Rising commodity prices are impacting the global economic recovery, fueling inflation, and damaging vulnerable businesses and households. At the same time, supply chain disruptions stemming from events like the global pandemic, Suez Canal blockage, and extreme weather are becoming more common.
Price volatility and supplier uncertainty are major sources of risk in commodity trading. Supplier diversification is one of the most effective methods to secure your supply chain and hedge against these risks. Supplier diversification is the process of selecting backup suppliers of different sizes, in different locations, and with different capabilities, so you do not completely rely on one source for business-critical materials.
With supplier diversification, you will not lose access to all your raw materials if a supply chain disruption occurs. You can increase orders from other partners and swiftly engage with secondary suppliers if your primary supplier increases prices too much or experiences a supply chain disruption. You have options.
While the concept of supplier diversification is easy to understand, implementing it can be challenging. Following these five steps can help.
1. Evaluate your current sourcing
Before you create a supplier diversification plan, you need to understand what commodities and manufacturing inputs are essential to produce your product. Evaluate how flexible your requirements are and assess which commodities you cannot afford to do without, which are most price sensitive, and which ones are most vulnerable.
For example, if you need a specific coffee that only grows in a handful of locations in the world, you have very few options for locations and must choose your suppliers carefully. You need to understand the risks involved in choosing your primary supplier or suppliers. You need to know how long they have been in business, how financially stable they are, if they can handle your quality requirements, and if they have the capacity to meet your demand. You also need to look at the region to assess if the area is stable enough to minimize supply chain risks and understand local regulations, tariffs, and potential supply chain bottlenecks.
2. Develop your diversification strategy
After you evaluate your current supply chain, ask yourself a few questions.
- What are the most unique inputs to the product (and therefore the hardest to source)?
- Which commodities are most critical for your business?
- What items have the longest lead times?
- What supply chain disruptions are most likely to occur?
Use these answers to develop a supplier diversification strategy. Analyze the probability of a given disruption occurring along with the impact it will have on your business. If you source sugar from a plantation three miles away, supply chain disruptions are unlikely. If your cocoa travels thousands of miles across an ocean, and is grown in a politically volatile location, supply chain disruptions are more likely.
Your strategy may be as simple as “use two different primary suppliers for this commodity with three backups” or as complex as “have three primary, four secondary and three tertiary suppliers for all commodities and make sure they are on different continents.” You must balance the costs with the risks.
3. Identify suppliers
Once you outline your strategy, you need to find suppliers that fit your requirements. For example, if the goal is to mitigate location risk by finding suppliers in different regions, you need to locate suppliers of each critical commodity located in different areas of the world. For example, cocoa can be sourced from Africa, Asia, and South America, and sugar can be sourced from North America, South America, Europe, and Asia.
4. Select suppliers
After finding potential suppliers that satisfy the goals of your strategy, you need to narrow the list down to the ideal candidates and select your new suppliers. These suppliers should meet all the requirements of your diversification strategy as well as your overall business strategy. Use qualification criteria to select which supply partners you want to engage, including detailed assessments of supplier operations and even onsite audits to review processes and facilities. You may want to engage consultants to get third-party validation of potential partners.
5. Adjust operations
Once suppliers have been selected, the final step is to adjust your operations to integrate the new suppliers. You may be sourcing from multiple suppliers in different regions, so you need to ensure you have systems in place to manage shipments, payments, and contracts for different suppliers in countries with different regulations, currencies, and tax structures. In most cases, your original supplier will remain your primary supplier even after diversification since you chose them as your supplier for a reason.
When doing business with multiple suppliers, you need to standardize your paperwork (RFQs, purchase orders, etc.). Keeping accurate and consistent audit trails for all transactions is essential for companies working with multiple suppliers.
Once you have updated operations to incorporate your new diversification strategy, your supply chain will be more stable and secure, reducing risk for your operations. When disruptions occur, you will have a plan in place to quickly shift to alternate suppliers, ensuring your business remains operational despite the disruption.
If you are worried about commodity risk, contact iRely today or download our commodity risk management overview to learn how we can help.