Friday, December 16, 2011

Allocation of Supply.

There are a number of reasons why a supplier may have constrained supply and need to place the availability of that product on allocation. If you negotiate procurement contracts I think its important to understand the dynamics that occur when a supplier goes into allocation There are two natural tendencies that most suppliers will follow when a product is on allocation. First, since there is limited availability they want to allocate supply to where they make the most profit. A moderating factor to that is not wanting to alienate key customers.

To understand where you might stand in this process you need to first consider where you would be from a supplier profitability perspective. Profitability is determine by several major factors. Supplier will normally sell through a number of different sales channels. The profitability by sales channel going from the least profitable to the most profitable in general would be 1) Original Equipment Manufacturers (OEM), 2) Value Added Resellers (VAR), 3) Distribution, and 4) Other direct sales such as internet sales.

Profitability is further managed by what’s called tiering within an individual channel. Within the OEM Channel a Supplier could have three tiers with each tier getting different terms and discounts or pricing based upon their value to the supplier and their volume. A Tier 1 in the OEM channel would get the highest discounts and would represent high volume, valued OEM. Tier 3 in the OEM Channel may get a price that is only slightly better than what they would pay if they bought the product from Distribution. Tier 3 OEM’s would be low volume, non-strategic customer. This means that the combination of the channel and the tier establish the profitability. For example a Tier 2 OEM Customer represent the same level of profitability as a Tier 1 VAR customer.

If the Supplier allocated product on profit alone, the vast majority of product would be sold to other direct sales or distribution where the supplier makes the most profit. The problem with that is they would be alienating their biggest customers, the Tier 1 OEM’s and Tier 1 VAR’s. Many companies also rely heavily on distribution for their sales, so they may not also want to alienate them. This means that left to their own choices, the groups that would get the least allocation would be the lowest tier OEM’s and VAR’s and the Other Sales customers.

To protect against having a situations where supply could completely dry up because of allocation, a company may seek to negotiate an allocation of supply provision. The concept of an allocation of supply provision is simple. As an on-going customer you want the supplier to commit to you that you will get your fair share of the available supply. Most of these clauses seek a pro-rata share of the available supply based upon your past purchase history in comparison to the total market for the product. If you purchased two percent of the products before it went into allocation, you want to be provided two percent of the available amount.

If a supplier values your business they should have no problem with committing to giving you a commitment to provide you with your reasonable share of the allocated amount. If they won’t, I would expect that if an allocation were to occur that supplier would focus on what’s best for them. I would never single source that kind of a supplier as I would know that I couldn’t depend upon them for supply.

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