Diversity in the supply chain
The - perhaps - counterintuitive value of inclusion in procurement
Competing for the lowest price
It is commonly known that competition leads to the lowest possible price in the market. If you want to buy a product or a service you can hold an auction, where suppliers make offers to get the order. In direct competition, the prices will go down until only one company offers to supply the product or service at this price. This will be the winner and the buyer has secured the lowest price in the market.
At least that is, what is usually thought will happen, but the assumption is flawed and therefore the assumption that supplier diversity will lead to higher costs is also flawed.
The fly in the soup
Auctions runs by exclusion. The consistent elimination of suppliers until there is only one starts from the costs associated with participating in the auctions. The qualifying conditions to participate in the auction can be so complex that smaller companies simply don't have the manpower and/or the financial muscle to bet on a high entrance fee with a small chance of winning. Consequently, they abstain from participating.
In many product categories there is a pattern of a few highly efficient suppliers and a much larger group of slightly less efficient suppliers. In a straight price competition, the slightly less efficient suppliers don't stand a chance to win as the large suppliers only need to be a dollar cheaper than the competition.
The effective market is reduced to very few, large suppliers who have no special incentive to innovate or reduce prices further. In some cases the market looks like a monopoly.
The inclusive approach
Inviting more suppliers to the table to participate in the procurement process can on the short-term lead to better financial results (*), because it keeps everyone focused on making the best offers, when winning the order is not a given.
It also adds flexibility and resilience to the supply of products allowing companies to better adapt to changing customer needs and new market segments. Better relationships with the supplier base also opens for more collaboration on innovative solutions.
Negotiations are an excellent way to capture the flexibility and the competitiveness of the inclusive approach. Needless to say, buyers are still looking to keep costs low and competitive negotiations help keep the cost factor in check while also having other value creating parameters in mind. Old habits and fear of the complexity have kept many away from using this approach, but technology is changing how negotiations in procurement and trading can be handled. You can read more about this in our blog post "Navigating negotiations", which you can find here and you can read more about our Rational Assistant technology here. We also recommend, that you read the article "Maximizing the benefits of B2B supplier diversification" mentioned below, where the value of diversity has been analysed in more detail.
Feel free to contact us to learn more about how we may help you move to inclusive trading and procurement.
(*) The article "Maximizing the Benefits of B2B Supplier Diversification" by Simha Mummalaneni and Jonathan Z. Zhang in MITSloan Management Review is an excellent read on this topic. Find it here.