at the time....

Defining a purchasing strategy should take into account, among other things, the value of turnover with a supplier in relation to the value of its total sales. Analysing the risk and calculating this „level of dependency” we have, for example: value of purchases from the supplier €3.5m, turnover of the supplier €10m which gives us a level of 35% „makes the supplier dependent on the customer”. From the buyer's perspective, this may seem like a favourable situation because he has quite a lot of leverage over the supplier. Unfortunately, it also has its bad sides.

Possible consequences for the buyer who makes the supplier dependent:

• financial risk - the limited ability of the supplier to compensate for loss of income in the event of seasonality or crisis in the industry. In 2009, the automotive industry was badly affected. Many companies were declaring bankruptcy, this was linked to the problems of the car manufacturers [OEMs]. This was particularly true for those companies that had become heavily dependent on one industry. This resulted in a loss of liquidity for the supplier and the consequences were borne by the buyer - urgent relocation of production, customer retention, supporting the supplier's business e.g. by financing the purchase of materials needed for production. An article summarising the situation in the US automotive industry: www.businessinsider.com
• continuous improvement - working with one main customer limits the supplier's ability to gain experience, to look at the same product but from a different perspective that other players in the market may have. For example, 20/30 years ago, many OEMs had T1 suppliers who were, as it were, ex officio involved in the production of new car models. Today, most of the parts suppliers are companies independent of the OEMs. This results in the need to compete, to develop in each of the Q,D,C,T,M areas.

Analysing the situation from the buyer's perspective, we can calculate the level of „dependency” by dividing the value of purchases from the selected supplier by the total value of purchases in the category. For example, the value of purchases of plastic parts is €1000,000, the value of purchases from the selected supplier is $200,000. This gives us a „supplier dependency” of 20%. 

Possible consequences for a buyer who becomes too dependent on a supplier:

• weakening of the position buyer negotiation
• possible lack of motivation on the part of the supplier to improve his offer in each of the areas Q,D,C,T,M
• dependence on intellectual property and know how suppliers 
• dependence on technology that is convenient for the supplier but ties the hands of the customer
• BackDoor Selling and loss of control by the merchant over internal partners

How much is the right level of turnover with a business partner? It is difficult to define a single value that is good for every industry, every type of product or service. When developing purchasing strategies with our clients, particularly in industries such as automotive, aviation, rail and marine at the initial analysis stage, we apply the 30/30 rule. Roughly speaking, it says:

• within a category, no supplier should exceed 30% of the value of our purchases
• our purchases should not exceed 30% in supplier turnover 

Of course, this is a very general rule and the level should be tailored to the industry, technology, supplier segmentation and the type of relationship we have or want to have in the future.

A sound analysis, a review of the internal situation and the market, and finally a risk analysis, are key to making the right decision. A conscious decision to become more dependent on one business partner should include an action plan for when our relationship changes or risks materialise. We review all of these areas with our clients, advising them on how to prepare a purchasing strategies and anlizing risks in their supply chain. These processes are supported by friendly tools such as ESSA.