Supplier Management: Begin with the Basics (Yes – You Really Need to Do This)
There are three key components of supplier management: contract management, risk management, and performance measurement. Through these key supplier management activities, procurement organizations can successfully reap the rewards of strategic cost management and procurement operational excellence. Effective supplier management requires data, analytics, well-defined service-level agreements (SLAs), performance measurement, industry and/or category expertise and open and transparent relationships.
Contract Performance Management
Effective contract management begins by collaborating with the line of business and focuses on operational effectiveness. Many organizations negotiate outstanding agreements, but may inadvertently create contracts that strain supplier relationships. A frequent hazard is developing SLAs at too high of a level or failing to specify the measurement methodology. This ultimately leads to SLAs that cannot be enforced due to lack of clarity between the supplier and the line of business, making compliance difficult.
In a recent example, a manager for a $17B insurance company recounted his SLA enforcement issues with IT service providers. The SLAs written into the master services agreement (MSA) were not specific enough nor did they outline measurement methodology or identify which items were included or excluded. As a result, he estimated that time delays and defects (which should be recoverable through the MSA SLAs) cost the company hundreds of thousands of dollars annually.
Supplier business review meetings are critical to ensure contract performance. During these sessions, performance scorecards and compliance with other contract terms should be reviewed. Examples of scorecard measurements include cost, quality, service, profitability and overall business impact. Both organizations should be carefully examined and corrective action plans developed to ensure continued achievement of contract objectives. Best practice dictates that performance measurement occurs monthly. If an organization waits to measure performance quarterly, three months of missed savings may go by, resulting in permanent losses. Performance measures must be used to guide improvement action or they provide no real value.
While procurement organizations are typically focused on reducing costs and improving working capital, they should also be as concerned about managing supplier financial, environmental and geographic risk. During the economic collapse of 2008, companies with weak risk management practices experienced supplier bankruptcies, supplier requests for financial support, and failures to deliver important goods and services. Additional failures are associated with natural disasters. Sole suppliers or several suppliers located in the same geographic region can put a supply chain at considerable risk. An example is the significant financial devastation which resulted from two major natural disasters in 2011 with the Japan Tohoku Earthquake and the Thailand floods.
Understanding a supplier’s financial risk on an ongoing basis is critical. For example, a $6B CPG company incurred substantial costs when a third-party logistics provider filed for bankruptcy. Upon initial contracting, the provider appeared to have low financial risk. However, the strain of taking on large incremental volume created cash flow issues until they were unable to pay their key suppliers, which halted operations. By the time the CPG company was aware of the issue and able to get involved, it was too late. The impact was sustained in the cost of moving operations and more critically, in the disruption of service to key customers.
Compliance and monitoring activities should extend beyond financials and include supplier risk scoring and contingency plans for key or sole suppliers. The best time to gather supplier information is during the strategic sourcing and contracting process, making transparency on an ongoing basis a requirement for business awards. Supplier self-scoring is never to be the sole component of any evaluation.
Performance measurement focuses on a balanced scorecard. Without performance management, organizations have limited visibility into whether suppliers are meeting expectations. Anecdotal evidence alone is not enough.
A balanced scorecard should include financial, operational, and continuous improvement areas. Specific components are based on the expectations of the supplier relationship. Financial scorecards should include total cost of ownership and supplier financial well-being, while operational scorecards should include compliance to SLAs. Continuous improvement scorecarding should include expected cost, service and quality improvements. The growing complexity of businesses requires the active involvement and commitment of suppliers to the success of the organization. Effective supplier management and engagement requires clear and measurable SLAs, balanced scorecards, risk management, and regular top to top performance reviews.
Barriers to an Effective Supplier Management Program
When supplier management programs are developed, the design should aggressively identify potential pitfalls that leave organizations vulnerable, such as:
- Lack of SLA target setting, as well as a consolidated, cross-functional balanced scorecard
- Misaligned SLA definitions and calculations between lines of business and suppliers
- Inaccuracies in data sources
- Lack of dedicated resources to conduct supplier management in both organizations
- Technical issues in sharing key information with suppliers (e.g., firewall issues)
To ensure success, supplier management programs require a mature and sophisticated approach based on trust and mutual benefit between both the supplier and the buying organization.