Supplier Performance Management
Understanding and Improving Supplier Performance
Supplier Performance Management
Manufacturing companies have been using supplier scorecards to measure basic supplier performance metrics for a long time. In the past decade, however, both manufacturing and service firms have become increasingly aware of the importance of supplier performance and its critical impact on their own performance and market competitiveness. The increasing reliance on outside suppliers has transformed both the perception of and the need for understanding and improving supplier performance from just a vitamin to a real painkiller. A number of factors have converged to create the perfect storm in the supplier performance world:
- Increased outsourcing and reliance on suppliers for both goods and services
- Globalization of business and of supply chains
- Increasing complexity in managing suppliers
- Increasing supply risks
- Viewing suppliers not just as a cost, but as a as a strategic input to their bottom line
Good supplier performance is a key ingredient in enabling firms to achieve business performance excellence. But how can firms manage or even influence the performance of outside suppliers? Supplier performance management (SPM) is being widely adopted as a method to understand and improve the performance of the extended enterprise.
Many companies pursue SPM as the quest for the perfect supplier scorecard. They believe that if they get the right metrics on the scorecard, then supplier performance will improve. SPM involves more than supplier scorecards, which are only one element in the process. Successful results include: reduced costs, reduced risks, and increased value. Successful SPM requires good leadership, organizational alignment, a good business process, effective communications and taking action as part of the process. This article discusses best practices for implementing supplier performance management from creating an effective process to developing meaningful supplier performance metrics to achieving successful results.
SPM - The Business Case
Some firms want to implement SPM because they have been told that it's the right thing to do.
They are convinced that supplier performance will improve and the results will speak for themselves.
While supplier performance improvement is a distinctly possible outcome, a specific cost reduction
based on that improvement can't be guaranteed because different firms implement SPM with varying
degrees of proficiency. However, success will have a much higher probability when senior management
understands the business case for SPM and therefore truly gives it support. One of the biggest
challenges, however, is that the business case for SPM is not cut and dried. That is, it is hard to
guarantee a precise return on investment (ROI) for SPM. Executives are focused on bottom-line
improvements and continue to expect them as their firms adopt improvements in strategic sourcing
methods and supporting technology. They have come to expect cheaper supplier prices as the only
true measure of ROI in Procurement; whereas the ROI for SPM is not so clear-cut. There are two
approaches to the SPM-ROI question.
Approach 1 - One approach to calculating SPM ROI is to estimate failure costs - the costs associated with poor supplier quality (such as defective materials or late delivery, etc.). Then, interpolate how much these costs could be reduced by implementing SPM. This gives senior management information on what types of savings can be expected and a better idea of cost of SPM versus return on investment. A large manufacturer of environmental care products calculated its total failure costs and then estimated how much a supplier performance management system could potentially reduce costs. Initially the goal was to allocate budget dollars to meet these baseline estimates. Ultimately, the company far exceeded its initial goals and proved the ROI for the SPM project. It continues to reap additional savings and benefits as it extends the use of the SPM program.
Approach 2 - Another approach to calculating the ROI of SPM is to estimate a poor-performance-to-cost ratio. For every dollar spent on critical suppliers, what percentage is lost to poor performance factors, such as poor delivery or poor quality performance? For every 1% improvement in this ratio, how many more dollars would be saved? Or, how many fewer sales dollars would you need to make up for poor supplier performance?
While ROI estimates are just that, estimates, they demonstrate the types of cost benefits that SPM can bring in monetary terms. As an SPM project is implemented and progresses, it is important to track ROI in order to maintain senior management support. Not all improvements are measurable in dollars. Many, such as improved supplier relationships, are qualitative and equally valuable, and are likely to lead to measurable savings. It is hard to calculate the hard dollar value of a supplier who always helps out during a crisis or time of need, but this is an extremely valuable asset that must be nurtured. An SPM program helps highlight these qualitative measures. Other beneficial qualitative value, such as joint overhead reduction and collaborative product development, are hard to measure but can deliver huge results. However, gaining support and budget for SPM solely on the promise of qualitative benefits may not succeed.
Creating an Effective SPM Process
SPM's success depends upon putting an effective business process in place. Many think that SPM primarily involves implementing supplier scorecards. How hard can that be? And if it's mostly about supplier scorecards, can't SPM just be left to Procurement to take care of? The answer is no. SPM is a process, not an event. It requires support from stakeholders beyond Procurement, as supplier performance impacts many functions.
While often led by Procurement, an effective SPM process should include key internal stakeholders who interact with suppliers as well as the suppliers themselves. A solid SPM program should:
- align with objectives of the firm, not be focused only on Procurement
- planned and designed with those corporate goals in mind - not just "happen"
- measure and monitor progress against a plan based on metrics
- undergo scheduled reviews and improvement processes.
The re-iterative SPM process steps are shown in the Figure 1 below:
In summary, the SPM process includes the following steps:
1. Establish an SPM strategy and plan – Any supplier scorecard should be developed with corporate goals in mind. The overall SPM strategy should make sure it is aligned with corporate objectives so they enhance them not conflict with them.
2. Develop supplier performance criteria and expectations – Identify basic criteria the company expects from all suppliers.
3. Select evaluation tools and process steps – The team must identify how it will collect, monitor and measure performance. It should also create a rollout plan to both the stakeholder and supplier communities.
4. Collect supplier performance data (qualitative and quantitative information) – Performance data must be collected and becomes valuable over time. Teams should establish time period associated with data collection, for example, quarterly.
5. Measure and share results – Once collected the data should be reviewed against criteria and shared with suppliers and stakeholders.
6. Set improvement goals and plan – Companies must act on the performance data collected so they can influence supplier behavior.
7. Review and recalibrate goals, strategy and metrics periodically – As a business grows and changes, the goals, strategies and metrics must be recalibrated so that everything is aligned.
Aligning SPM to Your Firm's Goals
In the initial states of an SPM project, the burning questions are often:
- What metrics do other firms use on their supplier scorecards?
- Should we benchmark other industries to find the best metrics to use?
Metrics are more successful when they are derived from a firm's own goals, objectives and strategies than when borrowed from others. Metrics should be derived from corporate goals. Figure 2 illustrates an example of the flow down of corporate goals and the alignment of supplier performance expectations and Key Performance Metrics (KPMs). It shows the suppliers' role in supporting customer satisfaction goals.
Figure 2: Aligning KPMs & Corporate Goals with Supplier Performance The purpose of SPM is to measure the performance of one's own suppliers and should be derived from a firm's own goals and strategies, not borrowed from other companies even if they are in the same industry and/or appear to be good at managing supplier performance. Metrics from other companies can provide ideas, but should not be the primary method for determining appropriate metrics. Metrics must support what your firm is trying to accomplish. If a firm bases their own metrics on what other companies are trying to achieve rather than their own objectives, then they will not derive full value from SPM. Metrics that are not aligned can derail the process and make it irrelevant. If Procurement derives its strategy from the company's overall goals and strategy, alignment of supplier performance metrics will be easier. Procurement should avoid being too internally focused. Also, aligning supplier performance metrics means that Procurement is supporting senior management goals and increasing the chances that senior management will support the SPM process and the SPM budget.
Alignment is important throughout the value chain. According to AMR Research, "best-in-class companies achieve greater value [in terms of savings and efficiency] the more they provide visibility and alignment of tools like SPM scorecards across their entire ecosystem".
What Aspects of Performance Should Be Measured?
As just described, metrics should flow from performance expectations. Performance expectations can be derived from and aligned with a firm's purchasing strategy, as shown in Figure 2. A supplier performance expectation can be defined as "a specific statement of a business practice, process, policy and/or the results anticipated or required from a supplier's performance or behavior in relation to the customer". Clarity of company and purchasing team goals should guide the development of performance metrics. Performance expectations are typically the business practices that the customer would like the supplier to follow and deploy. For example, a supplier performance metric for a corporate performance goal of cycle time reduction can either be the supplier's on-time delivery or its purchased-part lead time. Or, if the customer's performance expectation is supplier responsiveness, measures of responsiveness may include a) how quickly the supplier addresses corrective actions, b) how quickly the supplier responds to order changes, and/or c) how easy it is to do business with the supplier.
Segmenting the Supply Base for SPM
With so many suppliers past, present and future, a company cannot possibly manage performance plans for every single one of them. So what is the best approach to managing the vast number of suppliers?
- What percentage of, or how many suppliers should be measured?
- Which suppliers should be measured?
- Should the same metrics be used for all suppliers
Segmenting the supply base for purposes of performance management helps firms answer those questions. Additionally they are better prepared to manage and allocate resources.
Supplier segmentation is not a science. There are various four-box matrices that have been used for segmenting the supply base and can be used as starting points, not as rigid guidelines. Typically, suppliers are divided into strategic, collaborative, custom and commodity quadrants, with strategic suppliers being the primary focus and commodity suppliers requiring fewer resources. Firms should concentrate on strategic suppliers who are integrated business partners as well as core suppliers, who require integration and development plus other suppliers that may supply a high-cost or high-risk item.
In terms of performance management, a simple approach is to review suppliers who represent the top 10-20% of spend. Divide them into direct and indirect. Then consider ranking them based on the factors highlighted in Figure 3. Use a simple scoring methodology such as "Low=1," "Medium=2," and "High=5."
Other considerations for choosing potential measurement candidates and gaining more insight into their performance are:
1. Would the supplier add more value if its performance improved?
2. Would the supplier help the firm become more competitive in cost, quality, technology or responsiveness?
3. Does the supplier pose or create risks that need to be reduced or eliminated?
The supplier segmentation process is a starting point for discussions among Procurement and other stakeholders about which suppliers may have the greatest impacts on the company's own performance, which suppliers harbor the greatest potential risks, and which suppliers need to be measured, monitored, or improved. Supplier segmentation also helps identify supplier relationships that should be targeted for termination.
Creating an Evaluation Strategy
Now that you’ve determined which suppliers you want to measure. The next question is: where is the information going to come from? In many companies, the desire for information is much greater than the capability to generate or obtain this information. Manufacturing companies have enterprise systems that typically capture at least some supplier performance data. However, scarcity of readily available information is especially a challenge in performance management of service suppliers. Often supplier performance and responsiveness information must be generated via internal stakeholder questionnaires rather than gleaned from an enterprise management system. Figure 4 highlights sources of performance information.
In reviewing sources of performance information consider the following:
- Are there currently means for collecting the information, such as questionnaires, surveys, data feeds? Or do they need to be developed?
- How accurate are current information sources? Do they need manual manipulation, cleansing or adjusting? If so, what are the resource requirements?
- How credible are the information sources? Is the information likely to cause disputes with suppliers or stakeholders? (If data integrity becomes the focus, then SPM can become derailed.)
- What methods will work within our company? (For example, if asked to give feedback on suppliers, will internal stakeholders do so regularly and reliably?)
- Is information relevant to supplier performance available? (You want to measure the most important aspects of supplier performance, not choose areas just because they can be easily measured.)
- Do you want to use different scorecard flavors for different supplier segments? (For example, firms may wish to measure strategic suppliers in more detail and custom suppliers primarily in service and reliability.)
Developing Good Metrics and Scorecards
This article has described how to create metrics that are aligned with the rest of the company. But what are other characteristics of good metrics? How does a firm know that it has chosen the best or right metrics? Figure 5 details some characteristics of good metrics:
Another challenge is the question of qualitative versus quantitative information. With the old saw of "you manage what you measure" ingrained in many people, some managers do not believe a metric is valid unless it is quantitative. Sometimes quantitative information can give a false sense of security, as it can be subject to data integrity problems. However, another saying, "perception is reality" means that perception of a supplier’s performance by the organization is derived from the individuals who deal with that supplier - and is sometimes the only available source of valid performance information. Qualitative information about supplier performance is successfully used by many companies. The reliability of qualitative information can be verified during customer-supplier feedback meetings.
Metrics typically are expressed as KPMs or key performance metrics. A supplier scorecard can consist of KPMs at the top level or groups of KPMs. Sometimes the top level elements on a scorecard are calculated from several KPMs and rolled up into an overall score in areas such as quality, delivery and responsiveness. Structuring a scorecard depends on the scope of the metrics collected and how a firm wishes to present them. There is no better approach than following the principles in Figure 5. Above all, keep it simple and do not collect data for the sake of data. When it comes to supplier scorecards, less is more. More KPMs on a scorecard increase complexity and may require additional resources to derive and manage.
What Problems Do Companies Want to Solve with SPM?
Supplier scorecards are a means not an end. Some companies are so focused on data collection and the supplier scorecard itself that they neglect to use it for its main values as a:
- tool to increase a two-way flow of communication between customer and supplier
- way to improve supplier performance as well as uncover better processes that they as a customer can enable better relationships and performance
- tool to uncover hidden costs and cost drivers
- means to improve a customer’s own market competitiveness in the process of strengthening their part of the value chain.
Implementing a supplier performance management system can help companies:
- Understand their suppliers and their capabilities
- Gain better insights into their suppliers’ performance
- Build mutually beneficial relationships with suppliers
- Identify, prevent and mitigate supply risk
- Set criteria for new supplier on-boarding and an approved supplier list
- Put realistic SLAs (Service Level Agreements) into supplier contracts that are based on performance information gained from SPM
- Rationalize suppliers based upon performance information
- Disengage with low performers and high-risk suppliers
- Give more business to high performers
- Identify supplier continuous improvement opportunities
- Gain insights that help suppliers improve their performance and reduce costs and risks
- Work on product or service development projects with suppliers
- Create preferred or certification programs
Closing the Loop: Getting From Performance Management to Performance Improvement
Getting suppliers to improve performance does not happen solely because of scorecards. Some improvement will occur, however, just from the act of measuring suppliers. It's the "they know we're watching" phenomenon. But continual and sustainable performance improvement requires diligent communication and follow-up. Scorecards need to be distributed on a timely and regular basis. And with key, strategic and critical suppliers, firms should be conducting regular business/performance review meetings to discuss performance feedback, action items and plans, and share mutual improvement ideas. These meetings can be conducted via a telephone or web meeting, preferably after a face-to-face meeting to get things started. Many companies have uncovered significant supplier cost-savings and other mutually-beneficial ideas through regular interactions with suppliers. The feedback loop is occurs as you "measure and share results" and "set improvement goals and plans" as outlined in the SPM process (Figure 1).
One important aspect of capturing and tracking value is communicating the results both internally to stakeholders and externally to suppliers. If performance improvements and cost savings are not continually communicated, particularly to senior management, the support for SPM can erode. Too many firms neglect the communications piece. Executives may have short memories about why SPM was such a good idea in the first place and need to be made aware of the value it continues to add.
An important business practice where some companies fall short is following up on performance issues and corrective actions uncovered during performance measurement. Key issues that come out of scorecards and site visits should become part of supplier continuous improvement plans and be tracked until completion. Otherwise, SPM can become an empty process with no teeth or results.
Depending upon the scope of supplier improvement, supplier development resources may be required. Some firms have found that in-house supplier development for key suppliers pays for itself and can document healthy returns on investment. Many other firms are unable or too small to deploy in-house supplier development resources and may ask suppliers to hire outside consultants, if required, to tackle targeted supplier development projects. In many cases, suppliers may be able to address most of the issues that arise out of SPM by using their own internal resources. Exceptions to this may occur when customers ask suppliers to adopt a whole new methodology, such as Lean or Six Sigma, which typically do require consulting and/or supplier development resources.
Another issue that arises is whether a supplier is willing to make changes. This is particularly challenging when a supplier is larger than the customer or when the cultures and values of a supplier are not in alignment with the customer's. Sometimes improvement will just not be feasible. The customer must decide whether or not they can live with this situation.
So far this article has focused on SPM as a means for improving supplier performance. A best practice in this area is to ask the supplier for feedback about the customer (known as 360° feedback or reverse scorecards) – and to actually take action on the feedback. So often the customer's own business processes, practices and behaviors can prevent suppliers from performing well and need to be addressed and improved. If a customer asks for supplier feedback on itself, it must be prepared to take action or lose credibility in the relationship.
While sometimes a customer may need to disengage with a poor-performing supplier and use SPM to identify the performance issues, SPM is also about recognizing, rewarding and providing incentives for high-performing suppliers. Many companies award additional business to high performers. Once an SPM process is fully implemented, many companies develop recognition programs for their top suppliers. One approach is conducting a supplier day, where top performers can be recognized in front of both the customer company and in front of other suppliers. One caveat about supplier recognition and supplier days – they require a sufficient time horizon to plan (often a year) and solid agreement among management about the award criteria. Supplier recognition should not be approached casually. It should be undertaken only after a fully-functioning SPM program is in place. Successful recognition programs benefit both customer and suppliers. Being recognized reinforces desired supplier performance, presents role models to other suppliers, and demonstrates that a company is serious about supplier performance standards. It also sends a positive message to customers about a company's commitment to excellence.
Using Technology to Support SPM
Technology can be used to enable and scale SPM more readily. According to AMR Research, "Technology enablement is critical for measurement and data collection to be repeatable and accurate. Supplier scorecards and dashboards need to pull data from disparate systems, both structured and unstructured data formats." While SPM can be deployed using spreadsheets, word processing programs and on-line questionnaire tools, it is much more challenging and labor-intense to cobble together an ad hoc approach. The following are some of the capabilities that SPM systems can provide:
- Supplier survey & assessment development and deployment for both qualification and ongoing assessment purposes
- Systematic collection of assessment or evaluation results
- Stakeholder satisfaction surveys
- Reverse scorecards
- Scorecard creation:
- Creating KPM formulas
- Importing KPMs and performance data from other systems
- Rolling up KPMs to scorecards
- Sharing scores and results with suppliers
- Trend analysis, such as trends of individual supplier performance scores over time and comparison of suppliers with each other
- Alerts regarding performance issues
- Measuring performance against contracts and SLAs
- Tracking corrective actions & improvement plans
- Site visit or audit support
SPM information is useful beyond the SPM system. Supplier performance information can be used in other areas of the procurement
lifecycle and by functions outside of procurement:
1. Strategy development: Use performance information for supply base segmentation, Pareto analyses, and supplier rationalization.
2. Supplier qualification: Use performance information to guide some RFI criteria.
3. Sourcing negotiations: Factor performance of current suppliers into sourcing decisions.
4. Supplier quality management: Use performance information for managing supplier quality.
5. Contract management: Develop SLAs for contract compliance based on KPMs from SPM.
6. Risk management: Use SPM information as part of a cross-functional risk management system.
While SPM software solutions can facilitate implementation and provide important functionality, they still require such elements as: working business process, change management and continuous improvement skills, supplier management and development knowledge, and ability to work with a diverse group of stakeholders.
Another challenge is choosing an SPM implementation approach. Many companies find that a phased rollout approach is more effective than a "big bang" or full implementation. Firms need to work out the business process details before implementing SPM, and it is easier to do that in waves rather than all at once. In a phased rollout, firms choose the categories and/or suppliers to evaluate and the parts of the organizations that will be involved in the initial phase. Some companies may choose suppliers who are easy to work with and who are willing to provide early feedback on the SPM process. Some may choose problem suppliers or difficult categories in order to uncover and work out challenges in the process or to get started addressing supplier performance issues. The benefits of a phased rollout include:
- Reduced risk of failure, as the kinks can be worked out before subsequent implementation phases
- Internal users have time to develop SPM expertise and good business processes
- Early phase users gain expertise and knowledge and can help users in subsequent phases get up to speed
- A phased rollout can provide early wins, demonstrate the value and ROI and help maintain management support for subsequent phases
The big bang approach, while potentially riskier than a phased rollout, can be appropriate under some circumstances. Some of the benefits are:
- Support, momentum and enthusiasm for the system are captured and focused in a full implementation
- Sense of urgency helps make implementation a higher priority for the business
- Value may be realized much faster
- Budget is deployed more rapidly, thus avoiding future funding issues
Companies may benefit from using an outside consultant to guide them in the implementation process. A consultant can provide expertise, experience and an outside perspective to help make the project go more smoothly and successfully and can help the firm capture more ROI. A consultant can quickly assess business needs and help guide the company through internal and external challenges with minimal disruption to current operations. A good consultant can offer guidance on business process implementation and provide training tailored to the business. Whether they are implementation consultants from the software vendor or management consultants, consultants should be used to guide the implementation process and support rapid transfer of technology and knowledge in order to avoid prolonged and costly dependence on consultants. In the end, firms are responsible for their own SPM adoption and need to have the commitment, internal capabilities, and knowledge and to make it successful.
Six SPM Success Factors
As described in the article, "12 Reasons Why Supplier Scorecards Fail", there are many challenges to developing scorecards.
But scorecards are only one element of SPM, which is a multi-faceted business process. Here are six key success factors:
1. Management buy-in and support. Demonstrate to senior management not only cost savings and risk avoidance, but also the value that high-performing suppliers can bring.
2. Alignment of SPM with company and organizational goals and objectives. Without alignment, value is more difficult to demonstrate to senior management. As discussed, don't create SPM in a vacuum.
3. A good process in place. SPM is a business process, not a scorecard. SPM requires a good, closed-loop business process in place in order to add value and to succeed.
4. Communications: with suppliers and with the stakeholders in your firm. Don't keep SPM a secret between Procurement and suppliers. Communicate performance expectations with suppliers. They will appreciate it. Communicate the results with suppliers. Raise SPM visibility and broadcast success. Otherwise, SPM may die on the vine because only Procurement can see the benefits.
5. Actions. SPM without actions, improvements, and follow-up is futile. Go beyond collecting data for the sake of data. Deliver improved supplier performance, reduced costs and increased supplier value.
6. Measurable results. An SPM system is about results. When properly deployed and fully adopted, SPM can create both top line and bottom line value. Capture the value and communicate it to management.
SPM that results in Supplier Performance Improvement is not about getting a perfect scorecard for all the company's suppliers. That would indicate the best suppliers at a given moment in time. SPM is about continuously monitoring the company's business needs and measuring supplier's ability to meet those needs so that the company always has the best suppliers and that the capabilities of the supply base evolve with the company's business needs. SPM means monitoring requirements, collecting key supplier performance data, evaluating performance data with metrics that tie directly to high-level business goals, feeding evaluation data back to suppliers, creating meaningful supplier improvement plans, and, most of all, it means repeating all these steps to ensure performance monitoring is continuous.
SPM data should be critical in selecting, rewarding, and in some cases eliminating suppliers from a company's supply base. To achieve this goal companies must store and manage SPM data in such a way that they can analyze it with trend reports on individual suppliers over time and comparison reports on multiple suppliers.
SPM data allow companies to see deeply into their supply chains but its primary value doesn't stop there. SPM enables them to extend the reach of their company's goals and values so they can influence their suppliers to bring about change that resides outside of their company but rolls directly into what the company delivers to their customers.
A Selected Bibliography
1 Rizza, Mickey North. "Supplier Performance - Reality Check", 2007, p. 9
2 Gordon, Sherry R. Supplier Evaluation and Performance Excellence, J. Ross Publishing, 2008, p. 83.
3 Barrett, Jane and Rizza, Mickey North, "Supplier Performance Management: It's More Than a Scorecard - It's a Strategy", AMR Research Alert, June 6, 2008.
4 Barrett, Jane and Rizza, Mickey North, "Supplier Performance Management: It's More Than a Scorecard – It's a Strategy", AMR Research Alert, June 6, 2008.
5 Gordon, Sherry R., "Getting Senior Management Support for SPM".