Supplier Optimization Key to Manufacturer Success

Supplier optimization

As manufacturers rely more heavily on the use of suppliers today, how can they foster enough competition to keep their expenses low without alienating the companies they depend on?

That’s a question that intrigues OPIM professor Cuihong Li. She has developed a theoretical model to guide that strategy. Her solo research, titled “Supplier Competition and Cost Reduction with Endogenous Information Asymmetry,” is pending publication in Manufacturing & Service Operations Management.

“It’s a very complicated relationship between manufacturers and their suppliers,” Li said. “Manufacturers want suppliers to work hard for them, yet they don’t want to rely too much on just one supplier.”

Fewer manufacturers rely on only a single supplier today, Li said. Some firms operate with a handful of suppliers, while others may have dozens or more.

A larger supply base brings the benefit of supplier competition, allowing a manufacturer to select the best supplier while keeping the “upper hand” on price negotiations. But a large number of suppliers doesn’t always lead to better results, Li said. The manufacturer may harm the relationships that they need to ensure supplier investment in improvement.

Cuihong Li (Nathan Oldham/UConn School of Business)
Cuihong Li (Nathan Oldham/UConn School of Business)

“The outcome of this arrangement hasn’t always been clear, nor have there been specific guidelines about how large or small the supply base should be,” Li said. “The advantage of a large supply base had been touted in General Motors’ successfully saving billions of dollars in parts by purchasing through a system of worldwide competitive bidding of supplies in the 1990s, yet the strategy backfired with deteriorating supplier quality and relationships.”

Recently, manufacturers have trended toward shrinking the number of suppliers in order to deepen their relationships with them and to motivate suppliers to invest more resources (such as new technology and tools) to enhance quality and reduce costs.

“If you want to have negotiation power, it may not be a good idea to contract with a single supplier,” Li said. “In general, having two suppliers is a good idea. But we did discover a difference based on the margin of the products being produced.”

“For high-margin products, like electronics and automobiles, maybe two or three suppliers are enough,” she said. Apple, for example, had initially employed Samsung as the sole supplier of an iPhone screen but then opted to partner with a second supplier, LG Display, to gain bargaining power.

“For low-margin manufacturers, such as the maker of apparel and toys, a large supply base is preferable,” Li said. “We see this with companies like Nike and Mattel, that have hundreds of suppliers across the world, which gives them flexibility and negotiation power.”

Nike, for instance, has a worldwide manufacturing network consisting of more than 100 contract managers for footwear, and more than 400 for apparel, allowing the company to relocate production based on contractors’ performance.

Li’s research breaks new ground on a little studied topic in supply chain management.

“There is a general understanding of the pros and cons of a commitment to single suppliers versus maintaining a larger supply base. This is the first paper that delivers the more nuanced message about how such considerations drive supply base design with a rigorous model of different parties’ decisions,” Li said. “What’s especially key about this paper is that it provides an explanation, as well as a guidance, about how to design a supply sourcing strategy predicated on a manufacturer’s market and product margin.”