KEY CONCEPT

Building long-term relationships with select suppliers is seen as the way to reduce the risks of socially irresponsible sourcing and, by extension, damage to a company’s brand or reputation. It is not, however, a ‘magic’ solution to the problem of ‘rogue’ elements in the supply chain. New research finds that the success of ‘relational sourcing’ is directly linked to the structure of the supplier network — and that the ‘optimal’ structure varies by company and product category.

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IDEA SUMMARY

Procurement risks now include the possibility of someone in the supply chain flouting international labour laws, causing unnecessary damage to the environment or acting in other socially irresponsible ways. These risks are ‘high-impact’. Nike, which faced a storm of protest following sweat-shop scandals in the 1990s, is just one company to have discovered this.

Management strategies tend to rely on ‘relational sourcing’ — the practice of building long-term and collaborative relationships with suppliers — as a means of prevention. Successfully used by Toyota in the 1970s to improve quality standards, relational sourcing allows for ‘richer’ buyer/seller interactions than more traditional ‘transactional’ models and has been found to be more effective than competition, monitoring and audits at keeping the supply chain ‘in check’.

Most shifts to relational sourcing are accompanied by a re-organization of the supply network and most, unsurprisingly, involve the use of long-term contracts and designated exclusive suppliers. There is, though, considerable variation between strategies. In response to criticism of working conditions in its South Asian production plants, clothing retailer H&M, for example, has recently decided to source from fewer suppliers, each of which has a wider scope of activities. International Foods and Flavors, a Fortune 500 company that is the world’s leading provider of flavours and fragrances, on the other hand, has moved to relational sourcing via the use of more specialised suppliers, each of which has a narrower scope of activities.
Is there, then, an ‘optimal’ strategy? How do companies decide what will work best for them?

A new research paper from Chicago Booth and INSEAD business schools helps answer these questions. The first to relate the structure of the supply network to the impact of relational sourcing on socially responsible behaviour, it provides advice on supply network design specific to product types.

Two kinds of ‘general’ supply-chain networks are studied by the authors: star networks, in which the central node is a buyer and the peripheral nodes are suppliers; linear networks, in which the terminal node is a retailer and ‘in-between’ nodes are intermediaries in a decentralised multi-tier chain. These two topologies are broken down into networks of ‘higher’ and ‘lower degree’ — i.e. according to the number of ‘players’ involved. (Put simply, a higher-degree star network would be one with a greater number of specialised suppliers; a higher-degree linear network one with a greater number of echelons or tiers.)

The effectiveness of relational sourcing is evaluated using two metrics: the net gain for the supply network when it uses relational sourcing; the network’s ‘exploitation’ potential, or the sum of the gains individual players could make by unilaterally reneging on the terms of the relational agreement.

The preferred network structure is defined in terms of factors such as sourcing stability (the likelihood that the sourcing will continue), product margins, the costs of compliance with socially conscious sourcing, the probability of detection of non-compliance, and the damage to the brand if non-compliance is observed.

The paper finds that:

• Higher-degree networks are to be preferred when sourcing is stable, margins and detection probabilities higher, brand damage costs significant and compliance costs modest.
• Lower-degree networks work better for products when the probabilities of detection and brand-damage costs are lower.

The authors conclude that “network structure is crucial to the success of relational sourcing”. 

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BUSINESS APPLICATION

Socially responsible sourcing is now seen not only as part of ‘standard’ best practice but also as an opportunity to gain a competitive advantage. Increasing numbers of retailers and manufacturers are making it part of their business model, marketing socially conscious sourcing to socially conscious consumers. Examples include both ‘pioneering’ established businesses such as Patagonia Apparel and Whole Food Grocery Stores and innovative start-ups such as Honest By and Zady Fashions.

For these companies, relational sourcing appears to be the ‘default’ position. California-based Patagonia, maker of outdoor clothing, states in its official supplier-management policy that it wants to “form long-term relationships and work with” contracted factories “in the spirit of continuous improvement”.

Relational sourcing strategies need to be developed carefully, however. On the evidence of this paper, they’re more likely to be successful when the redesign of the supply network reflects the products being marketed and made. Strategies featuring a high number of specialised suppliers are likely to work better in some circumstances than in others.

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REFERENCES

Supply Networks for Relational Sourcing. Elena Belavina & Karan Girotra. INSEAD Working Paper (January 2014) DOI: 10.2139/ssrn.2375663.

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