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Purchasing: Risks in ‘Virtual’ Second Sources

I am a believer in using second sourcing as a primary security-of-supply strategy. I know some believe that close relationships with a single manufacturer can yield better overall value and better supply security, but I am not of that school.

My position is that two sources provide leverage by creating competition, which is good for pricing and provides a ready alternate supply option if there is any kind of short- or long-term interruption.

The favored situation is for second sources to have factories in different regions to protect against natural disasters, political instability, labor unrest, fire, bankruptcy, and a host of other potential risks. In our work at Lytica, we consider single-manufacturer alternate sources risky even when they offer components with dissimilar family part numbers.

I see a lot of lazy second sourcing. In these situations, engineers have specified a second source for the same component but with a tighter tolerance or higher speed grade. This is better than nothing for sole-sourced components but a very weak, almost useless, solution to adequately address security of supply.

In doing work this week on supply chain risk, one customer astutely observed that there may be risk in what he called “virtual” second sources. By this he meant sources that were technically qualified as drop-in replacements but whose pricing was so out of line as to make their use unacceptable. What great insight! In analysing its data, his company did in fact have virtual second sources, many more than I expected.

I believe this is likely a risk that many readers understand but don't have a clear handle on within their procurement organizations. Worse, given the level of outsourcing that has occurred in recent years, and the lean staff in many purchasing groups, many companies don't have the information they need to address the problem.

With virtual second sources, the risk really depends on how much of a price premium is seen as acceptable or can be absorbed. Does 20 percent work? How about 50 percent? What if the price was tripled? This may seem like too much of a premium gap, but I have observed all of these and more.

I would be interested in hearing from readers about their results, if they conducted their own analyses. Did you find virtual second sources? I am also interested in how you set a premium threshold and what you found as worst-case examples of price premiums.

1 comment on “Purchasing: Risks in ‘Virtual’ Second Sources

  1. elctrnx_lyf
    June 13, 2012

    It's very difficult to find multiple sourcing options with the exactly same price. So it could be still advisable to have second option at a little higher price also. But what is the limit to this is definitely decided based on critical nature of component sourcing.

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