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Single Source Premium: Unnecessary Cost

The results are in from the EBN poll on the Price-Supplier Equation. Fifty-five percent of respondents believe that the premium paid for being single sourced is greater than 10 percent, and more than half of these believe it is greater than 15 percent. This is a significant hike on cost and an unnecessary supply chain risk from single sourcing.

This level of premium is directionally consistent with what I see in Freebenchmarking.com data. There is, in most cases, a premium. For my analysis, I calculated the fair market price (target price) for each component by client. I then calculated the percentage difference between what clients are actually paying and their target price and separated the data into two groups; the group of single-sourced components and the group of multi-sourced ones.

Finally, I compared the results by client. I took steps to remove known sole-sourced devices and used only OEM companies as I felt EMS data would distort the analysis. My results show a wide variation from company to company and from commodity to commodity but overall a 5 percent premium is the average paid for being single-sourced.

My findings are summarized in the table below:

The Single Source Premium

In my analysis, 28 percent of my company-commodity values were negative, indicating single-sourcing was better than multi-sourcing and 70 percent of the company-commodity groups showed a premium. The average premium on positive groups was 10 percent. The median premium value for all groups was 5 percent, like the overall average. As this is a blog and not a scientific study and because the calculations involved a lot of manual data manipulation, I limited my study sample to 10 randomly chosen companies and 118 company-commodity groups.

One can speculate as to the root cause of this premium but my experience biases my thinking towards the missing competitive environment when single-sourced. I have seen many instances where noteworthy cost reductions come from the existing supplier when viable alternatives are tabled. Isn't capitalism great!

What's also interesting is that many companies operate with unnecessary single sourced component sourcing. One would think that an average 5 percent cost premium would justify the business case for alternate sources. Again using Freebenchmarkiing.com data, it appears that an average company has 30 to 50 percent of its components sole or single sourced and typically our reports identify drops in alternatives for over 25 percent of them. My definition of single sourcing excludes weak alternate sources like 5 percent versions of components from the same manufacturer as a second source for the 10 percent device.

It's difficult to understand why so many companies accept this higher cost and unnecessary risk.

7 comments on “Single Source Premium: Unnecessary Cost

  1. SunitaT
    August 14, 2012

    28 percent of my company-commodity values were negative, indicating single-sourcing was better than multi-sourcing

    @Ken, thanks for the informative post. I am bit confused with this analysis. Isn't it true that competition brings down the cost and thus multi-source should have more benefits compared to single-sourcing ?

  2. Eldredge
    August 14, 2012

    I agree that the premium associated with single-sourcing is at least partly from lack of competition. I also suspect that, at least is some instances, there is also a level of quality control or screening processes that are used to assure a level of perfromance above standard industry requirements that contributes to cost premiums.

  3. bolaji ojo
    August 14, 2012

    Ken, If the single-source premium is so high, and so obvious, I wonder why buyers are willing to pay the extra fees for this. Could this be because they feel beholden to the sellers or because they are willing to pay the extra premium to guarantee what they want? It couldn't be that they are not aware of the premium, could it?

  4. FLYINGSCOT
    August 14, 2012

    If a company can differentiate itself by using an innovative single source part then it is normally a price worth paying.  In fact I am surprised that the single source premiums were as low as your study found, especially for ICs.  I enjoyed your article and thanks for the info.

  5. Ken Bradley
    August 14, 2012

    Bolaji, I don't think buyers feel beholden nor are they willing to pay excessive premiums.

    I have seen how many companies have responded to financial pressures with downturns in the economy. Important groups are downsized in bad times without replacement when things improve. I believe too many key organizations are understaffed and their resources are significantly strained. Two groups in particular are procurement and component engineering although many organizations are thin overall relative to their responsibility.

    Stretched internal resources deliver on the highest priority items which are usually the ones impacting revenue and then those impacting visible cost. The Japan earthquake and Thailand floods demanded high priority responses. The problem with single source premiums is that they are not visible. It is not that buyers are willing to pay more; it's that they haven't had the visibility to determine what they should establish as high priority. Procurement professionals need hard data to convince management and design organizations that second sourcing is an important enough priority to move ahead of other key programs.

    As you know, Freebenchmarking.com reports provide visibility to costs and alternate sourcing opportunity. I data mine this reference database hoping to shed light on risks and opportunities for your readers. I know that companies cannot afford to add resources; hopefully better tools like Freebenchmarking.com and its information can fill the void.

     

  6. dalexander
    August 15, 2012

    Ken, I completely agree that the premium is because of a non-competitive environment advantage for the supplier. Also, when parts go on allocation, prices go mysteriously higher because the model approcahes that of sole sourcing. If I can only buy from one place, I either have to redesign or pay the piper. I know it. They know it. Everyone knows it. If the sole source part goes very high, then the competition of the same component type gets interested and does their own version. I saw that with Oscon caps when Sanyo made their big technology splash. Soon NIC and Panasonic had their own versions with the low ESR being the characteristic in demand for power supply applications. Nice work on the chart. It removes any doubt mmediately.

  7. Barbara Jorgensen
    August 20, 2012

    I have the answer as to why companies charge a premium for single-source product:

    Because they can.

    By definition, single-sourcing means the customer is at the mercy of the supplier. Instead of valuing the customer's business, suppliers take advantage. I am sure that is not always the case–some suppliers truly value their customers. But customers should arm themselves with information such as Ken/freeebenchmarking provides and have a long discussion with their supplier if they are paying a premium–at least find out why. If the price can be justified, and the relationship works, no harm done. But if not…

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