Industryweek 14804 Next Generation Newsletter White Bkgrnd

How to Manage Your Strategic Suppliers

Oct. 1, 2014
Supplier contracts may be necessary but they cannot really change business fundamentals.

If you read the August 28 entry to this blog you’ll recall that at one point in my career I was accused of being “too benevolent” by an executive level manager after broaching the idea of Extended Enterprise Supply Management. Reading the September 16 entry you could almost come away with the feeling that I am a bit “cold-blooded” since assigning suppliers to categories and management of those categories is based solely on the costs and order fulfillment exposure of resourcing.

So which is it?

I hope regular readers of the blog understand by now that Next Generation Supply Management strategies are designed to deal logically with business realities, regardless of emotion or what traditional practices might be. Please keep this in mind as you consider the issues laid out at the end of this entry since they will likely lead to further questioning of how you traditionally work with suppliers.

As I noted last time, this blog will lay out how to (and how NOT to) manage strategic suppliers. Let’s start by reviewing how strategic suppliers are determined: Resourcing business from a strategic supplier exposes a purchaser to excessive cost or order fulfillment risk.

Let’s be clear. Original equipment manufacturers are used to working with suppliers from a position of leverage, i.e., “power.” And most are neither comfortable with—nor adept at working with—suppliers whose leverage is either on par with or exceeds their own. Many OEM procurement functions try to ignore the reality of strategic supplier leverage and work with them using traditional positional strategies. The results of doing this are usually not very pretty—at least in the long run—since there is nothing worse than having an antagonistic source that is in position to dictate your schedules, sales and profitability.

How do OEMs typically try to minimize the leverage of strategic suppliers? They do so by drawing up contracts that attempt to try to pre-define acceptable results for virtually every possible relationship scenario. Let me first say there is nothing wrong with contracts if they focus on high-level parameters. By definition, this means a well-constructed contract is relatively concise and—I’ll pose the question—how many supply contracts have you seen that are short in length? Anyway, as I’ll discuss later, even well-focused contracts are not adequate for managing strategic supplier relationships. On the other hand, contracts can lead to a false sense of security. In fact, if they ever need to actually be referenced and/or enforced, chances are their prescriptions will lead to bad feelings by one party or the other.

Several years ago I had the opportunity to review the supply management program of a mid-sized OEM. They had just signed a contract with a much larger OEM (whose name you’d immediately recognize if I mentioned it) to manufacture some of their product offerings under the larger OEM’s brand, i.e., private label, such that they could be marketed as the purchasing company’s own product. When I asked about the terms of the relationship, I was shown the contract which consisted of 12 large bound volumes. I pulled one of them out of the bookcase and saw it contained over 800 pages, which implied that the contract as a whole came out to about 10,000 pages! Whoa!?!

When I asked, “How in the world could you manage to such a detailed document?” they smiled and said that they really didn’t need to. Instead, they said they operated the relationship based on what made business sense and, if their large OEM customer decided they didn’t like how the business was going, they could always “try to find another source” (i.e., there weren’t any!). Based on this response I asked why they had even bothered to participate in putting it together and signing it; they smiled again and said, “to let their customer think they were running things.”

The point I’m trying to get at with this example is that contracts may be necessary but they cannot really change business fundamentals. If you want to buy someone’s product and it is not available elsewhere, you really are not in position to dictate terms. My lawyers always told me that if I signed a contract that conflicted with the Uniform Commercial Code (UCC), it wasn’t worth the paper it was printed on. And I suspect that a multitude of UCC “holes” could have been found in that 10,000 page contract.

To this point, tailored supply contracts should focus on only the broad parameters of how two companies plan to work together. I actually prefer Memorandums of Understanding in place of contracts since they can usually be signed without legal department engagement and can be written to fill the same broad function that a contract would. And they do so without introducing the implied threat of possible litigation.

So, if contracts are not a complete answer to managing strategic suppliers what else is necessary? Application of the Next Generation Supply Management version of extended enterprise, namely: providing strategic suppliers the same level of technical support they would receive if they were internal factory departments.

This is primarily accomplished through a supplier development function whose primary role is to assist strategic suppliers progress towards the Lean end-game, namely becoming build-to-demand capable. This can be accomplished in a number of ways but should focus on aligning supplier operations with the end-use customer, both from a specification and order fulfillment perspective. To do this internal market-based policies will be needed relative to quality and order fulfillment so, if they don’t already exist, defining them will be a necessary pre-step in setting up a supplier development function. The role of these policies is to give both supplier development personnel and suppliers a performance target to shoot for.

Supplier development’s role in establishing a mutually beneficial extended enterprise relationship with strategic suppliers cannot be overstated. In fact, I hope to some day write a book on the subject of establishing and managing a supplier development function since there are as many “Don‘ts” as there are “Do’s” in working with suppliers. Perhaps the key point to remember is that supplier development should never be seen as a customer’s lever in the piece-price negotiating process. Lower prices will eventually come with improved supplier build-to-demand capability, but if price reduction—rather than overall efficiency improvement—is seen as the main driver of an extended enterprise engagement, suppliers are not likely provide the collaboration necessary for successful interventions and may even reject outright an offer of assistance.

Maintaining relationships with strategic suppliers is resource-intensive. That’s why it is important to consider the following relative to selecting your strategic suppliers—this is where the “questioning” I referred to prior may come up:

1. Are more than 10%-15% of your suppliers strategic per the Next Generation Supply Management definition of supplier? If so—and if your supply management organization and practices are what would be considered “traditional”—you really need to ask yourself if your procurement function is properly set-up to deal with the reality of such a high level of source dependence.

2. Are many of your strategic suppliers overseas? If you’re thinking it may be difficult and costly to develop an extended enterprise relationship with “local” suppliers, you will be shocked when you understand what it takes to do so with suppliers on other continents. Long-distance management of strategic suppliers can be feasible when they are limited in number, but doing so with large numbers of them can be overwhelming.

3. Are you managing your strategic suppliers for the short- or long-term? Do you differentiate timeframe in putting together supplier strategies for the four different supplier categories (strategic, key, approved, basic)? Extended enterprise management of strategic suppliers requires a long-term outlook and shouldn’t be managed on a quarterly or even an annual basis, while the management of the other supplier categories has successively less call for an extended management horizon.

I think I’ve given you enough to “chew” on for now. The next blog will touch on more detail of the organization required to optimize Next Generation Supply Management.

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