Best Practice: Supplier Stratification



By Dr. Barry Lawrence, Texas A&M University



Senthil Gunasekaran, Texas A&M University









Pradip Krishnadevarajan, Texas A&M University



and Dr. Malini Natarajarathinam, Texas A&M University











Distributors choose a customer type, the “core customer” as described in earlier blogs, and then arrayed resources to meet that customer’s needs. In the process, the distributor “invents” itself and determines what investments will be necessary to be successful (inventory, warehouse, equipment, human resources, etc.). One of the earliest and most important decisions is supplier selection.

Suppliers are selected based on their ability to serve the core customer. In the beginning, this is a very positive relationship with the distributor seeking to delight the customer, and the supplier seeking to find new ways to penetrate this new market. Over time, however, the relationship matures and sometimes goes awry. Suppliers may want distributors to broaden their offerings or buy in volumes inconsistent with what the core customer needs, often leading to excess and obsolete inventories. In other cases, supplier performance may decline or not keep up with the market, leading to customer service failures or a need for more inventory investment.

Many best practices have been developed in Supplier Relationship Management, but they are often misdirected in practice. One distributor maintained what the staff called a supplier report card (a well-known best practice). When asked how they used the report card, they said they took it into their pricing negotiation meetings each year with the supplier. This is not a report card; it’s a baseball bat.

The issue surrounds the basic definition of the distributor’s role in the supply chain. Some believe the distributor is the supplier’s customer, while others say the distributor is the supplier’s partner. The distinction is important. A customer is one to be served; a partner collaborates for the betterment of all. A customer seeks to optimize his or her own costs and operations without regard to the supplier’s needs. A partner, on the other hand, acts as the channel to market for his or her key suppliers and facilitates the success of both.

Returning to our original premise, the distributor selects suppliers based upon their ability to support the needs of core customers. The most significant (strategic) suppliers should carry products and skills that set them and the distributor apart. These suppliers must be partners. The ones that fill the small holes in the product offering and are only differentiated by price and by not product features or quality are vendors. To them, the distributor is a customer.


The new NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and return-on-investment (ROI). These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we continue to introduce a best practice and how it can improve earnings and/or ROI under current economic conditions. Using this blog, we encourage you, our readers, to ask questions, debate results, and offer your own experiences with these best practices, so that together we may further the knowledge of our community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING, and SUPPORT SERVICES) based on various distributor asset categories. This month, we focus on the SOURCE group (see exhibit 1). The SOURCE group has five processes, and we’ll discuss “supplier stratification.”






Best Practice: Supplier Stratification

The process of stratifying suppliers based on profitability, distributor services, performance, and loyalty is called supplier stratification. Other factors such as risk, relationship, and growth potential can be used as well. The analysis is spread across all suppliers or it can be limited to the suppliers that account for 80% of annual spend. The objective of supplier stratification is to understand the criticality of the supply base and to allocate key resources accordingly. The stratification helps develop relationships and improve profitability in the long term. Supplier stratification helps the sourcing team see the impact of buying activity on the firm’s profitability.
Supplier stratification techniques are gaining popularity, but they are often not applied correctly. The practice levels for supplier stratification are as follows:

COMMON practice: (1) No formal supplier stratification, (2) Based on purchase price variance and landed cost

GOOD practice: Based on a single factor (1) Volume of Spend $ (Cost of Goods Sold), (2) Pareto Framework (80-20 rule)

BEST practice: Based on multiple factors (1) Profitability, distributor services, supplier performance, loyalty (exclusivity vs. general), risk/exposure, (2) Combination method. A combination method developed by Texas A&M is shown in exhibit 2.



The stratification framework summarizes key supplier relationship factors in a supplier stratification model based on four factors:

• profitability
• performance
• loyalty
• distributor services.

Based on these factors, suppliers can be grouped within four categories:

1. Strategic partners: These suppliers represent strong brand, exclusivity, solid delivery capability, and, together with the distributor, high market control. Profitability is high with this group because sales and margins are high and the cost of doing business is low. Strategic suppliers help distributors sell with their strong brand recognition, at good margins through the exclusive channel, at lower cost-to-serve due to better deliveries, and with greater control of the market by leveraging the alliance.
2. Vendor controlled: These suppliers represent high service intensiveness and low market control, in addition to strong brand and exclusivity. The cost of doing business with this group is high for required services (repair, consulting, programming, and so on), but the suppliers are efficient and don’t drive up logistics and inventory expenses. These suppliers offer exclusivity, but demand high loyalty and good performance to protect their brands. Distributors should seek to develop a more balanced relationship that allows them to determine what services the customer needs and not be dictated to by the supplier.
3. Distributor controlled: These suppliers represent those situations in which the supplier’s brand is weak, but the distributor’s presence in the market is unchallenged. The distributor is able to dictate service levels and manage prices. Although this is an attractive area, it usually is not sustainable for long because the competition will soon arrive. The distributor should help the supplier improve its performance and increase its loyalty or find another supplier that will.
4. Out of control: These suppliers are opportunistic, but they are unwilling to shoulder any of the burdens in establishing and maintaining a market. Distributors should quickly discontinue these relationships.

Distributors want to do business with strategic suppliers. They want loyal/high-performing, vendor-controlled suppliers that can become more effective and loyal in a distributor-controlled environment, and then use the rest of their resources to penetrate new markets. Distributors might have to do business in the rest of the vendor-controlled area due to customer requirements to carry a brand. They also may have to do business in the distributor-controlled area to capture profitability, as well as in the higher end of the “out of control” area just to hit necessary sales numbers. From the start, however, distributors definitely should get out of the worst “out of control” business so that they can keep from losing resources for very poor ROI.

Even though supplier stratification processes influence many business factors, such as brand, exclusivity, and market control, most firms concentrate on two process metrics that affect financial measures:

• Growth potential. This determines the supplier’s ability to scale up shipments when the distributor grows its market share and geographic footprint, affecting revenue growth.
• Lead time and variability. These contribute to inventory levels, depending on a customer’s service-level requirements. Lead times and their variability are countered by the financial element inventory, reflected directly in the financial statements.

Revenue can measure both revenue growth and total asset turnover (asset efficiency). Inventory can be related to GMROII (profitability), working capital (cash flow), and inventory turnover (asset efficiency). These four financial drivers—asset efficiency, cash flow, profitability, and growth—contribute to shareholder value.

Best Practice in Action: Do Suppliers Respond to Performance Measurement?

In order to perform the supplier stratification as per the Texas A&M combination method, you would need to use four different factors as shown in exhibit 2. One distributor that decided to implement the stratification framework for suppliers began with “supplier performance” (one of the four factors in exhibit 2) to perform an evaluation of its top supplier. The top supplier accounted for about 15% of the distributor’s inventory. During initial negotiations with the supplier, contracts were drawn up based on agreed-to lead time variability. If the lead time is 30 days and the supplier often delivers the product between 25 and 35 days, then the variability is 5 days (the deviation from the lead time of 30 days). However, over the years as the supplier expanded its customer base, the lead time variability became 15 days instead of the initial 5 days (as per the contract). When the distributor discussed this with the supplier, the supplier said the variability would get better over time as the supplier increased capacity. However, this did not happen.

The distributor then wanted to understand the impact of increased lead time variability on its inventory levels and customer service. Due to this variability from the supplier going over the agreed-to 5 days, the distributor had to increase inventory levels by more than 20% so that it could still meet the same customer service levels. This increased its inventory investment, reduced warehouse space for new products, increased interest expenses, and so forth. The distributor was taking a heavy toll on its bottom line. Its financial statements became a key concern for top management and shareholders.

The distributor then began to develop a tracking report for supplier performance. The distributor presented the tracking report to the supplier on a quarterly basis. Keep in mind that this was just a report card, and not a baseball bat. The distributor also made the supplier aware of the additional amount of inventory the distributor needed to carry so that it could still meet customer service levels. The supplier then understood the impact of increased lead time variability on the distributor’s bottom line. In the real world, there are various uncertainties that suppliers just have to plan for. Unfortunately, the supplier could not reduce its lead time variability. However, the supplier compensated the distributor by providing price discounts and increasing the payment terms from 45 days to 65 days. As a result, the distributor was compensated for the increase in supplier’s lead time variability. This did not happen overnight, but the point is that the distributor got the message across to the supplier in a way that was beneficial to both parties.

The process of connecting lead time variability to shareholder value is accomplished using exhibit 3.

Most distributors do not believe that suppliers would respond to a measurement system. We’ve observed, however, that in many cases, a scorecard has turned out to be highly effective. In fact, a majority of manufacturers that we’ve encountered are impressed with their distributors’ attention to performance tracking and, as a result, they are willing to work with their distributors for improvement. Quite a few manufacturers also referred to the performance reporting mechanism as one of the value-added services that distributors could offer in general to all suppliers. The critical questions are

• Could distributors offer this performance tracking as a service to suppliers?
• Would suppliers value this offering?
• Could distributors get compensated for this service?

Moreover, if suppliers respond to your measurement system in a positive fashion, the end result is more than compensation; it is a partnership and sustainability.

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in Comments and email this blog to other interested parties.