Supplier Tiers Explained

Supply chains have evolved into complex networks of interconnected suppliers who collectively provide the materials, services and essential components needed to create a finished product. Managing these relationships effectively is crucial for companies to ensure their success in supply chain management.

Supplier tiering categorises suppliers based on their importance and proximity to the final product. The concept originates from the automotive industry and was applied to identify how far various elements are in the supply chain. As the benefits became obvious over time, procurement and supply chain experts from other sectors realised the importance of supplier classification and introduced supplier tiering into their businesses.

What Is Supplier Tiering?

Supplier tiering is a categorisation system that groups suppliers or subcontractors into tiers based on two key factors:

1. Distance from the final product: This refers to how closely a supplier is involved in the physical creation of the final output.

2. Level of importance to the business: This signifies the impact a supplier has on the company’s success, considering factors like cost, quality and delivery timelines.

This classification helps companies gain supply chain visibility, understand their supplier base thoroughly as well as empower them to make informed decisions regarding resource allocation and risk management, ultimately shaping their operational strategies.

While the impact of suppliers on businesses generally decreases with distance (tier 2 and higher), they can still be crucial for maintaining supply chain visibility and upholding sustainability practices.

The different tiers of suppliers are typically categorised into the following tiers, further explained in Figure 1:

Tier 1 Suppliers

Tier 1 suppliers are your closest partners with whom you directly engage and conduct business with. They’re also known as manufacturing partners who provide essential services and components used directly in your finished product. They have a significant impact on your business, specifically on your product’s cost, quality and delivery timelines.

Tier 2 Suppliers

Tier 2 suppliers are often referred to as secondary suppliers. These companies supply materials or services to your tier 1 suppliers. They are one step further removed from the end product and have an indirect impact on its quality and delivery.

Tier 3 Suppliers

These suppliers are even further removed from the final product and typically provide raw materials or services to your tier 2 suppliers. While their impact on the end item is indirect and generally considered less significant compared to tier 1 and 2 suppliers, they are still the base of the entire supply chain, and thus, essential.

[ Figure 1: Supplier Tiers Breakdown Table]

Real-World Example

As a simple example of the supplier tiering method, imagine a car manufacturer, illustrated in the table above.

A car manufacturer’s tier 1 suppliers might include companies that provide engines, transmission parts, car bodies, fasteners and electronics.

Tier 2 suppliers could be companies that process sheet metal for tier 1 suppliers or supply specific parts for sub-assemblies.

Finally, tier 3 suppliers may be companies that supply raw materials necessary to manufacture the goods and services, like iron ore to the steel company or aluminium to the engine parts manufacturer.

When Does Supplier Tiering Go Beyond the Basics? Exploring Advanced Considerations

While the basic three-tier system provides a valuable foundation, complex supply networks might necessitate a more nuanced approach.

Here are some additional considerations:

• Multiple tiers: Depending on the industry and supply chain complexity, there might be more than three tiers. For example, a car manufacturer might have a tier 4 supplier providing raw materials to raw material processing companies, which would be tier 3 suppliers in that case.

• Dynamic nature: Supply channels are constantly evolving, so supplier tiers should be regularly reviewed and updated to reflect changes in supplier relationships, product complexity and market dynamics.

• Beyond direct materials: Supplier tiers can extend beyond physical materials to encompass service providers crucial for the end product. For instance, a software company might have a tier 1 supplier providing software development services, a tier 2 supplier offering cloud infrastructure, and a tier 3 supplier supplying data security solutions.

• Risk assessment: Each tier should be evaluated for potential risks, considering factors like geographical location, political stability, and financial health. This comprehensive risk assessment allows for proactive mitigation strategies and contingency plans.

Why Is It Important to Know Your Suppliers?

According to McKinsey & Co., most organisations only visit tier 1 suppliers and rarely their third-tier partners. But supply chains face many challenges, such as scarcity, inflation, conflict, etc. You need to evaluate what is happening early on and be ready to adapt quickly.

Understanding your supply tiers and implementing a supplier tiering system offers several significant advantages for businesses:

• Reduced risk: According to Deloitte’s 2021 CPO survey, only a quarter of leaders could foresee the risks in their supplier base. By identifying critical tier 1 suppliers, companies can proactively address potential risks, such as delays, shortages, quality issues or production disruptions. This allows for mitigation strategies to be developed and implemented, safeguarding the company’s operations.

• Efficient resource allocation: By focusing resources on building strong relationships and developing strategic partnerships with the most crucial partners (tier 1 suppliers), companies can optimise their resource allocation. This allows for greater collaboration and improved communication, ultimately leading to smoother operations and enhanced efficiency.

• Better negotiation: Having a clear understanding of the entire supply chain, including multiple tiers, empowers companies to negotiate more effectively with all suppliers. This can lead to more favourable pricing, improved terms, and overall stronger supplier relationships.

• Increased efficiency: By focusing on the most impactful relationships (tier 1), companies can streamline their supplier management processes, reducing administrative burdens and associated costs as well as improving overall operational efficiency.

• Cost savings:  Utilising supplier tiering can contribute to cost savings through various means. Improved quality control throughout the supply chain, effective negotiation with varying tiers, and efficient resource allocation can all contribute to reducing overall costs. In addition, effective collaboration and information sharing can bring down supply chain costs by adhering to Design for Supply Chain principles.

• Sustainable practices: By understanding the entire supply chain (including tier 2 and beyond), companies can better assess the sustainability practices and social responsibility of their suppliers. This alignment with their own sustainability goals can enhance brand reputation and consumer trust.

• Ethical sourcing: By implementing supplier tiering, companies can ensure they are sourcing materials and machine components ethically and responsibly. This can involve avoiding suppliers with poor labour practices or environmental negligence, contributing to a more ethical and sustainable supply chain.

How to Improve Supplier Visibility?

Gaining deeper insight into your supplier network is essential for effective supplier tiering. Moreover, effectively implementing supplier tiering requires a strategic approach. Below are some key steps to take to achieve this:

• Mapping the supply chain: Create a visual representation of your supplier network, identifying all tiers, the flow of material and information, and the different types of suppliers or subcontractors involved. Map out the pain points in your supply chain and how they impact your performance as well as customer satisfaction.

• Supplier classification: Categorise your suppliers into relevant tiers based on their proximity to the finished good and their impact on your business.

• Data collection and analysis: Gather information about each supplier, including performance metrics, compliance records, and sustainability initiatives. Utilise a Supplier Information Management System (SIMS) to efficiently organise and analyse this data.

• Conduct supplier audits: Regularly assess the performance, capabilities, sustainability practices, and legal ramifications of your suppliers throughout the tiers.

• Developing supplier relationships: Foster strong relationships across all your supplier tiers by establishing open communication channels to share information, address concerns, and work towards continuous improvement. In particular, this should be done with your tier 1 suppliers through transparent communication, collaborative problem-solving, and mutually beneficial partnerships.

• Continuous improvement: Regularly review and update your supplier tiering system, incorporating feedback from all stakeholders and adapting to evolving market conditions. Invest in technology solutions that integrate data from multiple sources, provide real-time analytics and insights, enable seamless communication and collaboration, and automate workflows and processes.

The Benefits of Having Familiarity With Your Different Tier Suppliers

You need to know your supplier tiers well to succeed in the business world. It’s not just business, it’s a partnership. You need to understand their strengths, processes and challenges to work and win together. Knowing your tier supplier well brings many benefits, such as:

Lower costs and higher efficiency: You can save money and work better by knowing their costs, processes and networks. You can improve, get better deals, and make operations smoother. You can lower costs and make better use of resources, inventory and the supply chain.

Better collaboration and communication: You can work together better by building solid ties with tier suppliers. You can communicate better, share ideas, and have common goals. You can learn, solve and create together, improving processes and adding value to the supply chain.

More reliability and responsiveness: You can plan and decide better by knowing their abilities and limits. You and your suppliers can trust and depend on each other, leading to faster and more flexible responses to changing needs and markets.

Stronger quality control and compliance: You can keep quality and compliance standards high in the supply chain by knowing your tier suppliers well. You can check supplier performance, do audits and follow quality rules. You can ensure consistency, reliability, and compliance with regulations and customer needs, protecting your brand and customer loyalty.

Smarter risk management: You can spot and avoid risks in the supply chain by knowing your tier suppliers well. You can see each supplier’s links, locations and resilience. You can make backup plans and find other sources to prevent problems and keep your business going.

Conclusion

In today’s interconnected world, supplier tiering has proven to be a critical tool for businesses that allows them to navigate the complexities of modern supply chains.

Understanding the different tiers, their impact on the end products, and the benefits associated with implementing this system allows companies to enhance their supply chain visibility, mitigate risks, optimise resource allocation, and ultimately achieve greater efficiency and success.

To get even more value out of supplier tiering strategies, it can be combined with other supplier segmentation models such as the Kraljic matrix. Kraljic matrix provides a strategic framework for categorising procurement items based on their impact on profitability and supply risk, thereby informing more precise and effective supplier segmentation

This continuous improvement of processes, including monitoring, refining their supplier tiering strategy, and strengthening supplier partnerships, ensures a robust and sustainable supply chain that supports their long-term business growth objectives.