Utilizing Predictive Supplier Performance Information for Successful Non- Core Supplier Management

Transcription

1 Utilizing Predictive Supplier Performance Information for Successful Non- Core Supplier Management Jeff Baron Director, Open Ratings, Inc. 928 Commonwealth Avenue Boston, MA (617) Abstract: How well a company s product performs can be attributed to how well their core suppliers are performing. The consequences of choosing a poor performing supplier can mean the difference between significant cost savings or losses. But what are the financial and performance risks associated with choosing poor performing suppliers? Detail: According to a recent Purchasing Magazine study, non-core suppliers make up between 30-35% of spending at manufacturing organizations, and as much as 60-75% of spending at service organizations. While often a secondary strategic focus, non-core supplier management should be an important factor taken into account when evaluating your overall procurement objectives. Extending Supplier Management across the Spectrum of Suppliers The challenge for strategic procurement professionals is to go beyond the "low hanging fruit" and make improvements that systematically impact the procurement process. The solution, in procurement as in other fields faced with similar issues, is the systematic application of process control based on the measurement and management of standardized performance metrics. In this regard, many corporations are well on their way when it comes to their critical supplier and, to a lesser extent, their direct suppliers in general. What is usually left out is non-production or non-core spend. By allowing such non-core suppliers to go unmeasured, the resulting costs of poor quality eat into the profit margin. It is the proper management and control of these expenses that hold the greatest immediate potential for a company to streamline expenditures and achieve a competitive advantage. For the majority of procurement organizations, the inattention given to in-depth management and control of poor quality costs associated with non-core expenses is due to a lack of resources one Fortune 500 purchasing manager stated flatly that he didn t have the time or people to effectively and regularly monitor non-core suppliers and a lack of reliable high quality and consistent data, as evidenced by the fact that only one in ten purchasing executives are satisfied with their current supplier performance metrics. Fortunately, advances in information technology and the increased attention industry-wide on supply chain issues are alleviating the resource and data constraints. Now, utilizing

2 data currently available in corporate information systems and from third-party vendors, a comprehensive supplier performance measurement system can be established for all suppliers. How TCO applies to Non-Core Purchases Total Cost of Ownership (TCO) indeed applies to measuring non-core suppliers equally as well as core, direct purchases. TCO "is an assessment of all costs, both direct and indirect, involved with an item over the useful life of that item." The original purchase price is only one component (and often not the largest one at that) in the TCO equation. While the exact calculation will vary by industry, by company, and by product category and use (e.g., inventory versus capital equipment), other key cost components relate to delivery and timeliness, quality and reliability, administrative overhead, and financing arrangements. Total cost of ownership can be divided into three categories: Incurred costs These include the out-of-pocket expenses such as quoted price, shipping costs, and other fees and expenses directly attributable to the product or service in question and may be incurred at the time of purchase or after the fact. Performance factors This category includes costs associated with problems with the product or service quality, late delivery, and service or maintenance. These costs might be directly associated with a purchase or appear indirectly as resource or opportunity costs. Policy factors These are costs associated with purchasing within constraints imposed by tax, regulatory, or social requirements. Examples include use of a particular type of supplier (e.g., minority or women-owned suppliers), component type (e.g., recyclables), or country of origin. The first category, incurred costs, is best addressed using the traditional negotiating skill set of the procurement manager. The goal is to obtain the most advantageous deal. The third category, policy factors, is a matter of sourcing to accommodate corporate priorities and legal imperatives. Of the three categories of ownership costs, the second, performance factors, is where the greatest unrealized gains can be made through effective supplier management and supplier development. A simple case study of a non-core purchase is instructive. One manufacturing company studied purchased eight network servers, certainly non-core to their product production but critical to the operation of their business, for an initial purchase price of $352,000. Problems with the order arose early the delivery was late and several of the servers failed out of the box. A calculation of the total cost of ownership must include the costs arising from these problems:

3 Poor quality, diagnosing and fixing the defective servers over $15,000 per server Ten weeks of depreciation and price erosion of out-of-service hardware over $31,000 Implementation of a backup plan to use alternative servers to maintain production capabilities while problems with new servers were resolved estimated at over $96,000 $600,000 Hidden Cost Breakdown and Total Costs $550,000 $500,000 $450,000 $100, % $400,000 $350,000 $300,000 $31, % $96, % $580, % $250,000 $352,000 $200,000 $150,000 $100,000 Purchase Price Cost of Lost Hardware* Cost of Implementing Plan B** Cost of Defect Repair** Total Cost of Acquisition * ** Lost Hardware cost calculated as # of weeks delayed x 0.87% depreciation cost (assumes 45% annual depreciation cost) Plan B and Defect Repair costs calculated as (cost of fully loaded labor + opportunity cost) x number of FTE hours spent on the problem In this case, over a four month period the company incurred total hidden costs attributable to untimely delivery, poor quality, and slow responsiveness of over $228,000, 65% of the $352,000 purchase price! If this company had had some advance notion that this supplier had delivery and product quality performance problems, it may have been able to build in protective terms into the contract or identify an alternative supplier and ultimately avoid some or all of those poor performance-related cost "kickers." What To Measure and How In implementing non-core supplier management, what to measure and how is important to achieving success. A good starting point is a systematic analysis of current total cost of ownership by purchase category. What are you spending your money on? Are you incurring hidden costs due to poor performance? Typically, a supplier performance measurement system will include a combination of high- level and detailed quantitative and qualitative metrics around some or all of the following common performance aspects:

4 Delivery Does the supplier deliver its products or services on time and as promised? Quality This clearly will vary by purchase type. For manufacturing inputs, what was the parts-per-million (PPM) rejection rate? What was the field failure rate? Did the product or service delivered perform as promised? For services, do the individuals performing the work (e.g., programming, creative or legal services) demonstrate top-notch skills? Do the ultimate deliverables meet the original needs or is rework typically necessary? Cost This can take multiple forms. One common performance metric relates to cost containment tracking the prices charged by individual suppliers as compared to specific industry and category benchmarks. How do the supplier s prices change over time? Does the supplier meet internal requirements for cost reduction? Other cost-related performance metrics attempt to capture the TCO category of incurred costs to what extent do the final, total costs and fees associated with orders from the supplier exceed costs and fees agreed upon at the beginning of the order? Order Accuracy Does the supplier fill and ship orders to specification? Is the quantity always correct? Does the supplier provide appropriate and correct paperwork with its orders? Do the components delivered exactly match your orders or does the supplier frequently provide substitutes? This concept is typically used for manufacturing inputs and other product orders, but can be easily extended to service delivery. Does the service supplier adhere to requirements as stated in the RFP/RFQ? Customer Support Was the level of support offered sufficient to meet your needs? Did the supplier provide adequate documentation and technical support? How quickly did the supplier respond to requests or address problems that may have arisen in the course of the transaction? Business Relations How easy is it to do business with this supplier? Does the supplier have a dedicated account representative for your company? Do the supplier s salespeople and support staff maintain a professional, courteous, and respectful attitude in all interactions? Clearly, these issues overlap and can, and in many cases, should be answered to varying degrees of precision. In other words, by combining a set of highly detailed, product-specific metrics with other, more subjective, high-level metrics, a robust view of the supplier s performance can be achieved. In addition to defining metrics, how you view these metrics and the action you take is key to success. Technology vendors today offer a myriad of Supplier

5 Relationship Management (SRM) solutions. To be most effective, you must look beyond stock functionality to the solution s ability to predict problems in the supply base before they happen. Then, and only then, will true supplier management be possible. Specifically, in the case of non-core suppliers where information and visibility is often hidden or unavailable predictive metrics are the only viable method of accurately pinpointing opportunities and ordering them based on size and impact, as well as risk and cost mitigation potential. References: Harding, Mary Lou, CPM. "Understanding Total Cost of Ownership, " NAPM InfoEdge, May 2000 Millen-Porter, Anne, et al. "Why it's important to measure suppliers well," Purchasing, May 4, 2000 Millen-Porter, Anne. "Raising the Bar," Purchasing, January 14, 1999 Minahan, Tim (Aberdeen). Supplier Performance Management: Driving Supply Chain Success. May 2001 Scaife, John and Yacura, Joseph. Quality Metrics: A Proven Approach to Affecting the Bottom Line. March 2001.