What are Tier 1, 2, and 3 Suppliers?
What is a Supply Chain "Tier"?
Supplier tiers in a supply chain refer to the hierarchy or order of suppliers based on their strategic importance and proximity to an organization. The tier system is typically used by organizations to manage supplier relationships, conduct supply chain traceability and due diligence work, and assess supplier performance
When a company sources goods and materials from suppliers, those suppliers can be divided into tiers:
- Tier 1 suppliers are the primary suppliers that provide goods and services directly to your organization. Your top Tier 1 suppliers by volume will be considered to be strategic and critical to the organization's operations, and your organization should have a direct relationship with them
- Tier 2 suppliers are the secondary suppliers that provide goods and services to the Tier 1 suppliers. Tier 2 suppliers are also important, but traditionally their business relationship is with a Tier 1 supplier who purchases or sources from them the next step in the supply chain, not necessarily your organization
- Tier 3 suppliers are the tertiary suppliers that provide goods and services to Tier 2 suppliers
- Tier 4 suppliers (and perhaps Tier 5+) are typically a supply chain's raw material suppliers, depending on the supply chain
Supply Chain Tiers: a Practical Example
Let's take the example of a cafe that sells coffee. In an illustrative, simplified coffee supply chain, the coffee farmers and cultivators might be Tier 3 suppliers. They sell their beans to roasters, who act as Tier 2 suppliers. The roasters then send the roasted coffee to a coffee distributor (Tier 1), which packages up the coffee and transports it to the cafe, which sells it to customers.
In this case, from the cafe's perspective, the coffee distributor, the business they directly source their coffee from, is their Tier 1 supplier. That Tier 1 supplier might decide to source or purchase coffee from multiple roasters in different markets or countries, but the cafe still relies on their Tier 1 supplier to keep their coffee supply stocked.
From a consumer perspective (the person buying a cup of coffee from the cafe), the cafe itself is that individual person's Tier 1 coffee supplier.
Why are Supplier Tiers Important?
As a business, the more you identify, trace, and understand the flow of goods, services, and materials along your supply chain (Tier 3 → Tier 2 → Tier 1), the better positioned your organization is to take steps toward building a more reliable, transparent, and resilient supply chain. For example:
- Improved efficiency and cost savings: By understanding the flow of goods, services, and materials, a company can identify bottlenecks, inefficiencies, and cost or quality issues in different supplier tiers, which can then be addressed or streamlined to improve overall supply chain efficiency, quality, logistics, and sourcing costs
- Increased visibility: Tracing suppliers along different tiers provides a company with greater visibility into how its supply chain, which can help it anticipate, manage, and respond to potential disruptions or problems, such as supplier failures, human rights abuses, or climate risk
- Improved supplier relationships and collaboration: Engaging with suppliers in different tiers can help identify key Tier 2 and Tier 3 suppliers, and build stronger relationships with them, which can lead to increased supplier loyalty, reduced supplier turnover, and better supplier visibility around sustainability, human rights, and ESG data
- Better risk management: Understanding supplier tiers can also help a company identify and mitigate potential risks to its supply chain, such as political instability, natural disasters, or changes in regulations
- Improved sustainability: Understanding and engaging Tier 2 and Tier 3+ suppliers can help a business identify areas where it can improve its environmental and social impact, such as by reducing the carbon footprint, resource usage, and/or pollution along its supply chain
Understanding how a product starts as raw materials and moves along the supply chain before finally reaching customers' hands requires comprehensive analysis of a supply chain's sourcing operations, manufacturing partners, factories, vendors, subcontractors, and their suppliers. This type of supply chain mapping is often called a lifecycle assessment (LCA) or a supply chain traceability project. Sending out supplier assessment surveys to collect data from Tier 1 and Tier 2 suppliers can also serve as a helpful input in this process.
Where to Start Tracing Your Business' Supply Chain Tiers
Sustainable supply chain management is complex. It requires a holistic view of all the partners, processes, logistics, and raw materials involved in manufacturing and delivering your products to customers, plus the ability to track, collect, and connect data at each step. It also involves use of sourcing influence to shift suppliers in sustainable directions. For example, in sustainability, by reducing partners’ , you reduce your company’s Scope 3 emissions.
Your sustainable sourcing strategy should fit the needs and realities of your business, but at a minimum consider material ESG factors and key supplier relationships.
Supplier relations is an ongoing dialogue, and your organization will have varying degrees of influence in a specific value chain. It's also much easier to typically engage and gather information about Tier 1 suppliers, since you have a direct business relationship with them.
When working with suppliers on due diligence, traceability, or sustainability initiatives, it's important to be clear, consistent, and understanding with your approach and policies:
- Engage your CEO, CFO, or Chief Sourcing Officer (CPO) in this communication process. Make it clear to your suppliers sustainable sourcing and supplier due diligence is a company-wide initiative and top priority.
- Start by asking your Tier 1 suppliers what they're doing currently around sustainability and human rights, and what policies and controls are already in place now. In many cases, your larger and more strategic suppliers will already have been approached by their other value chain relationships around similar initiatives. Your partners may already have innovative approaches, products, and solutions they can bring to the table or engage Tier 2 suppliers on
- Educate each Tier 1 supplier on why sustainable sourcing matters for your business and stakeholders, as well as why investing in sustainability is beneficial to their business as well. Cite other brands and examples. Highlight the opportunities and risks of inaction.
- Work to engage your Tier 1 and priority suppliers around their supply chains. Who are their suppliers? What are their sourcing policies? Where are the biggest lower-tier risks, issues, and opportunities for improvement? Once you have visibility into your Tier 1 supply chain, you can start to work on - and with them - to approach Tier 2
Once you've established one or more sustainable supply chain programs, work with your suppliers to implement best practices:
- Introduce your Sustainable Supply Chain Code of Conduct and policies up front with Tier 1 suppliers. Make it publicly available on your website. Include it in contracts and RFPs. Track which suppliers have reviewed and signed on
- Help Tier 1 suppliers establish long-term sustainability goals and science-based targets
- Include your suppliers' suppliers (Tier 2, Tier 3) within these sustainability programs
- Request each Tier 1 supplier designate a sustainability lead and primary point of contact on their staff to work with you to extend the sustainability program(s) to lower-tier suppliers
- Offer training and resources to Tier 1 and Tier 2 suppliers and provide them with incentives for implement sustainable sourcing practices and building capacity
- Offer co-investment or supportive financing to help your strategic Tier 1 suppliers implementing sustainability practices like renewable energy, energy efficiency, and closed-loop processes (if your organization has the means)
- Conduct annual reviews and solicit feedback from your suppliers on how to improve
- Use independent audits, verification steps, and data checks
For example, in 2021 Hewlett-Packard (HP) launched a new Sustainable Bond Framework, which the company will use to issue bonds to help finance HP sustainability projects. The company plans to issue up to $2 billion in sustainable bonds, and one use of proceeds will be projects that help decarbonize its supply chain. Similarly, Unilever and Campbell Soup Company offer their Tier 1, Tier 2, and even Tier 3 suppliers technologies, guidelines, and products to help them optimize their fertilizer and water use and improve soil conservation.
Your Next Steps With Supplier Tiers and Supply Chain Management
Understanding and managing supplier tiers is an important aspect of effective supply chain management. By identifying and classifying suppliers as Tier 1, Tier 2, and Tier 3, organizations can better understand their supply base, assess supplier performance, and make more informed decisions about supply chain improvements. Being aware of the suppliers in each tier and understanding the flow of goods, services, and materials through each step of the supply chain can lead to improved efficiency, cost savings, increased visibility, improved supplier relationships, better risk management, improved sustainability, and increased customer satisfaction. It's important for companies to regularly review and evaluate their Tier 1 suppliers (and beyond) to ensure they're making the best use of their resources, and are able to respond quickly and effectively to changes in the market. Investing in a thorough understanding of your supplier tiers and supply chain can pay dividends in the long run and should be considered an important business practice.
Achieving sustainable sourcing and supply chain exellence does require internal capacity, resources, and investment. But, done correctly, it can boost everything from your firm's brand and reputation to employee morale and retention, operating financials, and risk management efforts.
