Wednesday, April 15, 2009

“The Weakest Link” or Why Supplier Management Is (Still) Important - by Stephan Brackertz

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In economic times like these, where do we invest our supply chain resources (or what’s left of them)? Clearly, we will want to invest them where we get the most “bang-for-the-buck.” That is, where we get the most result in a dollar-for-dollar comparison of investment options.

When we compare our options on what to tackle next in the supply chain, it is important not to lose the perspective on the total supply chain. OEMs can spend a lot of time on optimizing their own network, but neglect the interfaces to the remaining value chain, for example suppliers and dealers.

The Weakest Link

Any Formula One mechanic will know that engine power is only as good as how much of it you can actually get on the road. At a certain point, it is better to spend that extra hour of mechanic time on tires, tuning and aerodynamics rather than on the engine itself. The engine in this example is our internal network which we may have tuned quite a bit. Maybe it’s worth spending some mechanic hours on things like supplier management? At this point, the weakest link in your race car set up may very well be how you handle suppliers.

While every OEM already handles suppliers in one way or another, the benefits of doing supplier management well are enormous. This needs to be pointed out explicitly, because the voices inside the organization may tell us that supplier management is already being taken care of, that it is not an issue. I suggest that you challenge these voices. This will be especially worthwhile where supplier management programs are weak, or where supplier relations are currently handled single-handedly by your [Global] Purchasing Group.

So, how do you know if you have a supplier management problem? Do any of these sound familiar?
  • Your suppliers think “on-time” means whenever they get around to shipping
  • You find out that a supplier is late only when you run out of inventory in the warehouse
  • Your supplier requires you to order a minimum of 200 pieces at a time (which was just fine for production), even though you only sell about 30 pieces/year
  • You spend far too much time and cost repacking the parts the supplier ships to you
  • The minute a part goes out of production, piece prices skyrocket and service plummets

If none of the above sounds familiar, pat yourself on the back for being one of the few OEMs that has this portion of their supply chain under control. If however you find yourself nodding, rest assured that you are not alone.

Why do so many of us find ourselves in this position? It usually is a combination of three factors:
  1. We don’t tell the supplier what they have to do to support service parts
  2. We do tell the supplier what to do, but don’t really do much about it if they ignore us
  3. We tell the supplier what to do, we expect them to do it, but we have no way to monitor whether they’re actually following through

How Much Money Are We Talking About?

Our data shows that OEMs with strong supplier management have reaped large benefits on their investment. The dividends come in the form of lower inventory, fewer and shorter backorders, lower supply chain volatility, and higher dealer satisfaction. The dirty little secret here is that the investment doesn’t actually need to be very large to start seeing those dividends!

Let’s look at what moving the needle on supplier management means in dollars and cents. A simple comparison of companies with good supplier management vs. those with poor supplier management is quite revealing. Let’s take one of our conference metrics as a proxy of supplier management: percentage of supplier purchase order lines that were received “on time.” We’ll put companies with 70% on-time performance or more in the “good” bucket, and those with less than 70% on-time in the “poor” bucket. We’ll also agree for a moment not to get tripped up about how companies define the size of the “on time” window (we looked at the companies in the good group and the poor group and our industry knowledge tells us this is a pretty accurate assignment).

Now, the bottom line is in the difference between the “good” group and the “poor” group (see the table):
  • 2.3 fewer months of inventory, measured in months of supply
  • 33% smaller average backorder portfolio
  • 7 day shorter backorder duration

For a company with $1 billion in parts sales at dealer net, this amounts to over $190 million less in inventory. Measured at acquisition cost, and applying a 12% holding cost this amounts to a saving of roughly $11.4 million per year. Not bad at all – in terms of magnitude this is like taking out 10% of your supply chain costs. In addition, a smaller backorder portfolio will lead to fewer lost sales to the aftermarket. It’s a bit squishy to quantify, but for the same $1 billion company, this impact is roughly equal to another $5 million in profits. Overall, our example company would have increased profits by $16.4 million1.

Further, this estimate doesn’t even begin to include incremental costs associated with processing backorders/referrals, repack, excessive min order quantities, etc. All together, we’re looking at increased profits of over $20M for every $1 billion of sales…Given this, why wouldn’t everyone work on supplier management?

We Have Met the Enemy, And It Is Us

Historically, where supplier management has been controlled single-handedly by Purchasing, the result for aftersales has often been disastrous. The typical purchasing “piece price” incentive system is the primary culprit: with the majority of the piece volume flowing to production, Purchasing focuses all of their energy there, in order to show big unit cost savings. As such, we encounter our first problem – “we don’t tell the supplier what to do.”

Unfortunately, aftersales requirements are a whole different animal from production - smaller, less frequent, less predictable volumes, packaging, labeling, minimum order/set-up fee implications, etc. When these issues are not considered up-front by Purchasing, aftersales often pays dearly, in terms of increased costs (labor, transportation, and inventory) and lower service levels (backorders, referrals, etc.).

Even where Purchasing makes a commitment to support aftersales needs, this often amounts to empty words. The classic approach – selecting a new supplier for production and getting them simply to agree to “support service parts” (don’t worry, we’ll come back later and give them the details) – has never worked in our experience. We usually don’t go back to the supplier, and when we do, we have absolutely no leverage. Thus, the “we tell them what to do, but don’t do anything if they ignore us” syndrome.

Instead, Purchasing, Production, and Service Parts must be on the same page, with an integrated supplier approach. Suppliers need to be told both production and service parts requirements before bidding on the work, and should be selected based on their combined proposal. Further, acceptable support to service parts needs to be explicitly described (on-time delivery requirements, acceptable lead times, packaging, out-of-production pricing changes, etc.), with the threat of additional production volume tied to their support of service parts.

Plow Through Superficial Objections

Sounds easy, huh? But not everybody will welcome enthusiasm for improving supplier management. Probe, question, and plow through superficial objections. Big dollars signs are the reward for this as we have seen. It’s natural to hear statements like these from the people that handle supplier relations currently:

“We already have a supplier management program”: The pure existence of a program doesn’t mean a lot. Ask for performance metrics. Compare them to industry benchmarks.

“We must be good because our inventory is low”: Correlation is not causation. Lower inventory is a result of supplier management. But it is not an indicator of good supplier management.

“We don’t have a lot of backorders”: Take a look at backorder duration, long backorder resolution time is more detrimental than backorder quantity.

“We can’t improve performance until we implement the new software”: This is a typical sign of the “waiting for the Messiah” syndrome. Ignore all the reasons why it can’t be done today, ask for at least one option of how it could work today.

Unlearning and Re-Learning

OK, let’s say you get past the hard part and get your company internally aligned to optimize your supplier management process. What’s next? How do we actually work with the supplier to improve their performance?

Sometimes the hardest thing for us folks in the industry is to “unlearn” what we have learned previously. Let’s debunk some myths about supplier management that have been proven wrong by recent experiences in this area. All of the following statements are untrue:
  • You have your suppliers’ undivided attention (It’s actually divided across several customers. The biggest and loudest customer gets the most attention).
  • Suppliers meticulously read and remember all of your OEM communications (They don’t if it’s the typical long winded corporate laundry list).
  • A supplier commitment to a problem resolution date solves the problem (Look at the number of supplier commitments that were subsequently not met).
  • Demanding really small lot sizes from suppliers reduces your costs (It does not, it pushes inventory from you to the supplier, for which you eventually pay somewhere).
  • Threatening a supplier with financial penalties for underperformance works (It does not unless you have the guts to actually live up to your threat).
  • Vendor managed inventory is the ideal situation to move to (This is the flavorful Chupa Chups lolly that 3PLs like to wave around. VMI may be good, it may be bad. It depends on the situation).
  • Supplier performance improvement requires that whiz-bang software from a three letter software company (Not really, there is a lot you can do without software).
  • Improving supplier management requires a lot of investment (It does not, as we will see below).

Do It Now!

So, how can we quickly move the needle on supplier management? Here is some guidance for some immediate quick-and-dirty “do it now!” action…

First, make sure these prerequisites are in place: One prerequisite is clearly designated staff that is assigned to supplier management (yes, supplier management is a full time job). Another prerequisite is to measure supplier performance and make those measured results very visible inside the organization (no matter how discouragingly poor performance may be today). The third pre-requisite is culture. To be successful, your employees must buy into a vision of working with suppliers, not against them.

Second, you should do Pareto analyses. In fact, the Italian economist Vilfredo Pareto got it exactly right by saying that you need to focus on the 20% that lead to 80% of the results. Pareto invented a nice way of graphing key accounts which made him famous. For supplier management, this means focus your time on key suppliers and you will get most of the results. You should do two Pareto analyses: which are your top suppliers in terms of volume? Pick the top 15 suppliers (you will likely have 10-20 large ones). Next, you should Pareto your backorders. Which are the part numbers that are creating the biggest problems with backorders, and which suppliers are responsible for them? Then run these lists up against each other and make a consolidated list of priorities. Assign specific staff to specific suppliers on the list.

Third, work with the suppliers on your list of priorities. Frequently call suppliers and talk about delivery promises, actual performance, and targets missed. This is a version of the “squeaky wheel gets the oil” theory. You would be amazed at how simply more attention can lead to simply more results. For each supplier failure, insist your supplier give you firm commitments on when the issue will be resolved. Keep a dialogue with the supplier on how issues can be resolved and how you can help.

Don’t despair if supplier relationships are handled by purchasing today. There are plenty of ways to make improvements even in this case. You can add a lot of value by going back on already signed contracts to integrate aftersales with an addendum. Believe me, anything caught in the contract will be better than what the supplier quotes you later for things that are not in the contract.

This type of prioritized action will yield results fairly quickly and is a worthwhile task to kick-off internally.

Supplier Management 101

Once we’ve started the quick-and-dirty, however, how do we build something more robust and sustainable? The next steps are to put in place the six pillars of a strong supplier management program. These include:
  • Supplier set-up
  • Proactive management
  • Reactive management
  • Purchasing
  • Supplier cost management
  • System backbone/Infrastructure

Send me an email at if you would like details on these pillars and related best practices.

The Bottom Line

While every OEM does supplier management in one way or another, the benefits of doing supplier management well are enormous. If you are thinking about which activities to tackle of this year, I strongly suggest improving supplier management. Supplier management is often a weak link in your supply chain, its bang-for-buck potential is huge, and a scrappy “do it now!” operation can help you make the rubber hit the road immediately. Simply go to where the “bang-for-the-buck” is.

1 For those readers that will now use “ifs” and “buts” to reduce the magnitude of the estimate in this example, my reply is that we have also not yet added in the value of lower supply chain volatility, dealer satisfaction, and end-customer loyalty.

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