Tuesday, August 31, 2010

Best Practice: Supplier Report Cards

By Dr. Barry Lawrence, Texas A&M University

Senthil Gunasekaran, Texas A&M University

Pradip Krishnadevarajan, Texas A&M University

Wholesaler-distributors run complicated business models. The intricacies of business relationships combined with significant deployed assets makes for expensive operations. Operations expenses are driven by relationships, however. Suppliers have capacity and customers have needs. It is the mismatch between the two that creates the need for distributors and their capabilities. Most of our blogs to date have dealt with managing the customer relationship and methods to minimize its impact on operations. In this blog post, we address supplier impact and the use of the best practice tool — the supplier report card.

The current No. 1 best-selling NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and return-on-investment (ROI). These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we have introduced a best practice and how it can improve earnings and/or ROI under current economic conditions. We encourage you as you participate in this blog to ask questions, debate results, and offer your own experiences with such practices, so that we may further the knowledge of the community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING and SUPPORT SERVICES) based on various distributor asset categories. This month, we focus on SOURCE as shown in exhibit 1.

Best Practice: Supplier Report Cards

Supplier report cards are not a new concept, but how firms use them often falls short of best practice. In the supplier relationship, the most important criteria are the profitability the products/services provide, as well as the loyalty, performance, and level of services a distributor needs to offer to sell its product.

Exhibit 2 presents a Supplier Stratification model that demonstrates how to evaluate supplier relationships.

The profitability of products/services is a function of the supplier’s quality and innovation combined with the strength of the brand. Supplier loyalty is usually measured by the level of exclusivity the supplier gives to the distributor. If the supplier will sell to anyone and everyone, the competition will drive out all profitability. Distributor services are the levels of support a distributor must provide for less than cost to drive sales of a supplier’s product. Technical support, warranties, repair, and other services often cost more than the customer is willing to pay. Each of the foregoing can be tied directly to ROI, but the numbers are often soft.

Supplier performance, on the other hand, can be directly tied to expenses and asset efficiency (hard numbers). Some key metrics are lead time, variability of that lead time, incomplete orders, quality issues, and other channel specific ones. Performance metrics can usually be captured easily and placed in a supplier report card to assist in process improvement. The practice levels for supplier performance measurement are as follows:

COMMON practice: (1) No defined performance measurement (2) Based on on-time delivery (reactive measurement only) and quality

GOOD practice: Based on a single factor (1) On-time delivery (2) Lead time (3) Quality and delivery completeness

BEST practice: Based on multiple factors (1) On-time delivery (2) Lead time (3) Quality and delivery completeness (4) Lead-time variability (5) Combination methodology-supplier performance index (SPI)

To be clear, a supplier report card is a collaborative effort where a distributor is seeking to create an awareness of improvement opportunities. There are multiple ways a supplier can respond to a report card. One method is to wad it up and throw it away.

A second method, the theoretically correct one, is to proactively use the information to improve its processes for all customers.

A third method is to leave things as they are and make it up to a distributor. Some suppliers will simply make sure the distributor, who is measuring them, gets better treatment at the expense of other customers. Others will compensate the distributor for the cost of covering their failures. These cases often reflect challenges the supplier cannot overcome.

Case Studies

A distributor of automotive parts was having problems with supplier performance. The distributor had the foresight to reach an agreement with its suppliers on the length of lead times and their variability. Each supplier gave a stated lead time plus or minus a certain amount of time (variability). Later, when the distributor started measuring, it discovered safety stocks were running 38% higher than the supplier’s stated lead times should have required.
The distributor issued the report to each supplier. Some of the suppliers improved their performance, but most indicated that foreign demand (remember this was during the massive expansion of China and India demand for cars) was creating significant backlogs. These suppliers offered instead to directly compensate the distributor through rebates until the problems could be resolved.

Many readers may be thinking their suppliers would never do such a thing, and that this distributor must have had so much power that the suppliers were forced into action. This was actually a midsized distributor dealing with large suppliers, however. The suppliers were more concerned about what their performance failures might do to the distributor’s ability to support the end users.

An example that demonstrates how much impact reporting results can have is one about a small fishing distributor. This distributor had annual sales of $3 million and was dealing with a $3 billion supplier. The distributor discovered through inventory stratification that 80% of the supplier’s products were in the “C” and “D” categories. The distributor couldn’t buy in smaller quantities due to minimum order amounts, and line-card restrictions forced it to carry the slow-move items. The distributor decided to drop the supplier.

To the distributor’s surprise, the local supplier sales rep decided to investigate why the line was dropped. When he found out why, he asked for the data and an explanation of ways the supplier could improve. The distributor explained about the line-card rules and minimums. The sales rep took the information back and, through new minimum requirements and a different incentive program, was able to design a process that worked.

In retrospect, the response is not so surprising. This distributor was well known by peers for cutting-edge best practices. The word would have gotten out at the next fishing show and could have damaged the supplier’s reputation.

Bottom Line

The supplier report card adds value through either reduced inventory or other service costs or direct compensation from suppliers. The investment is minimal (make up a report) and so is the risk. Whatever the supplier does will be beneficial. Ever since quality management made its way into the manufacturing environment, suppliers have been using metrics to improve their operations. The supplier report card will be viewed by most as an opportunity. Those who do not will simply ignore it — a pretty good ROI with low risk.

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in comments and e-mail this blog to other interested parties.

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