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In Search of the Ideal Supply Chain

By weighing the advantages of pricing discounts against the costs of a supplier failure, companies can determine how many suppliers they need.

(originally published by Booz & Company)

The Optimal Number of Suppliers in the Presence of Volume Discounts and Different Compensation Potentials — an Analytical and Numerical Analysis

Sebastian Moritz and Richard Pibernik

European Business School, Research Paper No. 09-03

Date Published: 
December 2008

Relying on a single supplier can be risky. Honda Motor Company learned that lesson the hard way in 1994 when its only supplier for critical plastic parts used in every vehicle lost its plant in a fire. With no other vendor to turn to, Honda had to shut down production for three days. But having too many suppliers can also result in distressing operational headaches. A larger pool of parts vendors often results in greater overhead costs, weaker relationships with each individual supplier, and fewer economies of scale. Purchasing managers have to determine how many suppliers to work with, and must balance the costs of managing multiple suppliers with the risks associated with partnering with only one. In this research, the authors developed a model to help companies better understand the trade-offs, and to help them determine how much supply they should allocate to each vendor. The resulting formula could be helpful for operations managers who struggle with finding the optimal number of suppliers.

Bottom Line:
By weighing the advantages of volume-pricing discounts against the costs of a potential supplier failure, companies can optimize their supply chains.

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