Essential Steps to Manage Supplier Performance

Written by Song Fang, DPSM

by Song Fang, DPSM

Supplier performance management is the practice of measuring and analysing the performance of a suppliers to understand the cost, quality and risk impact on the business. Supplier performance can have a direct impact on the profitability of a business as most companies depend on timely delivery, price reduction and service quality to increase profit.  Hence, there should be an efficient mechanism to measure and improve supplier performance.

There are two key aspects of supplier performance management.  The first is to know if the suppliers meet the performance targets as specified in contracts.  The second is working with suppliers to identify performance gaps and improvement actions.

 Categorising Suppliers

A business may work with tens to thousands of suppliers for parts, raw materials and services. Therefore, it is not realistic to manage the performance of every supplier.  Hence, it is essential to segment the supplier base.  One method of segmenting supplier is the Kraljic Matrix. In this method, suppliers are classified based on their impact on profitability and supply risk. For example, suppliers that provide items with high profit impact and high supply risk are categorised as strategic suppliers. Another method is to look at the annual spend on a supplier, the volume of goods/services supplied and the value of supplier innovation. Suppliers that bring innovation are strategic suppliers. Suppliers that are essential for the operational needs are considered important.

Clear Internal Policy for Suppliers

Clear procedures are needed so that procurement processes are executed efficiently. These SOPs cover all purchasing operations such as supplier qualification, stock reorder, RFQ, contract negotiation etc. By establishing clear work flows, we can attribute failure in supplier performance to the correct cause rather than poorly-defined internal rules and procedures.  One example is a late delivery caused by failing to order on time, which can arise from not having clear reorder guidelines.For supplier performance management, frequency of performance and target review, and tracking methods of supplier issues and improvement actions must be defined for it to succeed.

Getting Higher Management Support

Management sponsorship is one of the keys to a successful supplier performance management program. Management involvement is important as it ensures that monitoring of supplier performance is aligned to corporate goals.  For example, as businesses place greater emphasis on corporate social responsibility, the same is expected of suppliers.  Another role of higher management is the regular review of key suppliers’ performance.  Regular meetings between management is useful in deciding future collaboration strategy and policy.

Developing Supplier Performance KPIs

To know if a supplier is meeting the performance criteria, we need to develop a set of indices to monitor the supplier performance. The KPIs should cover all aspects of supplier performance and are aligned with the corporate goals.  Besides the traditional areas of quality, cost and delivery, the KPIs should include innovation, responsiveness, CSR compliance and risk management.  For risk management, some companies mandate that key suppliers have a business continuity plan so that they are not impacted in a disruption.

Incorporating Supplier Performance KPIs in Contract

After we segment the suppliers and develop the performance indices, we need to decide on the KPIs and targets. The decision of which KPIs to be included and the targets in the performance monitoring should be discussed during the contract negotiation with the supplier. Once the KPIs are finalised, they must be stated explicitly in the contract to obtain the level of commitment from the suppliers as well as to form a basis for future discussions.  It is also important to emphasise the need for continuous improvement during the negotiation. We must also specify in the contract the penalties that are taken in the event that the KPIs continuously are not achieved.

Assessing and Monitoring Supplier Risk  

Performance management also implies understanding the risks posed by a supplier to the business.  These risks can come from environmental/safety non-compliance, poor financial management or lack of information security controls. Supplier EHS, CSR or IT compliance and adherence to regulatory requirements can be incorporated into the contract. Once this is done, the buyer needs to constantly monitor the risks.  Besides site audits, the use of risk monitoring software can simplify the process.  The software can pull from information risk intelligence data providers to provide insights into supplier risk and compliance status.

Damage Cargo
Image taken from https://fnm-vietnam.com/transport/how-to-deal-with-damaged-cargo/

Reviewing Supplier Performance

Periodic review with the suppliers is carried out to ensure suppliers are fulfilling the performance targets in the contract.Besides the hard targets, the review should also include soft issues such as communication difficulties due to cultural or language differences in the course of doing business. The review should not be the only channel of validating supplier performance. This can be supplemented by on-site audits and site visits. By categorising non-conformance on-site, audit findings can identify issues and improve the performance.

Supplier compliance
Image on supplier compliance audit taken from https://proqc.com/

Supplier performance review is also an avenue for suppliers to feedback on shortcomings on the buyer side.  Very often, the buyer’s business processes, practices and behaviours can hinder the performance of suppliers. Thus, the review becomes a two-way flow of information that is conducted in an open, transparent manner. Where performance gaps are identified, both parties should work together to determine the root causes and solutions.

Recognising and DevelopingSupplier

There should be a mechanism to incentivize suppliers to meet and exceed the performance targets. Some companies increase the share of business when the supplier performs well. Others award long-term contracts. Many companies also develop supplier recognition program, where the top performers are announced to all suppliers and the company. This demonstrates the emphasis the company placed on supplier performance and provides examples for other suppliers to follow. The award also benefits suppliers in bringing prestige to them and helps in securing new business deals. On the contrary, penalties may be imposed when suppliers consistently under-perform. These penalties could take many forms such as delayed payments or relegating suppliers to lower-value products or services.

Performance management should not stop at monitoring the performance.  Supplier development is the process of working with selected, individual suppliers to improve their performance.  Supplier development can take many forms such as improving the quality of the products, reducing the product cost, co-developing new products and even aligning of business objectives.

Avoiding Supplier Disputes

Disputes can happen if a supplier is unable to fulfil the terms of the contract.  During contract negotiation, early termination clauses, force majeure clause should be included to avoid disputes.  Suppliers and buyers can also explore the use of escrow agreements to minimise uncertainty of buyer payments to supplier or trouble of recovering payments when supplier cannot meet the quantity or quality expectations.  These measures can reduce the possibility of disputes.

Conclusion

Supplier performance management is an important part of delivering quality products and services to customers.  Using a collaborative approach between suppliers and buyers, performance KPIs are mutually agreed upon. These KPIs are clearly specified in contracts and SLA to create an open, transparent and healthy supplier-buyer relationship. Finally, Incentives and rewards help to encourage a continuous improvement mind set among suppliers.

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References

Benny Seet Jin Peng, DLSM. (2020). “Key Indicators to Measure Supply Chain Performance”. Retrieved from SIPMM: https://sipmm.edu.sg/key-indicators-measure-supply-chain-performance/, accessed 05/12/2020

James Khosala. (2017). “Supplier Performance Management (SPM): A Bird’s Eye View”. Retrieved from https://www.linkedin.com/pulse/supplier-performance-management-spm-birds-eye-view-james-khosala, accessed 03/12/2020.

Julie Kwek Choo Lie, ADLSM. (2020). “Key Focus Areas for Supply Chain Integration”. Retrieved from SIPMM: https://sipmm.edu.sg/key-focus-areas-supply-chain-integration/, accessed 06/12/2020

Nurazyyati Jaffar, ADPSM. (2018). “Key Strategies to Build An Effective Supplier Relationship Management”. Retrieved from SIPMM: https://sipmm.edu.sg/key-strategies-build-effective-supplier-relationship-management, accessed 04/12/2020

Samuel Shanthan. (2016). “Ensuring Vendor Continuity”. Retrieved from ISACA Journal: https://www.isaca.org/resources/isaca-journal/issues/2016/volume-3/ensuring-vendor-continuity, accessed 06/12/2020

Tan Sze Hwee Jacqueline, DPSM. (2020). “Overcoming Key Challenges in Supplier Development”. Retrieved from SIPMM: https://sipmm.edu.sg/overcoming-key-challenges-supplier-development/, accessed 06/12/2020

About the Author: Song Fang has substantive years of experience in the semiconductor manufacturing industry, and specifically in the specialized field of purchasing and contract management. She is a member of the Singapore Institute of Purchasing and Materials Management (SIPMM). Song Fang completed the Diploma in Procurement and Supply Management (DPSM) on December 2020 at SIPMM Institute.

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