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Performance management

Supplier metrics that matter

To be serious about collaboration with strategic suppliers, you need performance measures that reflect the true value of the relationship

 

Autumn 2005

 

by Jonathan Hughes

 

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Leading companies in industries from high-tech manufacturing to pharmaceuticals are starting to look at suppliers in a new light – not just as vendors from whom goods and services are procured, but as business partners with expertise, assets and capabilities that can be used to create competitive advantage. This shift represents an evolution beyond strategic sourcing. It is
the insight behind the emerging discipline of supplier relationship management, with the resultant need to more effectively manage the interactions a company has with its suppliers across functional groups and business units – to mange these interactions as a relationship, rather than as a series of transactions confined to functional silos.

 

If you want more from suppliers, you must change the way you measure performance. Metrics are not sufficient to transform supplier relationships and the value they deliver. Nevertheless, changing what a company measures is a critical step to changing how it views and works with suppliers, and, in turn, maximising the value it creates through its relationships with them.

 

As procurement becomes more strategic, the metrics that organisations have used to measure suppliers and their performance need to be augmented. Metrics need to be defined to evaluate, and ensure management focus on, suppliers’ contribution to business objectives. They need to be used to improve co-ordination and the quality of collaboration between customer and suppliers.

 

This means supplier scorecards can no longer be the sole province of procurement. The definition of supplier metrics and the gathering and analysis of data against supplier scorecards needs to be a cross-functional endeavour. This gives procurement groups an opportunity to interact at a more strategic level with internal business clients by helping them to determine where to leverage supplier assets and capabilities to meet strategic objectives – and then by ensuring that supplier relationships are managed such that greater value is delivered.

 

Why measure suppliers?

 

At many companies, supplier scorecards and performance monitoring have become ends, rather than a means to increase the value gained from suppliers. Procurement professionals and supplier relationship managers spend a lot of time gathering and reporting data to generate reports that provide limited insight, and do little to affect what is being measured. A common indication (and consequence) of this pathology is the tracking and reporting of too many – at some companies, hundreds – of metrics and KPIs. Not only is time and energy wasted in the gathering and reporting of such data, the results are too overwhelming to enable effective analysis and decision-making. This pattern of over-measurement and resultant data overload chokes out the time and attention required to define new, more strategically relevant metrics.

 

So it is worth asking: why are supplier performance metrics important? An answer might be: “To ensure that suppliers perform well.” But how exactly? A common approach is to use metrics retroactively, to apply penalties in cases of sub-par performance to offer incentives for future improvement, or to use metrics to deselect suppliers that fail to meet performance benchmarks – to fix supply problems by changing suppliers. Usually the hope is that the threat of penalties or of switching will encourage suppliers to perform well. While this is true to some extent, it is also true that an uncertain environment discourages investment. Companies that rely mainly on the threat of withdrawing business from suppliers to encourage supplier performance pay a heavy price, though not the kind that traditional metrics are good at highlighting.

 

There is a difference between a threat – “perform well or we’ll take our business elsewhere” – and a collaborative system of measurement-supported accountability: “Here’s what we expect, and we are committed to working with you to help you meet our expectations, and to do so in a way that is sustainable for you – and, if we find we can’t achieve the target level of performance together, then we’ll need to discontinue our relationship.” As has been  documented by Jeffrey Dyer, author and professor at Brigham Young University in the US, the former was the General Motors way during the 1980s and early 90s; the latter was Chrysler’s. The difference in the financial performance of the two firms during that period speaks for itself. 

 

Threat-driven supplier management policies assume that collaboration and accountability are mutually exclusive. Such policies put off suppliers from forming commitment to a customer, and instead encourage a minimalist “perform to the letter of the contract” mentality. They also drive suppliers to use leverage to the detriment of their customers when opportunity arises; they all but ensure suppliers will not invest in developing capabilities to serve such customers more effectively in the future; and they encourage suppliers to take technological innovations and market insights to competitors. Consequently, some companies are adopting a more enlightened philosophy of self-interest, based on joint commitment to shared success, and are pursuing a reputation as a customer or partner of choice with their suppliers (see next Who's the fairest of them all? for more on this).

 

“This does not mean less stringent expectations for our suppliers – often it means the opposite,” says Marcia Glenn, senior vice-president, global procurement, at Kraft Foods. “But it also means we are committed to helping our suppliers be successful. We want to earn access to their best ideas and most talented people by being the company whom they trust most, the one that works with them most effectively to help them improve, and the company most willing and able to share information and resources with them to achieve more than either of us could independently.”

 

Metrics should also be used to provide early warnings of potential trouble, and to facilitate the resolution of problems. The first step in enhancing supplier performance measurement is to think systematically about the different ways that metrics can be used as part of an overall supplier relationship management system, and to define clearly the fundamental purposes of any and all supplier metrics (see table).

 

 

Few companies would admit to selecting preferred suppliers or awarding competitive bids solely on price. Any procurement executive will emphasise that price is only one measure of cost, and cost is only one element of assessing the attractiveness of a supplier. Nonetheless, the reality is that price-related metrics dominate the way most companies view and manage interactions with their supply base. Given that most procurement organisations are still evaluated primarily on their ability to deliver measurable cost savings on an annualised basis, it is hardly surprising that they in turn apply the same narrow span of measurement to their companies’ suppliers (see analysis below).

 

The other dimension of measurement along which most companies devote significant time and attention is what might be termed the operational dimension – quality measures such as parts per million defect rates, service level measures such as time to respond to enquiries, and the like. Most companies focus on measures of suppliers’ operational performance because these are relatively straightforward to track, and because most companies, especially those in manufactured goods industries, have developed reasonably robust electronic systems (usually at the plant level) for capturing data on defect rates, on-time delivery, inventory levels, and so on.

 

Narrow areas of measurement

 

While operational metrics are important, few companies spend adequate time relating such measures to the strategic goals of their business. These areas of measurement emphasis are too narrow. Traditional supplier metrics obscure and discourage potential areas of collaboration with supliers and their contribution, and ignore many forms of financial value that can be delivered through supplier relationships. They also do little to enable companies and their suppliers to assess and improve how well they are working together.

 

Companies such as Kraft Foods are beginning to share more information about their strategic business initiatives with their key suppliers, and engage in joint discussion about how suppliers can contribute and what metrics can be defined to assess those contributions. For example, some key suppliers have research organisations and patent portfolios that rival Kraft’s, so scorecards for those suppliers are being expanded to encompass metrics related to joint product enhancement and new product development. Kraft is also asking suppliers to share more about their strategic priorities to enable both sides to more effectively evaluate opportunities for collaboration and to ensure that suppliers benefit from their relationships with Kraft.

 

In addition to greater focus on strategic contributions and value, most companies would benefit from expanding the financial metrics on their supplier scorecards to include more than just price or total cost (which are relatively easy to measure). Procurement groups should facilitate creative thinking about, and measurement of, all the ways that supplier relationships can contribute to important financial outcomes. These might include incremental revenue generated by a product or enhanced features developed with a supplier that the supplier can amortise across multiple customers.

 

Perhaps the most overlooked category of measurement is that of relationship quality – the nature and efficiency of interactions between a company and its suppliers. As a category of measurement, this involves looking not at what we are doing together, but how; these are procedural measures of our relationship rather than substantive ones. Such metrics are joint or bilateral – they involve assessment of the customer by the supplier as well as the reverse.

 

Why focus on the measurement of such soft and intangible factors? Because the quality of the working relationship between a company and its suppliers has a huge impact on the business value it receives from its interactions with them. For example, a high level of trust between a company and its suppliers makes it more likely that suppliers will invest in research, facilities and so on to better support its customer’s needs. It also increases the likelihood of, and reduces the risk associated with, sharing information about future plans and about marketplace trends, thus enabling customers and suppliers to invest more wisely and efficiently, and to respond more effectively to changes in technology and competitive threats.

 

While there is no ideal set of metrics or a generic scorecard with broad applicability across industries and purchasing categories, the framework opposite (see figures 1 and 2) has proven useful as a way to think about what metrics to put in place with different suppliers. It is a framework that procurement groups can use with their internal business stakeholders to take a broader view of potential areas of supplier value and performance measurement. Operational metrics still matter, but rigorous definition and measurement of supplier contributions to strategic business objectives is also emphasised, along with a broader perspective on forms of financial value. Lastly, explicit focus is placed on the quality of the working relationship (not what we are doing together, but how we are working together, and the perceptions we have of one another – beliefs that necessarily impact what we decide to do together as business partners in the future, as well as how effectively and efficiently we interact).

 

 

This framework also makes explicit the fundamental, but often overlooked in practice, distinction between measures of outcomes (strategic and financial), and predictive measures (operational performance and relationship quality) that are means to achieving business outcomes, not ends in and of themselves. Lack of clarity with respect to this distinction lies at the root of common measurement pathologies: the measurement of myriad operational measures that don’t necessarily correlate with or contribute to business goals; the focus only on outcome measures, such that the ability to affect and actually manage outcomes, is compromised; and the lack of emphasis on measures of the quality of the working relationship with suppliers because they are “soft” and are not directly translatable to dollars and cents.

 

How to use metrics

 

Regardless of how carefully metrics are defined, how elaborate the scorecard, or how sophisticated the data-gathering and reporting system, metrics rarely if ever yield unambiguous answers about what to do. Consequently, it is useful to think of the purpose of metrics as raising important questions and facilitating productive conversations (internally and with suppliers) and providing information to ground those conversations.

 

Steve Rogers, a former purchasing executive at Procter & Gamble and programme director of the Conference Board’s SRM conference, notes that “the human interactions that occur around metrics are the most important element in ensuring improvement and making the right decisions about supplier relationships and how to manage them. That is why the implementation of software tools that capture and enable reporting of data are not enough to turn metrics into actual results.”

 

Because relatively few companies have such a perspective on supplier metrics, most focus their efforts on defining metrics; they spend relatively little time and effort designing and implementing the process by which scorecards are developed and agreed to by internal stakeholders and suppliers, and by which data is gathered, reported and reviewed. In my experience, it is the process a company implements around supplier scorecards that drives performance and results, far more than the specific metrics that are used. Moreover, a collaborative process that engages internal stakeholders and suppliers in ongoing dialogue about what to measure (ideally guided by a common framework like the one offered here and supported by libraries of specific KPIs), and how to interpret and act on what is measured, will eventually yield a useful set of metrics.

 

At one large pharmaceutical company, a cross-business unit committee facilitates the tracking and reporting of metrics designed to highlight areas for supplier improvement or development, to provide early warning of potential problems at suppliers, and to ensure the ongoing health and viability of preferred suppliers. This committee meets quarterly to review and compare key metrics across suppliers to diagnose systemic problems, and to identify new collaboration opportunities and supplier management best practices. The risks and limitations of subjective (but important) metrics that involve individual perceptions and/or human judgment – for example, measurement of the financial value of a supplier-generated improvement in clinical trial data analysis – are mitigated by the fact that such metrics are reviewed by the diverse members of a body representing different constituencies and possessing a broad spectrum of skills and experiences.  

 

A critical function for the internal review of metrics at the firm is to align around a common interpretation of complex data and a consistent set of messages to share with suppliers about their performance. So the next step in the cadence of supplier performance-management activities is for relationship managers to meet their supplier counterparts to review scorecards. During these quarterly meetings, suppliers see how their scores compare with the average of other suppliers. Both sides diagnose the causes of any problems and discuss how they can collaborate, to improve the suppliers’ performance, and to increase the value the supplier gets from the relationship. Focus is also devoted to exploring suggestions that suppliers have for improving how the company works with them.

 

If procurement is to fulfill its aspirations and its promise to be a strategic function in the enterprise, it needs to get serious about defining and reporting metrics of a strategic nature. As sincere as the desire is at most companies to collaborate more effectively with suppliers in order to innovate with them, to access and even share new technology, to create new products, and to re-engineer supply chain processes to achieve major efficiency gains, the reality is that few have a clear vision of how to do so or the organisational competencies and capabilities required.

 

For many, the place to start is to move beyond traditional supplier metrics, to begin to measure the qualities of relationship that enable effective collaboration, and the value of results other than short-term cost savings narrowly defined.

 


 

ANALYSIS: Diagnosing the overemphasis on cost

Over the past 10 years, a gulf has emerged between supply chain theory and practice. Amid increasing talk about collaboration with suppliers to drive innovation and achieve competitive advantage, most companies continue to manage suppliers in decidedly non-collaborative ways, and to focus on decidedly non-strategic goals in their management of supplier negotiations and relationships. Why?

 

Rarely, in my experience, is the gap between rhetoric and reality a matter of hypocrisy. Most procurement groups and their business unit stakeholders sincerely believe that cost is a relatively small piece of the total value equation when it comes to their more important suppliers, and that measures of operational performance, while important, do not begin to quantify the potential value they are looking for from key suppliers. They also believe that the way to maximise the value they get from these suppliers is to collaborate more effectively with them. So why do they continue to select and manage suppliers with such a heavy emphasis on cost?

 

As the old adage goes, if you can’t measure it, you can’t manage it. The corollary for most companies is that whatever you can measure most easily and accurately is what you end up measuring, and that what you measure is what you will end up managing. Cost data is relatively easy to come by and is, on the face of it, unambiguous. And the simplest, though perhaps most misleading, indicators of cost and cost competitiveness are price and spend. Procurement groups and professionals have decades of experience measuring and managing cost and operational performance. So it is no surprise that this is where the emphasis in customer-supplier relationships remains.

 

The other reason that cost in particular (and even more specifically price) is emphasised so heavily in the management of suppliers is because it seems to operate within a short time horizon. (It is worth acknowledging that suppliers too are often complicit, with short-term revenue considerations and narrow and simplistic sales metrics frequently driving opportunistic behaviour that similarly undermines opportunities for more strategic customer-supplier collaboration.) Although less frequently than in the past, I still have procurement executives say to me: “I know if I push hard enough, I can squeeze another 5 per cent price reduction out of my suppliers this year. I can measure that saving; how and when can I measure the value of enhanced collaboration with suppliers?” 

 

I even hear this question from executives (and there are many) who have driven suppliers out of business, and have found that the cost of searching for, selecting, certifying and training new suppliers often vastly outweighs the short-term savings that were extracted – and this is without even counting the productivity and revenue losses that often result as new suppliers iron out quality and production volume kinks. Nevertheless, the hard truth is that short-term savings tend to trump long-term costs and value (even of far greater magnitude), especially when the short-term savings lend themselves to relatively straightforward measurement in dollars and cents.

 

The spirit is often willing when it comes to strategic collaboration with suppliers, but the flesh, when confronted with quarterly earnings pressures and opportunities to reduce spend another 5 per cent by squeezing key suppliers, is weak. Until procurement groups help their companies to change the metrics they use to select, award business to, and manage suppliers – and change the metrics by which they themselves are evaluated – talk of collaboration with suppliers will remain largely talk, and sought-after innovation, as well as truly breakthrough improvements in efficiency and cost reduction, will remain all too exceptional.

 


  

CHECKLIST: Seven principles for defining and implementing supplier metrics

 

1. Measure what is important, not simply what is easy to measure.

 

2. Develop and utilise predictive metrics as well as measures of outcomes.

 

3. Become comfortable with subjectivity and approximations – critical dimensions of measurement (the quality of the working relationship and strategic value) by definition require dealing with individual perceptions and the application of human judgment.

 

4. Situate metrics in a process that facilitates effective dialogue internally and with suppliers: about how to interpret metrics, about how to improve their performance, and about how to improve the quality of supplier relationship.

 

5. Define metrics jointly with suppliers and use them collaboratively, not (only) punitively. Use metrics to diagnose what you each did or didn’t do to contribute to any problems, rather than simply to assign blame or decide whether or not to apply penalties – that is, use metrics to jointly diagnose and solve problems.  

 

6. Share data with suppliers that shows how they compare to their peers.

 

7. Define metrics that enable you and your suppliers to assess the value they receive from the relationship. In the long run, you cannot succeed at the expense of your suppliers – and the long run may not be as long as you think.

 


   

Jonathan Hughes is a director and head of the sourcing and supplier management practice at Vantage Partners, a relationship management consultancy based in Boston (jhughes@vantagepartners.com)

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