3 Managing Suppliers

Note. From Kumar, 2021. Licensed for reuse under the Unsplash License.

Learning Objectives

1. Explain what can be measured in terms of Supplier Performance.
2. Apply different types of supplier performance evaluation techniques.
3. Understand why and how to optimize the supply base.
4. Apply a supplier development process.
5. Understand how to maintain relationships with suppliers.

What Do You Know About Managing Suppliers?

After choosing suppliers to provide all of your goods and services, it is essential to monitor those suppliers to ensure they provide the goods and services as agreed. It is also important to ensure you have the right number of suppliers to minimize risk efficiently. Too many suppliers can be costly in terms of time managing numerous suppliers, and too few suppliers can increase your risk. Replacing poor-performing suppliers can also be costly; working with existing suppliers and developing them can sometimes be a better option. Developing long-term relationships with suppliers is a strategy that can be beneficial to both the supplier and the buyer to improve a supplier’s performance.

Measuring Performance

How do you determine if a supplier is living up to the terms and conditions of their contract?  How do you determine if you want to continue working with a supplier? How do you determine if your supplier is doing a good job? You need to measure their performance.

What Can You Measure?

What you measure can be very similar to what you evaluated when choosing a supplier. You want to measure what is important to you the customer. If price is the most important factor, you want to measure factors relating to price. If quality is important, you want to measure factors relating to quality. If delivery is important, you want to measure factors relating to delivery. How many things you measure and how much time you spend on measuring performance depends on how important the good or service is to the company, how difficult it is to find another supplier, the length of the relationship, past performance, and how much money is spent or volume is purchased with that supplier. Below are considerations to make when evaluating regarding a supplier’s performance (Monczka, et al., 2016)

Delivery

• Correct quantities delivered
• Shipment delivered on time
• Paperwork correct (lot numbers included, packing lists provided, invoices correct, etc.)
• Shipment received in the expected condition

Quality

• Number of rejected or nonconforming shipments
• Samples within control limits
• Quality improvement

Cost

• Comparison with other suppliers
• Cost reduction

Continuous Improvement

• Corrective action response implementation time
• Lead time reduction
• Lot size-reduction
• New- production development support
• Adoption of new technology
• Sustainability initiatives

Other

• Frequent communication/response to a communication
• Buyer/seller compatibility
• Sustainability Measures: Emissions, resource usage, hazardous waste disposal, environmental fines and sanctions, recycling, renewable energy usage, transportation fuel efficiency, environmental certification, and awards

How to Measure?

Once you have decided what to measure you need to decide what technique to use and how to measure. You need to gather the right data. You can gather data from within your company, from the supplier, and from a site visit. When measuring you need a standard for comparison – a benchmark for performance. Measuring each company on a predetermined standard of acceptable performance. There are a variety of techniques to use. Here are some methods for evaluating supplier performance:

Informal Evaluations

Weekly or monthly statuses on suppliers based on feedback from internal customers such as production assemblers, quality inspectors, receiving clerks, accounts payable clerks. The buyer can ask all of these internal customers of products and services from the particular suppliers if their performance is satisfactory or unsatisfactory. You can also evaluate the supplier based on information learned about the supplier in the press, at conferences, during meetings. This method is useful in small organizations where there are few suppliers and buyers are in constant contact with suppliers and internal customers. This method does not work well in larger organizations where buyers are not in constant contact with suppliers and internal customers.

Another type of informal evaluation is doing a roundtable discussion at the executive level annually. Top executives from the buying company and top executives from the supplying company meet annually to discuss past performance, future performance, long-term goals, and expected trends. This evaluation is done mostly for high dollar and critical items. These annual meetings are great relationship builders and create great information sharing and idea-generating opportunities. The downside of these types of evaluations is that it is not feasible for every supplier and evaluating a supplier only once a year may not be enough (Johnson, 2020, pp. 373-374).

Formal Evaluations

Categorical Evaluations

Categorical evaluations require easy categorization or check-offs that describe suppliers’ performances across different categories, including suppliers’ costs, quality, and delivery timeliness (LINCS in Supply Chain Management Consortium, 2017).

Here is an example of a categorical evaluation:

The buying organization needs to decide when action needs to be taken with the supplier according to the evaluation. Action may need to be taken when the supplier has one Needs Improvement. Action may need to be taken when the supplier has three declining periods. Action may need to be taken when the supplier has more than three categories below Good.

The benefit of using this type of evaluation is it is easy and quick to use and as a result is inexpensive to implement. However, this method is subjective. There are no clear definitions of what the definition of the ratings are and subject to what one’s personal opinion stands for. For example, what does “excellent” delivery mean? One rater might think “excellent” delivery is 90% on time where another rater might think 100% on time is required to be “excellent”.

Weighted Point Evaluations

The most common type of supplier performance method is the weighted point evaluation, also called the linear averaging method. This type of performance evaluation chooses categories, assigns weights to each category, develops a scoring system, determines suppliers’ scores within each category, and calculates an overall score for the supplier. (LINCS in Supply Chain Management Consortium, 2017, p. 86). See the below example for the steps involved in a weighted point evaluation:

Example 4.2 Weighted Point Evaluation Evaluation of Company Z for First Quarter 2021

1. Choose the categories to be evaluated.
   • The categories for Company Z will be: Delivery – On Timey, Delivery – Correct Quantities Delivered, Quality – Number of Rejects, Cost – Comparison with other suppliers, Communication, Corrective Action Response.
2. Choose the weighting of each category as a percent.  Each category can have a different weight.  The weight of the category reflects the importance to the buying organization.  The total of the weights needs to add up to 100%.
   • The weighting for Company Z will be as follows: Delivery – On Time (15%), Delivery – Correct Quantities Delivered (15%), Quality – Number of Rejects (30%), Cost – Comparison with other suppliers (20%), Communication (10%), Corrective Action Response (10%).
3. Choose a well-defined, quantitative where possible, scoring system for each category.
   

   Table 4.2 Scoring System for Categorical Evaluation of Company Z

   Score	Category: Delivery – On Time	Category: Delivery – Correct Quantities Delivered	Category: Delivery – Quality – Number of Rejects	Category: Cost – Comparison to other suppliers	Category: Delivery – Communication	Category: Delivery – Corrective Action Response
   5	All shipments on time	All shipments have correct quantities	No rejects shipments	Price less than all other suppliers	Supplier responds within 24 hours 100% of the time	Corrective Action is taken within 30 days 100% of the time
   4	Up to 5% of shipments late	Up to 5% of shipments incorrect	Up to 3% of shipments rejected	Price the same as the lowest-cost supplier	Supplier responds within 24 hours > 90% – 99% of the time	Corrective Action is taken within 30 days >90-99% of the time
   3	>5% – 10% of shipments late	>5% – 10% of shipments incorrect	>3% – 6% of shipments rejected	Price no more than 3% higher than the lowest-cost supplier	Supplier responds within 24 hours >80% – 89% of the time	Corrective Action is taken within 30 days >80-89% of the time
   2	>10% – 15% shipments late	>10%- 15% of shipments incorrect	>6% – 9% of shipments rejected	Price is >3% – 5% higher than the lowest-cost supplier	Supplier responds within 24 hours >70% – 79% of the time	Corrective Action is taken within 30 days >70-79% of the time
   1	>15% – 20% shipments late	>15% – 20% of shipments incorrect	>9% – 12% of shipments rejected	Price is >5% – 10% higher than the lowest-cost supplier	Supplier responds within 24 hours >60% – 69% of the time	Corrective Action is taken within 30 days >60-69% of the time
   0	>20% shipments late	>20% of shipments incorrect	>12% of shipments rejected	Price is >10% higher than the lowest-cost supplier	Supplier responds within 24 hours <60% of the time	Corrective Action is taken within 30 days <60% of the time

4. Score each category for the supplier. This scoring is based on data from the supplier, information from the buying organization, and outside research.
   •  Through the research of the buying company and Company Z the following data was found and resulted in the following scores:
     • • Average delivery rate: On-time 95% of the time. Results in a score of 4.
       • Correct quantities were delivered 93% of the time. Results in a score of 3.
       • Quality – 3% of the shipments are rejected. Results in a score of 4.
       • Cost Comparison – Price is the same as the lowest-cost supplier. Results in a score of 4.
       • Communication – Supplier responds 80% of the time within 24 hours. Results in a score of 3.
       • Corrective Action –  Taken with 30 days 80% of the time. Results in a score of 3.
5.  Calculate the weighted score for each category and total the overall weighted score for the supplier.
   

   Table 4.3 Weighted Score for Company Z

   Category	Weight	Score	Weighted Score
   Delivery – On Time	0.15	4	0.6
   Delivery – Correct Quantities	0.15	3	0.45
   Quality – Number of Rejects	0.30	4	1.2
   Cost Comparison	0.20	4	0.80
   Communication	0.10	3	0.30
   Corrective Action	0.10	3	0.30
   Total	blank	blank	3.65

6. Decide which scores result in follow-up or development activities with the supplier. For Company Z: Scores >=4 and <=5 no action required, Scores >=3 and <4  follow up with supplier regarding the requirement to improve performance to a 4 by next period, Scores >=2 and <3 suppliers are put on a supplier development program, Scores  <2 suppliers are candidates for removal from the supply base. Suppliers who have their score decline in 3 consecutive periods are also candidates for supplier development.   Based on the overall score and this rating system we have calculated for this supplier, we would send a warning to improve performance and they would be on watch to make sure they do not consistently decline in performance and need to be put on supplier development.

The weighted point evaluation system is a much more quantitative and objective method than the categorical method resulting in a more accurate evaluation of performance. However, it does take more time to develop, requires more time and effort to collect data, resulting in a higher implementation cost and cost of use. It is still subjective in terms of the creation of weighting and the creation of scoring criteria. It also is not a one-scoring system fits all system. It should be adapted and modified for different types of goods and services.

Cost-Based Evaluations

Cost-based evaluations can be used to evaluate supplier performance by determining the total cost of using a supplier. (Supply Management and Procurement Certification Track, 2017, p.85). By determining the total costs of using a supplier a  Cost Ratio can be calculated. The cost ratio considers the initial purchasing costs plus the internal operating costs associated with the particular product or service. Internal operating costs can be nonconformance costs, quality, expediting costs, late delivery costs, and service costs.  The higher the cost ratio the poorer the performance of the supplier. The cost ratio can be calculated as follows (Goh, 2018) :

Cost Ratio = (Purchase Cost + Internal Operating Costs) / Purchase Cost

Example 4.3:  Supplier A has the following costs associated with buying Widget Z and operating using Widget Z

Cost Ratio for Supplier A = ($1,130,000 + $48,150) / $1,130,000 = 1.04

The buying company then needs to determine a good Cost Ratio and a Cost Ratio that causes concern. For example, the buying company may have these parameters in place:

• Cost Ratio of =<1 .05 no need for concern,
• Cost Ratio of >1.05 <=1.1 warning sent to supplier that they need to assist in decreasing operating costs and get Cost Ratio under 1.05
• Cost Ratio of >1.1 <= 1.2 supplier development measures are put in place
• Cost Ration of >1.2 supplier is a candidate for removal
• A supplier who has 3 periods in a row of increasing Cost Ratios will either be sent a warning to assist in decreasing operation costs or put on supplier development.

Supply Base Rationalization

LINCS in Supply Chain Management Consortium (2017) identifies Supply Base Rationalization as:

Primarily aimed at determining the appropriate number and mix of suppliers for all organizations. This process is ongoing as organizations’ needs change over time, and it involves analyzing the number of suppliers required for current and future needs of purchased items and/or services. Supply base rationalization focuses on developing the best blend of suppliers, given organizations’ requirements. The intention is to identify the best values and the appropriate number of suppliers for all commodities, based on overall business strategies” (p. 39).

If you have too many suppliers you may be spending too much money and time managing suppliers and not enough time strategizing with fewer suppliers to lower costs and improve quality and delivery. You do not want to have too few suppliers as you are increasing your risk of supply disruption due to natural disasters or suppliers going out of business. Also, too few suppliers give suppliers greater power when it comes to negotiations and contract renewals.

Here are some methods you could use to optimize your supply base.

Pareto Analysis

You could optimize your supply base using a Pareto Analysis, also called an ABC analysis or twenty/eighty rule, to identify 20 percent of the suppliers receiving 80 percent of the supply spend and eliminate the rest. Alternatively, analyze the supply base based on quality to identify 20 percent of the suppliers that cause 80 percent of the problems and eliminate them. You need to be careful using this method as you cannot eliminate suppliers who provide items that no one else can, have the potential to become excellent suppliers or have the capabilities to provide more products or services.

Watch this video on how to use a Pareto Chart.

HarvardX. (2017, April 19). How to use a Pareto chart [Video]. YouTube. https://www.youtube.com/watch?v=ltBw6kwD3_o.

Example 4.4: A spend analysis on suppliers to determine which suppliers may be candidates removal based on low spend amounts. 

A company manufactures automotive components.  Here is a list of suppliers and parts they buy along with information on annual usage and unit cost.

We could summarize from this example that we could get rid of all Class C suppliers to reduce our supply base in half. This would reduce administrative time in dealing with half the number of suppliers. However, the A and B suppliers may not be able to supply the products Class C suppliers provide. This also increases our risk to supply chain disruption. This is a very simple example with few suppliers. However, it illustrates how an analysis can be done to look at possibilities in reducing the number of suppliers.

Supplier Performance

Based on the evaluation of supplier performance we discussed in the previous section we categorize the suppliers into one of three categories:

1. High – Quality supplier requiring no improvement assistance.
2. Development – Supplier has not consistently met the required performance measurement and is a candidate for supplier development.
3. Unacceptable – Supplier is a marginal performer and is a candidate for removal.

Example 4.5: Referring back to examples 4.1 to 4.3 on supplier performance, each method has been categorized into what is High, Development, and Unacceptable and what the example would be categorized as.

Supplier Development

What is Supplier Development?

Watch this video on supplier development:

Skill Dynamics. (2012, March 20). Supplier development course: What is supplier development – Procurement training – Purchasing skills [Video]. YouTube. https://www.youtube.com/watch?v=5V2kMFLUMCo

Supplier development represents buyers’ activities or efforts to improve the performance of their suppliers. This process is a major component of the supplier management process. In the past, it was common to work with many suppliers, but the prevailing view today is to work with fewer and fewer suppliers because it is more efficient to manage and engage in value-creating activities with a comparatively small number of primary suppliers.

Most supplier development activities in the U.S. have been reactive, in that suppliers tend to react to problems that require immediate attention after they happen, whether they involve late delivery, poor quality, or increasing supply costs. It is preferable, however, to focus on preventive activities such as identifying quality improvement opportunities on the supplier’s side to help prevent those problems from occurring in the first place.

Historically, supplier development has been most often applied to under-performing suppliers. When working with higher-performing suppliers, the objective is primarily to develop additional and advanced supplier capabilities like designing or providing new products and services. Supplier development efforts fall primarily into three broad categories:

1. Working with suppliers to improve existing performance capabilities.
2. Resolving problems with an existing supplier’s capabilities.
3. Working with suppliers to create performance capabilities where none previously existed.

Any initiatives designed to improve supplier performance are considered part of supplier development. Examples of development techniques include providing education or training programs, enhancing working relationships with suppliers to promote joint improvement efforts and information sharing, and providing direct financial support. Other types of supplier development include providing suppliers with onsite support personnel, process equipment, and technology.

Supplier development also may introduce risk. These risks can include buyers making financial commitments to suppliers and development efforts failing to produce anything of substance. Another example of risk can occur when buyers work to improve suppliers’ performances, but other customers—perhaps even competitors—also benefit from the suppliers’ improved performance. For example, benefits derived from improved supplier performance resulting in reduced cost or improved quality might also be passed on to that supplier’s other customers, who could be competitors of the company that invested in the supplier development efforts.

Supplier development, particularly when the focus is on developing new performance capabilities, may also create new and more powerful suppliers that can eventually become competitors. Another example occurs when a supplier’s enhanced performance capabilities make it attractive for a takeover by other companies that are not sympathetic to the supplier’s current buyers.

Factors Critical to Supplier Development Success

As is true of any initiative, it is critical to identify the key attributes that define success. Here are examples of what critical success factors (CSFs) entail:

Executive Commitment

Major initiatives may fail if they do not have senior-level executive commitment. For supplier development, this also includes a commitment from buyers and suppliers. Buyers’ executives show their commitment by making resources like funds and personnel available to support development efforts. Suppliers’ executives demonstrate their commitment by supporting the goals of the development actions, such as reduced costs, improved quality, and improved delivery timeliness.

Trust-Based Relationships

A number of years ago, a major company began to pursue its own version of supplier development. This involved sending a team to visit a supplier for a week to make plant layout changes. At the end of the week, the buyer demanded double-digit price reductions from the suppliers. Soon, the suppliers began to fear these visits from these buyers. The complete lack of trust that characterized this buyer-seller relationship was a major inhibitor to the success of the development initiatives. As with other processes, supplier development requires trust-based relationships to be successful. Without trust, the probability of openly sharing information diminishes.

Data and Measurement

Financial and other resource constraints ensure that most companies can only engage in a limited amount of supplier development activities. This requires companies to be careful about where they allocate their resources. In making such decisions, buyers must determine which suppliers offer the best development opportunities, which suppliers are not worth the effort and should instead be candidates for replacement, and what performance measures are in place to verify the success of any efforts. Many companies will use their supplier scorecards to help identify development opportunities. In theory, this sounds reasonable, but according to Trent (2010), far too many companies have poorly designed scorecards that are of limited use.

Financial and Personnel Commitments

Supplier development is driven largely by people, so it often relies on process engineers, quality personnel, logistics personnel, and others to be part of development efforts, often working directly at supplier locations. Unfortunately, few organizations have people committed specifically to supplier development activities, which means that supplier development competes for personnel and financial support with other business endeavors, including employees’ regular job responsibilities. Without adequate personnel support, supplier development initiatives are likely to be severely limited or completely unsuccessful. Additionally, supplier development usually requires travel and financial commitments.

Credibility

Buyers that initiate supplier development should have credibility with suppliers, who must perceive that buyers have expertise in their particular subject area. For example, if a supplier provides engineering design services to customers, the buyer may also assign engineering design personnel with skills complementary to those of the supplier.

Power Relationship

Power represents the ability to exert influence over other parties. Supplier development usually features larger buyers working with smaller suppliers, so this size difference usually enables buyers to approach suppliers about supplier development. Smaller customers can also approach larger suppliers, but this is not as common as the converse, because these smaller customers do not have the majority of the power in the relationship, which makes it more difficult to influence larger suppliers with a view to engaging in supplier development efforts.

Watch this video to learn more about supplier development capabilities.

Walton College Supply Chain Management. (2020, April 5). Supplier development capabilities | SCMT 4653 [Video]. YouTube. https://www.youtube.com/watch?v=uFeBWQ2WvfY

Maintaining Procurement Relationships

In an ideal world, the contract resulting from a procurement process is a formal expression of a trusting relationship that already exists between two parties. Even in a less-than-ideal world, to achieve the best possible results, it can be helpful to think of procurement as a relationship-building process, one that can span many years. It is a form of networking that inexperienced engineers might dismiss as mere schmoozing but is in fact a means of identifying and cultivating the people and organizations who can help you complete your existing projects, develop opportunities for new ones, and advance your career over the long term. A conversation you have with a potential client at a conference might lead to lunch six months later when you both happen to be in the same airport, which could, in turn, spark an idea for a new project that might only come to fruition half a decade later.

Of course, you need to balance the positive focus on building effective relationships with the need to avoid inappropriate preferences for business partners, which can lead to the unethical practices associated with nepotism, such as kickbacks, bribes, overpricing of supplies, and other unethical practices. By working to get to know potential business partners over time, you can find out if their organization’s culture and ethics, as well as their goals and needs, are a good fit for yours. As management consultant Ray Makela (2019) explains, this kind of knowledge can be vital in determining if a proposal is a good fit for your company:

Culture fit and ethics are difficult to assess in an RFP, but are one of the most important “intangibles” that can make a difference in who the organization engages with initially and who they continue to do business with in the future. Understanding the culture of the organization and demonstrating behavior that indicates ethics, collaboration, and communication can go a long way to cementing a relationship for the long term. (para. 11)

Even if you are not currently responsible for any procurement tasks, you’d be wise to get to know the people in your organization who do manage procurement. In an article for Supply Chain Management Review, Paul Mandell (2016) discusses the unexpected cost-cutting benefits of cultivating relationships within your organization: “[o]nce you have a strong rapport with peers throughout the company, it is increasingly likely that you will gain insight into potential economies that were not otherwise obvious to you” (para. 5). If you lack the people skills for creating and nurturing these types of relationships, you might want to focus on improving your emotional intelligence.

Key Takeaways

Management thinker Peter Drucker is often quoted as saying that “you can’t manage what you can’t measure.” (Lavinsky, 2021). Managing suppliers takes discipline and effort.  It is important to measure supplier performance to make sure they are fulfilling their contracts and to make sure they continue to improve. There are many factors of performance you can measure. It is important to focus on measuring what is important to the buying organization and to use a technique that fits with the strategic direction of the buying organization,  the amount spent, and the resources available to measure supplier performance. Measuring a supplier’s performance can help in optimizing the supply base. Poor-performing suppliers can be eliminated based on their poor performance or their small sales volumes with the buying organization. Reducing the number of suppliers frees up resources to spend on high-performing suppliers and suppliers that are candidates for development. Although reducing the supply base too much does increase supplier risk. When evaluating a supplier’s performance suppliers can be identified as requiring development. Putting the supplier through a supplier development process will help improve your supply base. Through the procure-to-pay process, it is important to maintain good supplier relations. Maintaining positive supplier relations will help promote cooperation, investment and improvements buy the supplier. 

Review Questions

1. What can be measured to evaluate supplier performance?
2. What are the different methods used to measure supplier performance?
3. How can you rationalize the supply base?
4. What are the three reasons to develop suppliers?
5. What are the benefits of maintaining good procurement relationships?

Check your understanding of this chapter’s material by completing this quiz:

References

LINCS in Supply Chain Management Consortium. (2017, March). Supply management and procurement certification track. Version: v2.26.  https://www.skillscommons.org/bitstream/handle/taaccct/14294/LINCS%20Supply%20Management%20and%20Procurement%20Content.pdf?sequence=1&isAllowed=y.  

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