Value Creation Through Strategy, Supply Chain and Sourcing

Three S Consulting offers a full range of management, organizational, and business advisory services that help clients achieve competitive advantage while delivering significant cost reductions. We deliver tangible and high impact results through an innovative approach and collaboration with client teams.

Mission

Three S Consulting mission is to deliver business excellence through supply chain and sourcing.

Results

Our supply chain and sourcing expertise, as well as a customer-centered approach, is a proven model for success. Case studies below provide examples of results achieved for our clients:

Sourcing

  • Leading Biotech Company – Delivered $130 million in annual run rate cost reduction primarily through sales & marketing effectiveness programs.
  • Largest Hedge Fund – Sourced excellent solution for Real Estate organization and delivered $8 million in annual savings.
  • Leading Multi-Brand Retailer – Delivered $30 million in savings by managing investment in store cost.
  • Global Facility Management Provider -Increased innovation by leveraging a diverse pool of suppliers for different hard and soft services.

Demand Management

  • Leading High Tech Manufacturer – Delivered $50 million in annual savings through managing demand of electronic, plastic, and metal components.

Supply Chain

  • Leading Multi-Brand Retailer – Debottlenecked Pooler network to reduce cost by 50% and inventory by 30%.
  • Global High Tech Company – Improved customer satisfaction by creating a Supply Chain design responsive to customer requirements.

Innovation

  • Global Medical Devices Company – Created R&D, technical and quality capabilities to support next generation product launches.

Strategy

  • Global Handset Manufacturer – Drove revenue by creating a distribution network responsive to market demand.

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Should Cost Modeling for Marketing and Services Spend

Should Cost analysis determines what a product should cost based on materials, labor, overhead, and profit margin. The tool was originally developed by the Department of Defense to assist procurement officers with determining fair and reasonable pricing. It was later adopted by the commercial industry and is now widely used for product costing and tear down analysis.  The use in services sourcing has been limited.

3S Consulting has been using Should Cost modeling to complement strategic sourcing for complex service categories such as marketing, manufacturing, professional services, R&D, facilities, transportation and others.

The goal of the modeling effort is to –

  1. Identify the underlying cost drivers
  2. Optimize them to deliver better business outcomes while reducing costs
  3. Negotiate a win-win agreement
  4. Operationalize a sustainable agreement

While the emphasis is on cost-cutting, we think an equally important objective is to improve performance and service. At 3S Consulting, our Should Cost modeling effort identifies areas where costs can be redirected to improve our clients’ overall operations.

Our team uses the Should Cost modeling tool to conduct open book negotiation with suppliers, focuses on developing a win-win solution, and reduces negotiation time by as much as half. We have consistently received praise from both customers and suppliers on the approach. In turn, some suppliers have even used the models in their own negotiations with other customers.

The below infographic provides an overview of our approach and how it was used to improve a client’s call center operations.

Should_Cost_Modeling_Infographicsv201 (1)

Sourcing 3.0 – How to Breathe on Mars?

India recently launched a satellite to Mars. This is a great accomplishment for any country to have a successful launch in its maiden effort. I was curious to hear my ten year old daughter’s views about it. I framed my question awkwardly and asked her “how do you breathe on Mars?” She looked at me curiously and answered – you need an oxygen tank! We discussed and realized that if one has to live on Mars and not visit Mars; one can’t continue to bring the Earth’s environment to Mars. We have to adapt and find a way to use the resources there. Of course, my daughter and I couldn’t solve the problem; scientists are still figuring it out. One thing was clear, though, given differences in gravity, closeness to the Sun and arid environment, we will have to do many things differently that we unconsciously do on Earth, to breathe and survive on Mars.

Where do you find “Mars” in business?

Think of companies such as Apple, Nike, Starbucks, Google, and others. You will find these companies have a culture of excellence driven by their business strategies. On one hand, the focus on excellence allows these companies to set themselves apart from their competition and capture higher profits. On the other hand, it provides a challenge as traditional business approaches may not work well in their culture.

For example, to maintain their competitive edge, they demand buying highly customized solutions instead of standard solutions available in the market. Starbucks had to develop a supply base for its coffee blends in several developing countries to support its unique offering instead of buying coffee beans that were readily available in the market. Traditional competitive sourcing approaches are not suitable to buy these customized solutions effectively. To be successful, Sourcing teams have to identify what’s valued in a company’s culture and then tailor their approaches to those values, to drive right business outcomes.

[The challenges mentioned above are not unique to Sourcing organizations. In this post, I am focusing on what a Sourcing organization can do to be successful in these companies. The same concepts can be utilized for other functions as well.]

How do you source excellence?

Excellence in my mind is like utopia; everyone wants it, but no one knows how to get it. Sourcing in this environment is tough because of the lingering question as to whether the solution being sourced is truly excellent. I spent significant time on my first project with a client team in multiple iterative cycles to source a solution they would consider excellent. Every time we came up with a solution someone invariably challenged if it was truly excellent. Eventually, we came up with the right solution through a process of elimination, but it was painfully inefficient.

After reflecting on the experience, I realized that there is a better way of executing this type of sourcing projects. Instead of using a structured Strategic Sourcing approach, we adapted our approach to suit what’s valued in the client’s culture.

Described below is the approach we used at a highly successful financial services firm that value excellence in every aspect of its business.

Approach for Sourcing Excellence

  1. Define Excellence: The first step is to define what the client would consider an excellent solution. It requires strong collaboration between the business and sourcing teams. There are multiple ways to arrive at this – voice of customers, expert opinions (in-house and external), research, select supplier interviews, etc. Also, it requires triangulation with different stakeholder teams to ensure the solution being developed is truly excellent from different perspectives.
  2. Validate: The Sourcing team then validates the solution with external providers through an RFI followed by in-depth supplier interviews. The objective is to learn whether such solution already exists in the market and if not, how to arrive at it through a combination of suppliers and in-house resources. Cost is looked at from an aggregate level to ensure the solution being developed is practical.
  3. Source: After validation, the next step is to select the right supplier and supplier team. Learning from previous sourcing efforts, selecting the right vendor is not sufficient. To achieve excellent outcomes, we have to select the right supplier lead and team. A different approach than just selecting a supplier in the traditional approach. The sub-steps are:
  • Identify right suppliers – Assess capabilities of different suppliers and select the ones who are capable of operating in client’s culture.
  • Select team – This is the most time consuming and critical part of the process. Initially, when we started selecting the supplier team, we would interview them. We soon realized that we are encountering interview bias i.e. we are selecting team members who reflect the interview team instead of the team required to perform the job. To avoid interview bias, we have started selecting supplier team through personality tests. This approach has been successful, and we are still refining it.
  • Negotiate pricing and service level agreements – In parallel with the supplier team selection, we negotiate price and service levels. The technique of “should cost” modeling is particularly useful here as buying customized solutions makes a financial comparison and negotiation with suppliers that much more difficult.

We have successfully used the above approach to different source types of products and services that the client would consider excellent while significantly reducing time to source.

Can we breathe on Mars?

Yes, breathing on Mars is not as difficult as it sounds particularly in a business culture of excellence – of course, more difficult on the real planet Mars. It requires keeping an open mind to work within an organization’s culture. Tailoring the sourcing approach and creating a team that can work in this environment will evolve Sourcing’s value proposition. It will help in transforming Sourcing organizations from a cost center to a business partner – an evolution I am calling Sourcing 3.0.
In my subsequent post, I plan to discuss how Sourcing organizations can develop a long-term collaborative relationship with strategic suppliers – a key element of Sourcing 3.0.

About Author: Suman is a Partner with Three S Consulting. The firm drives value for clients through Strategy, Supply Chain, and Sourcing.

Pharmaceutical Industry – Bringing Back Glory Days

Drug prices have gone up significantly in the last several years. According to an analysis conducted for Bloomberg, since October 2007 the cost of brand-name medicines has soared, with prices doubling for dozens of established drugs that target everything from multiple sclerosis to cancer, blood pressure, and even erectile dysfunction while the consumer price index rose just 12 percent during the period. There was an article on BBC late last year mentioning the high profitability of the pharmaceutical industry (http://www.bbc.com/news/business-28212223). Per the article, the pharmaceutical industry made spectacular margins well ahead of banks, autos, oil & gas and media industries. The society expects the industry to save lives and alleviate suffering and not profiteering from the old and weak.
However, this profit trend may not last long. There are fundamental challenges faced by the industry that may be why it’s trying to shore up its short term profitability.

What are these changes?

  • Pharma innovation model is at risk: The business model for pharmaceutical companies is based on developing and launching new drug products every few years. In the interim years, they extend the life of their existing patented products through product extensions. This approach to product development is no longer sustainable. Look at any of the pharmaceutical and biotech company’s product pipeline, you would find that the revenue and profit potential is significantly lower than what used to be 10 to 15 years ago. Why is this happening?
  • Drugs for peripheral diseases: Drugs for most of the common diseases have already been discovered. R&D investments are currently focused on peripheral diseases. Take for example Ebola, it is a scary disease but only infected a small population. Drug development and testing for such small disease incidence are expensive due to difficulty in getting sufficient patients for clinical trials. Also, these drugs have lower lifetime revenue potential as only a small population will pay for it. A recent study found that new drugs are twice as expensive to develop and are likely to generate half the revenue of earlier blockbusters.
  • Getting approvals for product extensions becoming difficult: A large number of drug patents have active ingredients (main ingredient) that are out of patent. Pharmaceutical companies try to improve the efficacy of these by mixing and changing other ingredients in drugs. Though regulatory bodies were happy to provide patent extensions on these in the past, there is now greater push back from both consumer groups and regulatory bodies on these practices.
  • Declining demand for expensive / patented drugs: Though pharmaceutical companies seem to increase their prices at will, governments, insurance providers and patients are moving away from expensive drugs.
  • Move towards generics: Generics are growing rapidly with the expiry of patents for major drug products. With competition from generics, the revenue of patented products drops by 90% plus after the patent expiry. There is a concern about generic producers increasing their prices as the industry consolidates. This is probably a short-term problem. Since the product know how is available, there is nothing stopping other generic companies from entering the market if they find the pricing attractive.
  • Drop in government reimbursements globally: Government reimbursements are a key source of revenue for pharmaceutical companies. It not only determines how much Governments are willing to pay for different drugs but also sets benchmarks for insurance companies. Governments across the globe are looking to manage their budgets and clamping down on reimbursements.
  • Difficulties in penetrating developing markets: With most countries signing WTO agreements, pharmaceutical companies were expecting increased revenue from developing markets. Developing countries are worried about the impact of patented products on their budgets and the ability of their population to afford such expensive drugs. To address these concerns, several countries have created restricted drug list that essentially keeps the patented drugs out. Pharmaceutical companies have been able to become part of the private insurance market, but these are not having a significant impact on their revenue and bottom line results.

How is the industry reacting?

The industry is trying to address these issues through traditional ways. There is a general focus on cost cutting. Headcount reduction is usually the first and has been going on for some time. Many pharmaceutical companies have started to move their R&D, manufacturing and back offices to lower cost countries. Also, there is a great appetite in the market for merger and acquisitions. Companies are looking to bolster their product pipeline through the acquisition of start-ups along with a desire to remove duplicate headcount and infrastructure to improve short term profitability.
Though these measures can help to bolster short term profitability, they are not sufficient to address the core challenges facing the industry.

How to bring back glory days for the pharmaceutical industry?

  • Rethink business model: There is a need for pharmaceutical companies to think out of the box, perhaps starting with listening to customers and stakeholders. Increasing short term pricing and lowering structural cost through consolidation or move to lower cost countries is not going to give the desired competitive advantage against generics. It will end up alienating the goodwill they will need in the market. Perhaps, they could think through their business model and come up with a new way of doing business. Key areas to focus are:
  • Innovation: The market is not asking for newer drugs for newer diseases. The days of thousands of people dying from the plague, cholera, or other epidemics are long gone. People are living longer, and they are more health conscious than before. What is needed now is a general focus on affordability. Pharmaceutical companies will gain by focusing on how to reduce the overall cost of medication (total treatment cost instead of just the drug cost). It would require them to partner with medical service providers to identify ways of reducing the cost to patients and governments.
  • Sales & Marketing: Traditional heavy sales force and branding focus are not working. Some of the practices have reduced the credibility of the industry bringing in restrictions from regulatory bodies. There is a need to rethink the value generated from the money spent on selling expenses versus a focus on targeted education to doctors and patients.
  • Manufacturing and Distribution: Pharmaceutical products are manufactured through large batch processes. The focus is on control, tracking, and ability to explain it to regulatory bodies. There is a great reluctance to introduce the latest practices in manufacturing and supply chain. The reluctance comes from the fear that change will introduce new variables that can lead to bad regulatory reviews if something goes wrong. This, in turn, has created an industry that can’t respond to market changes efficiently and creates huge waste (expired drugs and raw materials) throughout the system. The industry would benefit by considering small / distributed manufacturing and demand driven planning (instead of primarily relying on forecasts) that would allow better response to market demand.
  • Sourcing: Pharmaceutical companies spend significantly more on services than raw materials and capital. These services include wholesale agreements, contract manufacturing, and professional services, etc. Due to the sensitivity of these relationships, sourcing teams are typically kept out of this buy. Pharmaceutical companies will benefit if they open their services buy to the latest sourcing practices. Total Cost of Ownership (TCO) is a good way to structure and drive value from these relationships instead of a traditional negotiation approach.

Our team has helped many leading companies to make significant advances in the above areas and regain their momentum.

Summary:

Short-term profitability is probably the pharmaceutical way of building a war chest to survive upcoming merger and acquisitions. The current business model seems to have reached its end of life, and there is a need to rethink with a focus on innovation to improve overall treatment affordability, targeted selling/education, and latest supply chain and sourcing practices. Everyone including companies themselves, governments and regulators have a role to play in ensuring financially viable healthcare and pharmaceutical industries for generations to come.

About Author: Suman is a Partner with Three S Consulting. The firm drives value for clients through Strategy, Supply Chain, and Sourcing.

What’s Ailing Supply Chains?

The supply chain and logistics discipline started during World War II when armies needed to be supplied across multiple global theaters starting from Northern Africa to Europe to small Pacific islands.  A complex planning and coordination effort at a time when there were no computers and the internet. The ability of military planners to achieve this feat caught the eye of the commercial industry.  At the end of the war, they hired the experienced veterans to run their supply chains that had begun to span the globe.  Now, let’s move forward to the present times when we have computers, the internet, and real time information systems.  One would expect to see further great strides in supply chain management.  Unfortunately, United States Government Accountability Office (GAO) has been highlighting for the last several years that “Department of Defense supply chain management as a high-risk area due in part to ineffective and inefficient inventory-management practices”.  We are talking about hundreds of billions of dollars in excess inventory with huge back orders.  Plainly stated, the Government has too much inventory that it doesn’t need and too little the things it requires to fight war resulting in several billion dollars of losses to taxpayers every year.  More significantly, it compromises military readiness.

Is this problem unique to the Government?  No. Any big corporation, whether retail, automobile, oil & gas, consumer goods, health care and any other manufacturing industry will tell you that they experience precisely the same trouble.  They have a huge inventory of things their customers are not buying and back order of things that are selling.  The problem is very acute.  It’s estimated to take Gap, Inc. 9 to 12 months for their new designs to reach the market.  Imagine trying to predict fashion trends in advance, and then start the process of procuring fabric and making clothes globally to supply markets. On the other hand, Zara claims it takes them 10 to 15 days to get product from the design stage to stores.  They have designed a highly responsive and demand driven supply chain that they credit for their success.

Before we discuss the root causes behind supply chain problems, let’s understand what drives supply chain performance.

 What drives supply chain performance?

Simply put a supply chain the process of taking material from suppliers through manufacturing or conversion process and distributing to end users or customers.  Below is a simple pictorial that explains the process.  It would, of course, vary from industry to industry and depending on the scale of operations can get very complex.

Supply Chain

There is one simple metric to understand supply chain performance  – Total System Cost (the impact of customer service is built in as out of stock or missed opportunity cost).  The objective of the supply chain is to minimize the Total System Cost or maximize profit.  The costs are lower at the supplier end and builds up quickly as you get closer to end users or customers.  Depending on the industry, sales cost can range from 20% to 50% of the total system cost.  For some industry, the total system cost may go beyond their four walls and may include inventory being held by dealers or wholesalers (depending on how much liability and influence a company has in the inventory) to provide an overall perspective of the supply chain.

Supply Chain Cost Drivers ver2.jpg

What are the key challenges with supply chain?

  1. Hidden cost: Due to General Ledger structure in many companies, costs gets allocated to different functions that fail to provide an overall picture to management for decision making.  Some of the costs such as missing sales never show up in GL.  In our experience, among all the cost buckets sales cost is typically computed erroneously as the opportunity cost of missed sales and inventory costs are not well understood.  Inventory cost includes the cost of carrying the inventory, warehousing, obsolescence, pilferage and other costs.  Similarly, missed sales cost should include both the lost margin and the impact of lost advertising, after sales revenue and potential long term impact of losing customers to the competition.  Without proper computation of cost, management may make decisions that are not financially sound.  Sometimes decisions are made to hold more inventories or run longer batch sizes without really understanding its impact on the total system cost.
  2. Silo decision making: The supply chain gets broken into different organizations within any company.  The sourcing organization manages material cost whereas manufacturing organization is responsible for the conversion.  Most managers tend to make a decision that optimizes metrics they are accountable for, without understanding interdependencies and impact on other parts of the company.  For example, manufacturing organizations may like to increase the batch size to improve throughput without fully taking into account inventory and obsolescence costs upstream.
  3. Archaic planning and business processes: Most companies and governmental agencies have implemented ERP systems.  Financial transparency and control are the primary focus.  The business processes for most other functions have been ported from pre-ERP days to ERP without fully utilizing the capabilities of the new system.  So, the new system instead of being helpful works as a roadblock to achieving business results.  To our surprise, we have found many supply chain planners use Excel and other point solutions to plan their dispatch instead of utilizing the capabilities of the ERP system.
  4. Increasing complexity: Supply chains are becoming more complex.  The trend of globalization has extended supply chain to its limits.  It’s common now for products to be manufactured in China, assembled in another country and sold in a third country.  The lead times have become longer which directly impacts system inventory.  Also, products have proliferated due to the desire of companies to mass customize.  One has just to step into a grocery store to see how many different varieties are available for simple things such as salt or yogurt.  Product proliferation significantly increases cost all through the system – more products have to be manufactured, they have to be held in inventory and higher potential for going out of stock.
  5. The cost impact of service levels not well understood: Sales organizations may not be fully aware of the financial impact of service levels and in their desire to do better than competition makes service level commitments that could break the bank and the supply chain.  At a large telecom company, the sales team was making promises of delivery of equipment to large corporations with unrealistic lead time resulting in significant penalties.  This practice is quite common across industries.
  6. Data analysis not leveraged: ERP system provides real time point of sale and supply chain performance data.  Most companies don’t have the capability to analyze this information on a monthly or quarterly basis let alone in real time.  There is a trove of valuable information available that can be used for better decision making.

What can companies do?

  1. Get total system cost: Finance organizations can put together a by and a large picture of system cost that could significantly help in making informed supply chain decisions. The trickiest part is to estimate the sales cost as there are no agreed norms for estimating inventory and missed opportunity cost.  With some basic principles agreed (such as inventory cost as 15% to 20% of inventory value), these could be estimated consistently across product lines or geography.
  2. Ensure business goals drive organization metrics: It’s important to rethink functional metrics tied to overall organization goals to avoid silo decision making.  For example, for high margin companies, manufacturing throughput is not as important as responsiveness to back orders.  If plants are not able to meet their orders in a timely fashion, then sales cost will increase significantly.  Similarly, if suppliers are unable to provide quality products, it would result in rejection during manufacturing or recall at a later date.  In that case, it doesn’t make sense for the sourcing organization to save money by focusing on these suppliers.  There is a need to understand interdependencies better to reduce total system cost.
  3. Move to demand based planning where feasible: Due to ERP and point of sale technologies, demand data are now readily available and can be used to plan for shipment.  But many companies and government agencies spend enormous time and money trying to forecast customer demand and use it in shipment planning.  Which one you think is more accurate, actual demand data or forecast based on historical data?  Demand based planning has shown to reduce inventory, complexity, and cost while increasing quality.  Procter & Gamble in India implemented demand based planning which reduced total delivered cost from 75% of sales to 55% of sales, reduced system inventory from 115 days to 60 days, perfect order (right quantity, right time, right billing) from 40% to 90% and improved quality (PPM) from 30,000 to 5,000. Then, why demand based planning is not popular?  Well, it requires significant change management.  For example, you need the discipline of not shipping or producing more than what is being demanded by end users.  This is tricky when you are dealing with organizational silos and old ways of cost accounting.
  4. Manage complexity: We can’t change the trend towards increasing complexity – globalization and product proliferation are likely to continue.  Apple launched iPhone with one model; now it comes in so many different sizes and colors.  A better way is to think about how best to manage complexity with supply chain design.  Most companies have one size fits all supply chain for all types of products, whether the demand patterns are regular or random.  A product that has regular demand, it would be logical to have a streamlined manufacturing and supply chain.  Think of it as an assembly line production.  However, a product that has unpredictable demand (for example, cosmetics) an assembly line production will not be appropriate and would require much more flexible manufacturing and supply chain.  These turns of the supply chain by demand pattern have shown to reduce sales cost by reducing out of stock and inventory.
  5. Ensure sales team understands the cost implication of service levels: Most companies don’t have a good way of evaluating the financial impact of different service levels.  A modeling exercise could provide insights into the cost involved.  Agreeing with the principle of rationalizing service level based on some customer profitability metric is helpful and provides guidance on the sales team on what they can promise to customers.
  6. Use data to identify improvement areas: Data analytics can not only provide timely reporting but also help in modeling and simulation exercises.  For example,  many companies assume their network design is fixed.  However, data analytics can provide insights into how best to optimize and tweak the network as market demand changes due to seasonality or changes in consumer preference.

Supply chains can provide significant competitive advantage to companies.  However, increasing complexity (globalization, product proliferation, etc.) is overwhelming it.  Getting total system cost to drive design and improving business processes can fix the underlying ailments.  Processes such as demand based planning, tiering of supply chain based on demand pattern, and rationalizing service levels based on customer profitability have shown to improve supply chain performance.

About Author: Suman is a Partner with Three S Consulting. The firm drives value for clients through Strategy, Supply Chain, and Sourcing.

Sourcing 3.0 – Supplier Engagement

Most successful companies acknowledge the role of their suppliers in their success. This could be driving innovation, running operations, improving efficiency among many other things. If this is true, then it’s important to create supplier engagement that helps in delivering business results.

It’s our observation that supplier engagement is not paid as much attention or done in a thoughtful manner to drive business results. For example, when Dell computer started, it collaborated with suppliers to quickly bring innovation to market. I remember the days when Dell computers used to be cool and affordable. However, over time, Dell changed its focus to be more cost efficient in its supply chain and lost its focus on bringing significant innovation to market. This and other business strategies led Dell to lose its edge in the market over time, as suppliers started to take their innovation elsewhere. The products are no longer cutting edge, and Dell lost its cool image. You wonder the reasons behind such a change in supplier engagement since hi-tech products sell because of innovation and not because they are affordable. Apple continues to command a significant premium in the market because of their focus on innovation.

Did Dell suppliers meet their quality, timeliness, and other tactical metrics? I am sure they did. Then what went wrong? Well, at a fundamental level, these measures don’t connect to business goals. These measures provide confidence to plants and procurement organizations that suppliers can run their delivery process well. However, they are inadequate to measure if suppliers are being utilized by their customers in a way that will drive overall business success.

Most companies have rolled out supplier engagement/relationship management programs with their key suppliers. My biggest criticism of current programs is that they are tactically focused and are grossly inadequate in helping companies achieve their business goals. Some of the key issues with these programs are:

  1. Lack of Partnership: For most American companies, the relationship with key suppliers is somewhat adversarial. Suppliers are meant to provide service whereas the companies are clients who pay for the service. There is a mentality that suppliers are subservient to the needs of the corporation. They lack a partnership approach to focus jointly on the same goal. Imagine having a similar relationship with your significant other, how long will that relationship last.
  2. Lack of expectation setting: Most companies lack a good way of setting expectations with suppliers. The concept of Service Level Agreements (SLAs) is not widely used. When SLAs are used, they don’t tie back to the goals i.e. they focus on tasks performed by supplier instead of business objectives a company is interested in achieving. For example, most Janitorial contracts have SLAs that define the frequency of cleaning and not how the customer perceives cleanliness. If a Janitorial firm cleans at a frequency agreed in a contract but it does not achieve the right level of cleanliness as perceived by customers, then SLAs are not tying back to the goal of cleanliness.
  3. Emphasis on cost vs. service: In companies where Supplier Relationship Management programs are implemented, we found overwhelming focus is on cost and not on service. It seems the role played by business organizations in setting up these programs is minimal, mostly being designed by Procurement organizations. It may be easy to measure cost, but it does not assure that suppliers are providing the right service as desired by business organizations. You know the old saying, what gets measured gets delivered. There is a need to review the supplier metrics to ensure suppliers are focused on the right areas.
  4. Limited supplier feedback and communication: Typically, most discussions with suppliers focus on providing them with feedback on their performance and the areas they could improve. We all know companies in collaboration with suppliers can also do things at their end that can help improve the overall results. To our surprise, many managers who are involved in the supplier discussions do not actively ask suppliers for feedback and suppliers are reluctant to provide the information for fear of alienating clients. It’s a missed opportunity for collaboration and partnership that could be easily harnessed.
  5. Emphasis on penalty vs. incentive: It’s well known that positive enforcement works better than negative enforcement. Ask anyone who had to help steer their children in the right direction. So, why then do we see that most supplier contracts only contain penalties for non-performance and little to no incentives for performing above and beyond expectations? It seems the overwhelming view among procurement teams is that suppliers are incented for performance when a company provides them with additional business. This may be true. However, behavioral scientists will tell you that direct incentives work better than indirect incentives. These incentives and penalties don’t have to be material, but a token something always helps in recognizing supplier efforts at a regular frequency.

What needs to change to make supplier engagement robust?  

A partnership approach while engaging with suppliers. It starts with accepting the fact that suppliers bring value to the table. This is why companies hire them in the first place. They are capable of delivering good outcomes in their specific area of expertise. The objective of supplier engagement should be to enable suppliers and hold them accountable for doing their job well. If suppliers don’t perform consistently, then disengage but resist the urge to micro-manage. Below are steps we found useful in holding suppliers accountable.

  1. Clearly defined business goals: It’s critically important to think beyond the obvious service or product a supplier is providing and understand the business goals to get better value from supplier engagement. For example, one of our financial services clients provides free bus service to its employees to transport them from New York to client’s offices in Connecticut. The business goal, in this case, is more than just providing safe transportation to the employee. It is to incent employees to make the trip every day, so it’s a both recruitment and retention tool. Also, it ensures that employees are productive while traveling, a trip that takes an hour or two each way. A transportation provider will have to be able to address these higher level needs in addition to providing safe bus rides.
  2. Tie SLAs / KPIs to business goals: There is usually confusion between Service Level Agreements (SLAs) and Key Performance Indicators (KPIs). The way I like to explain the concept is that SLAs are a simple way of translating your needs to someone and KPIs are metrics that help you measure how well these needs are being met. For example: in order to provide great transportation service to the financial services client, an SLA for the transportation provider will be to provide drivers that are excellent in customer service in addition to safe driving. Drivers are the first and last person to engage with employees every day. To measure how well transportation provider is doing in this respect, KPIs may include employee feedback on driver conduct, how well they kept the employees informed during the trip, their helpfulness, These metrics are in addition to driver’s driving and accident records.
  3. Provide both incentives and penalties: Link incentive and penalties to the KPIs upper and lower limits. It will help you recognize both what supplier should improve and what they are doing well. Providing small monetary benefits / pain ensures attention from the leadership of both company and supplier on these metrics. However, it’s critical that these incentives and metrics are not material as there is a risk of taking supplier focus away from the work at hand. Also, I like to provide incentives for a softer measure such as customer service / feedback and penalties to harder measure (such as timeliness, quality,) that are more in supplier control. For example: In Pharma world, particulate contamination (microscopic dirt) is becoming a real issue for medical devices companies as they tend to get the drug products, and there is additional scrutiny from FDA. This contamination is difficult to control due to its very nature. In a situation like this, Pharma companies can consider providing incentives to medical devices companies to reduce particulate contamination (not completely under their control) whereas penalties around product performance / dimensional accuracy, etc.
  4. Use fact/data based performance measurement instead of perception: Opinions are easy to get whereas facts are difficult to collect. An engagement works better if it’s based on data and facts and not swayed by subjective perceptions. Facts / data allow suppliers to focus on tasks and having productive discussions without emotions. Also, it’s easy to plot trends whether performance is improving or not. I sometimes get pushback for focus on facts because managers feel that not everything can be captured with data. This may be true, however, thinking through the right KPIs can help in devising good methods for data capture. It could be surveys, feedback on performance from key stakeholders during certain milestones, It helps to be transparent with suppliers on when and how data will be captured so there is no supplier concern on how their performance will be measured.
  5. Be open to two way feedback: Though the focus of the supplier engagement is to ensure supplier is providing the right level of service, it always helps to be open to ideas / feedback from suppliers. I have received excellent ideas from suppliers on improvements. They are closer to the work, and they have experience doing similar work for other companies. Missing out on opportunities to get supplier feedback is just plain unwise.
  6. Establish regular cadence: Setting up a regular cadence to measure and communicate supplier performance is always good. This avoids surprises and allows for the timely fixing of any issues. The biggest benefit is that suppliers understand that someone is reviewing their performance and publishing it to their stakeholders. This is the best way to hold suppliers and internal organizations accountable.

Most supplier engagement/relationship management programs are tactical and punitive in nature and don’t help in building a longer term relationship with suppliers.  A thoughtful design for a supplier engagement model will allow companies to drive better business results and value from their supplier base.  A greater effort in finding common objectives and innovative solution with suppliers can help in driving long term profitability and success in the market for both parties.

About Author: Suman is a Partner with Three S Consulting. The firm drives value for clients through Strategy, Supply Chain, and Sourcing.

Sourcing 3.0 – Perspective on Next Evolution of Sourcing Organization

Sourcing as a field of management evolved from Transaction Management to Category Management sometime in the 1990s. This had a tremendous impact on the way corporate leadership viewed Sourcing professionals. Sourcing moved from an organization that finalized pricing to an organization that provided expertise on the dynamics of supply market and helped companies drive value via the total cost of ownership. To make this transition companies hired MBAs with an ability to understand functional strategies and utilize supply markets to support them.

Evolution of Sourcing / Procurement Organization

Sourcing Evolution ver1

What’s next?

Logically, the next evolution will probably see Sourcing professionals directly contributing to business strategy – moving from being a cost center to becoming an integral part of the business similar to its Marketing or R&D organization. For lack of a better term, I am calling the next evolution as Sourcing 3.0.

A Sourcing team’s contribution to business strategy will be through developing and managing strategic suppliers who can drive business outcomes such as increased revenue, reduced risks or reduced cost at a corporate level.

Strategic suppliers can perform a variety of role for an organization. Based on their involvement with an organization they might be referred to as – innovation partners, outsourcing partners, contract manufacturing service providers, wholesale or sales related service organizations, etc. Whatever their involvement or name they are referred to by, one thing they all share is making a significant impact on business outcomes. Traditionally, these suppliers were considered out of scope for Sourcing organizations because they required different skills and toolkits than currently exist, and businesses preferred to manage them directly.

Leading Chief Procurement Officers (CPOs) during our interactions recognized strategic suppliers as an opportunity area but highlighted the issues with lack of toolkits and skills in their organization to effectively engage these suppliers.

What are these different skills and toolkits?

Working with strategic suppliers requires two key skillsets – a collaborative mindset and an analytics based approach. This is different from the approach used for category management where market / competitive forces drive efficiency.

As an example, one of the tools we have successfully used is the “Should Cost” modeling. We have used the “Should Cost” models across many different industries and corporations where we readily shared the information with the strategic suppliers. This approach requires financial and analytical expertise in addition to the commercial expertise typically required from a buyer in a Strategic Sourcing organization. It also requires “influencing skills” so that suppliers view it as a win-win relationship and look at the organization as true partners. These multi-year relationships require careful ongoing relationship management by linking performance incentives to business outcomes. Sourcing organizations will have to play an active role in making these relationships successful because their success will drive the success of their parent company.

Example of a toolkit – “Should Cost” modeling

Sourcing organizations have been developing cost models for specific requirements, but this is not widely practiced. Developing cost modeling toolkit becomes critical for strategic suppliers as understanding the underlying costs can identify opportunities for outcome improvements.

This concept is sometimes confusing to our clients as they think the objective of cost modeling is to reduce costs, and they do not understand the linkage between the improvement of outcome or service.

Cost modeling is a tool that can also identify areas where cost could be added or redirected so as to improve service or quality of the product in addition to making the operation more efficient. The level of sophistication and collaboration required for “should cost” modeling for strategic suppliers is far greater as it requires a greater level of trust from both parties that such information will be used in a constructive fashion.

An example of “should cost” modeling below illustrates the value it can bring to decision making. A specialized call center contract at a Pharmaceutical company specified that the provider maintains infrastructure at a particular location with a set of stringent technical requirements. The requirements changed significantly over time due to changing business environment; however, both companies struggled to figure out how best to restructure their relationship.

Should Cost modeling showed significant potential for service improvement by spending more on representatives who attend the phone and less on overhead areas such as program management and administration. The change in contract structure was also a win for the provider as they now have more flexibility in setting the infrastructure and location.

Restructuring of Strategic Call Center contract through Should Cost Modeling

Call Center Cost Model ver1

How then do we affect change?

Creating these new capabilities could be the change agent that will evolve the Sourcing organization from a cost center to becoming an integral part of the business. This is similar to the category management expertise that led to an evolution of the Procurement organization to a Strategic Sourcing organization in the late 1990s and early 2000s.

In my subsequent posts, I hope to explore how an organization can transform itself into a Sourcing 3.0 organization.

About Author: Suman is a Partner with Three S Consulting. The firm drives value for clients through Strategy, Supply Chain, and Sourcing.