Supplier diversification is a tactic used to mitigate risk in a supply chain. It’s the primary, and perhaps the most effective, way to mature your supply chain and hedge it against risk. The process involves selecting backup suppliers of various size, in different locations, with different capabilities, along with other considerations, to lay the grounds for a recovery strategy in the event of a supply chain disruption. A good comparison for this tactic would be the process of investment diversification in a financial portfolio.
Why is supplier diversification important? Sticking with the analogy above, financial diversification mitigates risk in instances such as an industry having a low quarter, a company falling into financial trouble, or a CEO getting let go, sending stocks into turmoil. Investing in multiple companies spanning different industries and sectors reduces the damage done to an investment portfolio by one of these events. Supplier diversification can be thought of in a similar light.
Though unfortunate, it’s not uncommon for disruptions to occur which negatively impact supply chain operations. This could happen in the form of a natural disaster, a fire on a manufacturing line, shortages on material higher up in the supply chain, or a number of other issues. Supplier diversification is the base for a recovery strategy in these events. Effective supplier diversification means that if one or more of the above events occur, easy transition to a backup supplier can take place and the negative impacts of the disruption are minimal.
While the concept of supplier diversification may be simple to understand, executing it isn’t always as straightforward. Below, we break the process down into five easy steps.
How to Execute Supplier Diversification in 5 Easy Steps
1. Assess the Situation
The assessment step consists of attempting to acquire information to truly understand two things: the product(s) and the market(s). It’s important to understand how the product is made and the specifications it needs to meet. Can the product be made from various materials, or are there exact requirements that require using a unique tool? The product will probably fall somewhere in between these two extremes.
Likewise, evaluating the market is just as crucial of a task. The market evaluation will reveal information such as quality concerns, capacity constraints, supply chain bottlenecks, price fluctuations, and tariffs. This information will feed directly into the overall diversification strategy.
2. Develop Goals & Strategy
After the assessment has been conducted, the goals and strategy of this diversification plan should start to reveal themselves. While most strategies are structured similarly, diversification strategies are often most successful when they’re uniquely tailored to each product (or product line). To develop a strategy, ask questions like the following:
- What are the most likely supply chain disruptions to occur?
- Who are the critical suppliers to this product?
- What are the longest lead time items?
- What are the most unique parts to the product?
Use the answers to these questions to develop a strategy and build goals. Strategies may be as simple as “make sure there are at least three different primary suppliers for this product, and one backup supplier” or can involve complex goals such as bringing some production capabilities on-site, implementing backup or even tertiary suppliers for all products, using suppliers on multiple continents, and developing multiple sets of tools.
Tip: To determine the ideal level of complexity for your diversification strategy, perform an analysis to learn the probability of a given disruption occurring along with the impact it’ll have. This can be weighed with the costs of developing the strategy.
3. Identify Suppliers
Once your goals are solidified and the your strategy is outlined, the first step is to identify suppliers that satisfy the strategic requirements. For example, if the goal is to mitigate location risk by finding a supplier in a different region of the United States, then suppliers with similar capabilities in other regions of the United States should be identified and listed.
Tip: Many suppliers in the existing supply chain may have capabilities to take on additional parts. These suppliers could be primary suppliers for some parts, but backup suppliers for others.
4. Select Suppliers
After listing the potential suppliers that could satisfy the goals of the strategy, the next step is to narrow it down to the ideal candidates, then select the suppliers to include in the diversification strategy. These suppliers should meet all the requirements of the strategy and should be the best fit for this product out of all the above identified suppliers.
5. Adjust Operations
Once suppliers have been selected, the final step is to act by adjusting the necessary operations. This may involve moving certain production operations to a separate supplier, building additional tools, or establishing backup supplier contracts. After operations have been adjusted to incorporate the new diversification strategy, your supply disruption risk will be reduced and your supply chain will be more secure.