Supplier Diversity — Creating Shared Value for the Future of the Nation (Part 1)

In November last year, we wrote about Buying Locally – a great segue story into a broad topic commonly rolled into a convenient bundle called supplier diversity and also a corporate activity that stirs up all sorts of emotions. Jason stoked the diversity fire with A Critical Topic for Black History Month: How Far Should Supplier Diversity Programs Go? in February this year.  I think much of the controversy around this topic is based on lack of information and not enough perspective on the underlying drivers. Let me expand on that by quoting the famed Michael Porter – this is from Competitive Strategy, his legendary 1980 piece on the nature of competition:

“Where experience cannot be kept proprietary, new entrants may actually have an advantage if they can buy the latest equipment or adapt to new methods unencumbered by having operated the old way in the past.  A crucial strategic choice for competing in emerging industries is the appropriate timing of entry. Customer loyalty will be great, so that benefits will accrue to the firm that sells to the customer first.”

Tom Finn over on Healthcare Matters showed the power of this concept in Is the Airline Supply Chain Analogy Relevant to Healthcare? last month.  To summarize, competitive advantage accrues to a firm doing something better than its rivals – and new entrants (read: entrepreneurs, smaller, diverse firms) can be more successful than larger, established companies. Look at our successful Silicon Valley firms – they were all mere figments of someone’s fertile mind not long ago. What if the creative business focus that brought about those companies could permeate the country – and in all corners of the map as well as an in all walks of life?

Last year, co-authored with Mark Kramer, Michael Porter came out with a new study named The Big Idea: Creating Shared Value, which proposes a new way of looking at profits, and, by extension, a new approach to running businesses:

“Capitalism is an unparalleled vehicle for meeting human needs, improving efficiency, creating jobs, and building wealth. But a narrow conception of capitalism has prevented business from harnessing its full potential to meet society’s broader challenges.”

The piece has an apt summary of the current challenges with sourcing models built around no-longer-low-cost-countries:

“How -- could companies think that simply shifting activities to locations with even lower wages was a sustainable ”solution” to competitive challenges?”

Another Porter line states that “businesses acting as businesses, not as charitable donors, are the most powerful force for addressing the pressing issues we face.” And this is – perhaps contrary to perception – what ultimately drives corporate supplier diversity programs. Certainly you can find handout contracts, just as well as you can find single-source arrangements with family members and high school buddies that have little to do with creating value and only serve to jeopardize corporate stewardship of assets. These arrangements are the exceptions, regardless of the benefactor, and when discovered, they usually end poorly for both the vendor and the employee signing for the company.

Before we go further into supplier diversity, let’s go back to shared value: what does this mean from a tangible business perspective? First of all we have to leapfrog the oft touted view that social improvements can only be had if a company sacrifices its own profit goals; a point of view which creates false adversaries. Let me provide an example from the corporate social responsibility program world (an area which typically goes hand in hand with supplier diversity, and is often managed by the same director) and the so called “fair trade” approach to procurement, a concept fueled by the adversarial approach implicit in mainstream economic models, which amounts to little more than a zero-sum redistribution of value. On the other hand, a shared value model changes the underlying system itself. Let’s see how that works out in practice – from Porter:

“Fair trade aims to increase the proportion of revenue that goes to poor farmers by paying them higher prices for the same crops. Though this may be a noble sentiment, fair trade is mostly about redistribution rather than expanding the overall amount of value created. A shared value perspective, instead, focuses on improving growing techniques and strengthening the local cluster of supporting suppliers and other institutions in order to increase farmers’ efficiency yields, product quality, and sustainability. This leads to a bigger pie of revenue and profits that benefits both farmers and the companies that buy from them. Early studies of cocoa farmers in the Cote d’Ivoire, for instance, suggest that while fair trade can increase farmers’ incomes by 10% to 20%, shared value investments can raise their incomes by more than 300%.”

It’s pretty impressive how broadening your point of view creates greater success. The more efficient farmers with higher quality, fewer production disruptions, and greater capacity are exactly the kind of suppliers a company is looking for. Another procurement example from the Porter study:

“Nespresso, one of Nestlé’s fastest-growing divisions, has -- expanded the market for premium coffee. Obtaining a reliable supply of specialized coffees is extremely challenging, however. Most coffees are grown by small farmers in impoverished rural areas of Africa and Latin America, who are trapped in a cycle of low productivity, poor quality, and environmental degradation that limits production volume. To address these issues, Nestlé redesigned procurement. It worked intensively with its growers, providing advice on farming practices, guaranteeing bank loans, and helping secure inputs such as plant stock, pesticides, and fertilizers. Nestlé established local facilities to measure the quality of the coffee at the point of purchase, which allowed it to pay a premium for better beans directly to the growers and thus improve their incentives. Greater yield per hectare and higher production quality increased growers’ incomes, and the environmental impact of farms shrank. Meanwhile, Nestlé’s reliable supply of good coffee grew significantly. Shared value was created.”

Note how Nestlé used their more favorable access to capital to effectively finance the transition, and deployed coffee “black belts” to create change, and used their name and leverage to drive contract terms at the 2-tier level. Porter continues:

“Embedded in the Nestlé example is a far broader insight, which is the advantage of buying from capable local suppliers. Outsourcing to other locations and countries creates transaction costs and inefficiencies that can offset lower wage and input costs. Capable local suppliers help firms avoid these costs and can reduce cycle time, increase flexibility, foster faster learning, and enable innovation. --- When firms buy locally, their suppliers can get stronger, increase their profits, hire more people, and pay better wages—all of which will benefit other businesses in the community. Shared value is created.”

I find the last paragraph especially intriguing – and it helps bring the discussion back to supplier diversity. As a refresher, or introduction, depending on your level of exposure, supplier diversity spans a broad spectrum – not only the most-often heard of categories such as MBE (minority-owned business enterprises), and WBE (woman-owned business enterprises), but also VOB (veteran owned business) and SDVOB (service disabled veteran owned business), and, the largest group of them all, SBE (small business enterprises). There are over a dozen categories in all, but the former are the main four categories typically talked about.  Additionally, EEO (equal employment opportunity) activities are sometimes dragged into the supplier diversity definition, but that is not what it is about and I suggest that you leave the EEO area to your HR people.

The regular supplier diversity approach among the Fortune 500 falls into engagement “maturity tiers” like this:

  1. Sell-side reporting compliance – the baseline – “we have clients that want us to reporton our diverse spend so I guess we have to do it,” at least enough to meet our SLA requirements
    1. This approach requires data cleanses of the vendor master to identify who the diverse vendors are, some A/P data added back and a handful or two of reports to provide to clients – second tier reports can also be added to bring visibility into the greater spend affected
    2. This is definitely a rear-view mirror approach that only counts where the beans fell
  2. Buy-side procurement effort– “our CEO has told us to buy more from diverse firms so we’re making some effort,” especially if it is tied to my annual performance review and bonus structure…
    1. This requires the same data cleanses and reports as described under #1 above. At this level, more firms add second tier reporting solutions to track where the money goes that they spend with their largest contractors
    2. This is still mainly a rear view mirror approach in most firms – although some firms incentivize their staff to actively engage with diverse companies
  3. Mission & Vision– “We’re fired up about supplier diversity from the C-room to the receiving floor and we see this as part of our corporate life journey.”
    1. All the technical solutions of the above two, as well as outreach activities, corporate social responsibility programs etc.
    2. In all honesty, few companies have adopted Porter’s shared value approach, so many activities are either focused on less productive guilt-driven redistributive efforts, or about the painfully slow process of growing successful small diverse firms into larger suppliers with greater capacity

To be honest, most firms by far fall in either bracket #1 or #2 above or a combination of the two – while talking a good #3 game.

To be continued in Part 2… 

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