Many of the issues in modern supply chains aren’t actually due to globalization. Rather, they’re a result of a de-emphasis in the importance of managing the relationships that “turn the wheel.” Many transactions are maintained by automated processes, and while procurement software, supplier relationship management (SRM) software, and other systems are great at helping individuals better manage complex transactions, they don’t remove the need for buyer and supplier relationships.
June’s Strategic Sourcing & Procurement (SS&P) Group conference call focused on a question posted by group member Ray Van Amerom from earlier in the year. Ray asked, “True or False: Do penalties improve supplier performance?” The call, which was hosted by Ariba’s Justin Fogarty, featured experts from around the world that provided an insightful look at issues related to supplier performance.
While the heart of the discussion centered on issues related to supplier penalties, the main takeaway was clearly about one thing: put the emphasis on improving buyer/supplier relationships. Here are the top takeaways from the call:
1. Incentives Needed to Balance Supplier Penalties
Supplier penalties should go hand in hand with supplier incentives. The intent of penalties shouldn’t be to save the buyer money for late shipments, but to ensure that the shipments are never late. Incentives help reinforce this.
Wal-Mart’s policy on supplier penalties for inventory delivered outside its time windows have been well documented. This works because, well, they’re Wal-Mart. They have the clout to ask for what they want, and the ability to turn to another supplier if their demands aren’t met.
Buyers other than Wal-Mart, however, will need to establish a relationship with their suppliers that is mutually beneficial. That relationship begins with rewarding success in addition to penalizing failure.
2. Increase Supplier Performance Visibility & Communication
Procurement operations rely on key performance indicators (KPIs) to evaluate suppliers and determine internal effectiveness. With the focus on specific metrics – such as return on investment, cycle times, and managed spend – many get so involved in the numbers that they forget about the suppliers needed to make it all happen.
Instead, use additional KPIs such as overall satisfaction to help keep a pulse on supplier relationships. In addition, ensure that goals and metrics are visible and clearly understood by suppliers. Instant, continuous feedback will ensure that suppliers keep these goals in mind and don’t unexpectedly under-deliver.
An interesting anecdote from the SS&P call was from a wine and spirits distributor. He described an instance where a supplier actually created its own KPI and self-imposed penalty. If the metric was missed, the supplier would provide free goods for 30 days. The metric was designed to increase the supplier’s confidence in its process automation, and it worked – to the tune of only one penalty being issued in over 9,000 transactions. This is a great example of how collaboration can help both parties.
3. Create Escalating Expectations to Avoid the Status Quo
An interesting debate during the call revolved around the long-term effects of supplier incentives and penalties. If suppliers find the happy medium of never late and never early, how will you encourage them to increase efficiency and output?
Escalating expectations help alleviate this worry. Penalties and incentives should only be set for a period of time, perhaps a few quarters or an entire year. Evaluating the successes (and failures) in that time period helps establish a better set of parameters to find the best balance between maximizing profits and increasing efficiency. This also helps cultivate relationships that ensure long-term success for both buyers and suppliers.
One caller described how he effectively managed his scorecard. In each supplier’s service level agreement, three tiers of expectations were established for failing to meet, maintaining, or exceeding expectations. When it came time for contract renewals, the buyer would evaluate how the supplier performed and set new expectation levels. He described the process as one that improved both the buyer and supplier.
4. Start Incentives & Penalties with High-risk Suppliers
These relations are relatively simple to envision managing, yet become increasingly difficult as supply chains become more complex and dynamic. Procurement departments get stretched thin, and keeping track of individual supplier metrics often takes the back burner.
Start by selecting suppliers that are the greatest risk. Whether they’ve had difficulties performing in the past, or are experiencing internal turbulence – these suppliers will have the most to gain from these efforts. And, the extra attention stands to have the greatest impact on improving both sides’ bottom lines. In addition, creating a h3 foundation and understanding is pivotal to applying these metrics to other suppliers.
One caller described such an example in starting small and growing their efforts to effectively execute penalties and incentives. He mentioned that his team of 30 would have been unable to monitor these metrics for over 20,000 suppliers. Instead, they selected the clients they felt were most “at risk,” and have kept a watchful eye on those suppliers.
5. Set Unique Goals for Suppliers Across Different Industries
At the same time, what works for some suppliers doesn’t work for others. Different suppliers and product inventories should not have to perform to the same KPIs to be effective.
For suppliers in telecommunications, for example, ideal performance may be tied to low defect rates, the ability to deliver on time, and in the amount of inventory promised. For someone supplying perishable goods, it may be more important to balance quality with time of delivery. Punishing for late deliveries may encourage suppliers to value delivery time over quality. The ability to understand each industry and how incentives and penalties will play in to that is an important aspect to manage.
How Can One Implement Penalties and Incentives?
Here at Software Advice, we’re big believers that software is just part of the solution; training and careful change management are critical to success. The right people must be thoroughly trained and seasoned to take on the complex task of managing supplier relationships. Otherwise procurement and SRM software will never be fully utilized. A methodical look at supplier relationships and deciding where to start is the best way to grab the reigns of any wayward supply chain.
What strategies have you used to better your supplier relationships? Let us know of any of your experiences below.
Thumbnail image created by Sudhamshu Hebbar.