Balancing supplier risk versus reward. kpmg.com

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1 Business Effectiveness Balancing supplier risk versus reward kpmg.com

2 1 / Balancing supplier risk versus reward In the wake of constant demand and supply market changes driven by recent economic crises, procurement and supply chain professionals are facing higher expectations from management to drive down costs. But what potential impact does this singular focus on cost savings have on supply and supplier risk? Because it can result in the unintended consequence of diluting the total value delivered from that supplier relationship, the key is to balance supplier risk with reward to obtain the greatest benefit from your suppliers while minimizing your risks. independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks

3 Balancing supplier risk versus reward / 2 While it can be difficult to find this balance, there are some approaches and tools that leading companies are adopting, which include: Defining and prioritizing supplier tiers Utilizing risk assessment processes for new product/service requests Incorporating initial and ongoing supplier due diligence; Utilizing balanced category scorecards Adopting robust supplier performance reporting and issue resolution Developing and regularly updating category market research profiles Implementing a supplier Six Sigma program The following is an in-depth look at these approaches and tools and how they can be effectively applied. Define and prioritize supplier tiers Most companies have critical suppliers that will significantly impact their revenue and profit. However, these suppliers and/or supplier tiers are not always formally defined nor have tailored programs been developed. Companies that adopt a one size fits all approach to managing suppliers run the risk of conducting less rigorous assessments of the critical suppliers and overassessments of noncritical suppliers. This can produce a number of false positives or false negatives which results in inefficient allocation of scarce procurement resources and ultimately decreases the value the procurement function delivers to their internal customer. The following table is an example of defining and prioritizing supplier tiers: Example Supplier Example Definition Category Tier 1 A significant spend supplier whose products/service are critical to a company s revenues and require: Complex contracts that drive continuous improvement Proactive supplier relationship management Detailed monthly supplier performance reporting Proactive forecasting 2 A moderately high spend supplier whose products/service are important to a company s revenue and require: Complex contracts Proactive supplier relationship management Detailed quarterly supplier performance reporting 3 A supplier whose products/service are not critical to a company s revenue but requires: Complex or basic standard contracts Annual performance reporting 4 A supplier whose products/service are not critical to a company s revenue and: Falls within a non-procurement managed category May utilize standard purchase order terms & conditions After creating a tiered approach like the above example, companies can then develop targeted and differentiated programs to adequately identify and manage risks based on the category and supplier.

4 3 / Balancing supplier risk versus reward Risk assessment processes for new product and service requests Many companies have some kind of process to identify risks related to new supplier requests but may not review the risk for additional products/services from that same supplier at a later point in time. This can lead to a false sense of security, since although the initial assessment of that supplier was positive, it now may not reflect the higher risk of that same supplier due to potentially new and higher-risk products/ services being acquired. By incorporating a risk assessment activity at the beginning of each product/service request for both new or existing suppliers, companies can ensure they identify and manage new risks effectively. The trick is to make the risk assessment process simple and streamlined enough so that it does not become onerous or non-value-added. In addition, one wants to make sure there are steps in the process where there is some appropriate procurement or strategic sourcing subject matter review. This subject matter review ensures the information provided and risks identified make sense. Also, this helps reduce requestors from gaming the process in order to get requests through the process as quickly as possible. 1. Request new supplier product/service 5. If risk is now higher, amend contract with appropriate terms & conditions 2. Complete risk assessment form 4. If risk is now higher complete additional due diligence if applicable 3. Assess if supplier s risk higher than before

5 Balancing supplier risk versus reward / 4 Initial and ongoing supplier due diligence Companies usually complete some high level of initial supplier due diligence but may not go to the appropriate detail level. In addition, companies don t always conduct ongoing supplier due diligence, or again, not at the appropriate detail level. The degree of supplier due diligence and frequency of assessment should be commensurate with the supplier tier and product criticality. For example, if a company spends a significant amount with a supplier, and that supplier provides critical products/services that directly impact that company s revenue, then that supplier should be subject to a significantly more robust initial and ongoing due diligence program then compared to a supplier or category with much lower spend and/or no/little impact to a company s revenue. In certain categories, there may be cases where even spending low amounts still requires a high amount of due diligence due to the overall risk with that supplier. Some examples can include payment processing, hazardous waste, and IT offshoring. It is important to define the right set of indicators to get early intelligence on a supplier s financial health. A common mistake is to rely exclusively on publicly available company financials. While necessary, that is not sufficient. The following are examples of some items to monitor for a critical supplier or category: Supplier financials Insurance certificate Business continuity plan Audit report Subcontractors to be utilized (if applicable) Vendor management policy and program of subcontractors (if applicable) Past and current references Country risk assessment (if supplier is supporting you outside the United States) Management turnover Product or plant closures Requests for payment term adjustments Deep discounting, etc. In addition, when dealing with critical suppliers who have access to highly sensitive data (e.g., information technology, financial service operations, etc.), companies should also consider the following supplier due diligence items: Physical security policy Asset management policy Background screening process Access controls Information security policy Information security breach history Incident management program Business continuity test results

6 5 / Balancing supplier risk versus reward Balanced category scorecards A balanced category scorecard is an effective tool to get a holistic perspective on total value delivered. A category is a common grouping of suppliers by a particular product/service. By developing a scorecard with appropriate categories, a company can better understand the value its suppliers are delivering. This can also help in identifying and mitigating risks. Some risks identified may be common within a category, while some may be impacting just one or two suppliers, so companies can make a distinction between broader, emerging risk trends and supplier-specific risks. A balanced category scorecard should also highlight the amount of supplier diversification and concentration a company has across various categories, which can also help companies respond quicker to emerging risks and help drive toward greater value. Category Profile: Contingent Labor Category: How do we describe the expenses in this area? Spend by Major Subcategory 11% 13% 17% 18% 41% IT Admin Finance Legal Marketing $40.0 $30.0 $20.0 $10.0 $0.0 Vendor 1 Vendor 2 Vendor 3 Vendor 4 Vendor 5 Spend by Vendor How much do we spend with the key vendors? Category Characteristics What have been the internal (the Client) and external (industry) events in this category? Category Characteristics Due to current market conditions, good time to source labor related categories in developed countries Currently excess supply of skilled workers Forecasted unemployment rate over the next X months expected to stay relatively high Areas of Potential Focus Opportunity to consolidate vendors currently have XX vendors Opportunity to renegotiate with Vendor 1 as labor subcategory B contract expires in 20XX and no other contract for labor subcategory B exists Opportunity to negotiate and incorporate volume discounts with Vendor 1, Vendor 2, and Vendor 3 Recommendations and Considerations What would you recommend we do or change? What else should we consider exploring? Category Summary Major Subcategories What does this category consist of? Sub- 20XX Potential Potential Potential Opportunities category Spend# #Suppliers Savings % Savings $ (Low, Medium, High) Amount Total 80% Low High Low High Volume Mark Req. Process (million) Spend leverage up optimization improvement IT $XX.X XX Y X% XX% $X.X $YY.Y High High High Med Admin $XX.X XX Y X% XX% $X.X $YY.Y High High High Med Finance $XX.X XX Y X% XX% $X.X $YY.Y High High High Med Recommended Sourcing Strategy How would you suggest we go about obtaining the savings? Legal $XX.X X Y X% XX% $X.X $Y.Y Med High Med Low Marketing $XX.X X Y X% XX% $X.X $Y.Y High High High Med Totals $XXX.X XX YY X% XX% $X.X $YY.Y # of Suppliers by Subcategory How many suppliers do we use for this category? Savings Estimates On a percentage basis and in $s, how much could we save on this subcategory?

7 Balancing supplier risk versus reward / 6 Robust supplier performance reporting and issue resolution For a company s key strategic suppliers, utilizing a robust supplier performance reporting and issue resolution process is a critical component to help balance risks and rewards. Companies should consider utilizing a multistep reporting and issue resolution governance approach like the following example for key strategic suppliers: Example Frequency Daily Example Activity Supplier daily report is developed and reviewed between supplier first level management and company s first level management Majority of key questions and tactical issues are resolved in the daily meetings Weekly Supplier weekly report is developed and reviewed between supplier first and second level management and company s first and second level management, and procurement Some of the remaining key tactical issues are resolved in the weekly meetings Monthly Supplier monthly report is developed and reviewed between supplier first, second, and third level management and company s first and second level management, and procurement Any escalated tactical issues are resolved at this level Majority of strategic related issues are identified and resolved at this level Quarterly Quarterly monthly report is developed and reviewed with supplier senior management and company s senior management Any escalated strategic issues are resolved at this level For nonstrategic suppliers and categories, less reporting and governance may be appropriate.

8 7 / Balancing supplier risk versus reward Category Packs A Category Pack is a collection of external market research about a particular industry or sub sector including supply and pricing trends, competition, risks, and key suppliers. Developing and regularly updating a Category Pack provides insight into new information and trends within the marketplace. This can include emerging products/services, price changes, and new risks. Because risks can arise from various causes including inflation, government regulation, supplier consolidation, supplier bankruptcy, supplier s supply chain issues, and supplier fraud or quality issues gaining insight sooner to new information and trends enables companies to shorten their reaction time to new risks. Relative Cost Drivers 4% 2% 2%2% Hours Worked Base Labor Rate The primary cost driver for the industry is based on the variable cost of hours worked. 6% 8% 53% Travel, Per Diem & Incentives Fringe Benefits Insurance & Taxes Supplies & Tools From a margin perspective, the overhead, profit, and contingency numbers are relatively low. Primary opportunities are to: 8% 15% Overhead Contingency Profit Reduce demand for higher skilled resources Focus on process efficiencies to limit hours worked Constrain travel to minimize obligation to per diems Supplier Market 4.2% 15.6% 25.9% Supplier 1 Supplier 2 Supplier 3 Historical market conditions were trending up until 20XX. 20XX had a significant decline in overall industry demand and caused deflationary pressure on pricing as well. 7.6% 8.7% Supplier 4 Supplier 5 Supplier 6 Projections for 20XX and 20XX are an increase in price, but pricing is still expected to be below the 20XX peak. 12.4% 25.6% Others % Billion Market Forecast 2008 % Billion % Growth 10.00% 8.00% 6.00% 4.00% 2.00% 0.00%

9 Balancing supplier risk versus reward / 8 Supplier Six Sigma program Another approach that can help reduce risk and drive significant value from your strategic suppliers is implementing a supplier Six Sigma program. Six Sigma is a methodology that uses facts and statistics to measure, analyze, and improve processes, and reduce variability in outcome. Using this methodology can help reduce supplier costs, improve supplier quality, and reduce supplier risks. One of the first things to consider is identifying a few key strategic categories and existing strategic suppliers. Since this program requires investment of time and resources for both your company and the suppliers, one should consider focusing on existing strategic suppliers that can help you achieve the sizable benefits. In addition, assessing if the existing suppliers have instituted a company-wide Six Sigma program is another important step. This is because you want to try and partner with suppliers that already have the Six Sigma knowledge, experience, and tools. By using suppliers that already have a Six Sigma program in place, you have the potential to gain additional benefits including shorter time to implement and higher probability of success. The following are some additional key considerations when implementing a supplier Six Sigma program: Think big, start small, scale fast Obtain management buy-in for the program Use experienced supplier Six Sigma resources (e.g., Master Black Belt), either internal or external consultants, to help plan and implement your program Develop a stakeholder assessment and communications plan both internally and externally (suppliers) Partner with your suppliers to help identify what criteria and which Six Sigma projects to consider Document and agree upon key milestones for project reviews

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11 Conclusion Today, a constantly fluctuating demand and supply market demands that companies have an agile and flexible supply chain, and one that derives more value from suppliers while allowing for proactive risk management. Those companies that unlock the value in their supply chain can save money, improve quality, reduce risk, gain revenue, and gain efficiencies. Companies that can deliver significant benefits across the organization can be a critical competitive advantage.

12 Contact us For more information, please contact one of the KPMG LLP professionals listed below: Samir Khushalani, Principal Business Effectiveness T: E: Byron Tatsumi, Director Business Effectiveness T: E: The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks