Thou Shalt Manage (and Cherish) Thy (Best) Suppliers
In its recent report Shifting C-level Business Priorities as the Recovery Takes Hold, Saugatuck Technologies claims that top business priorities are returning to a pattern more consistent with a growth economy. This was the case in the company’s 2006 research, wherein sales/revenue growth, which led the list of top business goals, was followed by reaching new customers.
However, a sign of the trying times is the continued high priority assigned to increasing profit margins, as firms continue to focus on strengthening their balance sheets and projecting confidence on Wall Street in the face of an economic recovery, which is framed by tight credit, depleted housing wealth, and weaker-than-normal labor demand.
Why Is Supplier Management Important?
One of the first places businesses start cutting (or at least controlling) cost is on the spend side (sourcing and procurement). With the issue of rising prices of some sourcing categories and commodities, simply raising the selling price to counter supplier price increases can impact margins only temporarily (if the market can bear even that much).
With the advent of the Internet (and the so-called “global village”), virtualization, and outsourcing, organizations are relying on ever more suppliers. A company relies on its suppliers and contractors to support its trading network, and if it doesn’t manage them properly, then its business is at risk.
There is simply a risk of not being able to meet new profitability targets due to eroding cascades across the entire supply chain and the ensuing changes in requirements that many suppliers can’t meet. The company then must keep on taking hits in its costs of goods sold (COGS) or delivery to meet its goals, but it will continue to erode margins to the point of no sustainability.
And yet, too many organizations continue to under-invest in the management of their suppliers and outsourcing service providers. Instead of a disciplined centralized approach with a holistic “bigger picture” perspective, many companies still spread and fragment vendor management responsibilities and activities around their organizations.
We concur with Gartner that, as the popularity of cloud-based IT services and solutions grows, vendor management will become even more complex. Why? Business units and local purchasing departments will likely assume a greater role in buying decisions, possibly with their myopic views. Thus, the key here is to ensure that strong corporate-wide vendor management controls are in place to help business units manage sourcing and vendor relationships consistently.
Proactis says that supplier management is often viewed as a discipline for procurement, but there are quick financial wins (low-hanging fruit) to be had if tackled properly. Namely, how many suppliers are made up on a daily basis (on the spot) to fire-fight an impending invoice? If the financial systems are then littered with casual supplier records what does that tell us about being able to “bring spend under management”? What is the cost of managing these suppliers—i.e., not just managing the data but also the inability to leverage volume discounts, savings, etc.? What is the negative impact on accounts payable (AP) when it comes to more invoices, more supplier enquiries, etc.?
Not All Suppliers Are Alike
All too often, the focus of vendor management has been on standard performance metrics and management processes across all vendors (so-called blanket regulation). Many forward-thinking organizations are now categorizing and stratifying their strategic vendors, separating those considered critical (preferred, sole, etc.) to their business from those delivering more commoditized products and services. Needless to say, strategic vendors require different levels of vendor management attention than vendors supplying tactical and less important items or services.
If one can segment vendor relationships, then one can more easily prioritize vendor management fundamentals and take actions based on supplier performance data. For instance, “Should this supplier relationship be cancelled?” or “Is this a strategic supplier that should be developed and improved?” are only a couple of the questions that should only be answered based on solid evidence.
In order to be able to institute the necessary changes that immediately impact margins and supplier relationships, companies need actionable data to make the right sourcing and spend decisions. Data modeling can take it to the next step and spend analytics tools can help pull some of the data together in a role-oriented manner.
Vendors such as Ariba, Emptoris, Zycus, Proactis, Endeca, Workday, SAP, Oracle, and Epicor (to name only some) provide nifty dashboards that can manipulate data on the fly for personalized, high-impact reports. Corporate users can drill down into critical information such as spend by approved/unapproved suppliers, potentials for supplier consolidation, cost savings through alternate specification, etc., in order to uncover holes in their spend program and make informed decisions.
However, users should be aware of the “eye candy” nature of sexy dashboards that have no substance underneath. They should ensure that the underlying data is captured in a structured way for the analytical models to work. In addition, they should make sure that the data can be easily manipulated and can be update frequently in a cost-effective manner.
As examples of relevant concerns and questions that some sourcing and procurement employees (and their roles) within the company might have, let’s start with a diversity manager. He/she might want to know how compliant the company is with its supplier diversity program or what exact percentage of, say, the transportation spend, is associated with diversity (e.g., minority-based businesses) suppliers.
For their part, commodity managers will want to know what the performance and spend trends can be discerned in their particular commodity (e.g., steel ingots or plastic resin) across all business units. In addition, they might want to know how many vendors account for the top 50 percent of, say, the transportation spend, and what percentages of the transportations spend is with preferred suppliers.
Chief procurement officers (CPOs) and chief financial officers (CFOs) care about the “bigger picture” issues, such as how the global program is performing and where the next wave of opportunities might be. They need to build compelling summaries to win executive support for new sourcing programs.
Some of the aforementioned vendors provide printable “brief books” (in a click-to-print manner) available to chief executive officers (CEOs) for easy, offline scrutiny of spend data for organizational insight into spend with top suppliers, top 20 spend categories, departmental governance such as supplier performance, non-contract-based spend, etc.
From organization to organization, supplier management programs will certainly vary. After all, everyone is operating at a different level of maturity. But as a discipline, supplier management should entail the following activities at its core:
• keeping vendors aligned with the organization’s business goals via supplier performance management
• managing and optimizing costs
• assessing and mitigating supplier-based risks
Companies must be able to quickly assess their organization’s dependence on a particular supplier and whether or not that vendor is easily replaced. They should know how much money the enterprise has invested in the vendor’s products, and identify the risks of walking away. Once companies have the answers to those questions, they should know better where to spend more time and effort.
What about the Need for Agile Contract Management?
The remaining critical factor in supplier relationship management (SRM) is managing the commercial terms and conditions of contracts with critical suppliers. Contracts are the glue that keeps both trading parties more secure in their relationship. On one hand, the supplier has some business guarantee in terms of quantity and time, while on the other hand, the buyer is guaranteed the quantity, price, and time-phased delivery of critical items and services.
Organizations typically spend an inordinate time building and negotiating contract terms, especially those that contain significant performance-based payments and incentives (or penalties in the opposite case), and often rely on the contract as the tool for managing their vendors. Contract management goes well with strategic sourcing and services procurement, since companies can even better evaluate and monitor their suppliers and spend based on contract performance.
Solutions from vendors such as Emptoris, Ariba, Zycus, Upside Software, iMANY, Nextance, Proactis, Selectica, Oracle, and SAP provide immediate feedback on supplier performance trending. Key performance indicators (KPIs) offer an objective way to assess contract compliance and supplier performance directly from contracts. The goal is to visually and intuitively understand when and where suppliers are in danger of failing to provide the important items and services to which they have agreed, or when and where they have failed to deliver.
Users can create formulas that determine alerts for a KPI, such as, e.g., overall defects (which include defects at receiving, in the field, or returned by customers) are negotiated to be no less than 99 percent. Moreover, users can configure the level of severity of the violation of the rules; for example, if the supplier falls below 99 percent, but is still above 95 percent, then there is a yellow warning indication. Should the supplier fall below 95 percent, then an e-mail alert is generated and the measure is graphically represented in an alarming red color.
From their role-based dashboards, purchasing managers can then explore the details of the contract to understand the complete picture of the relationship with the supplier. They can drill down to the spend transaction detail, as to be able to review the discrete transactions that the spend comprises.
Procurement users may want to drill into the spend of the contract to understand the progress of the relationship, such as how much has been spent with this supplier against this contract thus far. Other examples of questions:
• What divisions are buying from this supplier/contract? What commodities are being purchased?
• What is the invoice receipt-to-payment time? Are we paying these suppliers too early or too late?
• What percentage of our spend is contract-compliant?
• What percentage of our spend is tied to invoices paid without a purchase order/contract?
• How many business units in our company are using the same supplier but with different contracts and terms?
Contracts Will Not Monitor Themselves
Many companies expect their contracts to self-operate in an auto-pilot or cruise control manner. But for companies to maintain proper control and get the value they are expecting in their dynamic business environments, easy oversight is critical. The lack of contract visibility leads to faulty control over business contracts and failure to manage compliance to agreements.
Conversely, being able to manage contracts on the fly enables companies to be responsive to regulation, nimble enough to meet ever-changing market conditions, and confident in their business processes. In other words, by enabling information transparency companies are better positioned for competitiveness due to their anticipatory prowess and strategic pro-activeness.
For some industries in particular, contracts are not merely about widgets’ quantity, price, and time-based delivery numbers. For example, in health care or software/professional service sectors, contracts have to cover tricky areas, such as so-called statements of work (SOW), non-disclosure agreements (NDA), and service-level agreements (SLA).
The ability to manage a greater number of complex contracts and to amend them en masse when necessary, for faster better results in a rapidly changing market, is another critical capability. For example, there might come a new US Food and Drug Administration (FDA) regulation that sternly says “take the drug XYZ off the market… it is not safe!” The manufacturer in this case has to quickly find all relevant contracts, amend them, present them for a review to proper instances, and execute new contracts in its trading network.
The mass contract creation ability and the ability to respond to large-scale contract changes in one fell swoop (from contract search results) are essential here to ensure compliance of all contracts to any regulatory or industry requirements and changes that may occur. They reduce the risk for companies entering a volatile regulatory market.
The most sophisticated contract management solutions in the market enable simultaneous amendments (including tracking all the authoring rights and actions) for the same contract, either in case of multiple affected items and services or in case of multiple contract sections being affected by amendments. Often, the contract amendment will require handling (collating, checking/reviewing, etc.) multiple documents that are connected to the contract. Last but not least, it’s often critical to be able to perform an operation (e.g., contract presentation, execution, review request, recall, and sub-status updates) simultaneously on a group of contracts that will in turn require multiple documents for each contract.
Some Best-of-breed Vendors Voice Their Opinions and Capabilities
Upside Software is arguably the contract lifecycle management (CLM) leader in terms of the number of customers and features. The vendor points out the need for reducing the negotiation cycle time. As an example, through UpsideContract, users can make and track requests at a clause level by template (i.e., indemnification clause on a service agreement). Through this intelligence, the organization can gain visibility into how many times a clause changes and to what degree, as well as how long it took to get through negotiations.
With all this data, it becomes clearer what changes need to be made to the template so that future negotiations go faster. A good example: one Fortune 50 manufacturing client found that in over 80 percent of cases within a certain contract type, the final indemnification clause selected was their option #3 (their playbook indicated to start with option #1, then move to #2, and so on). Based on the low risk, they decided that option #3 should now become the new option #1 and with that move, they would save about 600 hours of legal review time.
Incorporating e-signatures (digital signatures) allows for faster contract signature cycle time and helps the suppliers get payments in quicker, while allowing the customer to get their goods/services faster. Also, with the availability of low cost software as a service (SaaS) options for contract management, we are seeing an increasing number of small/mid-market customers adopt the software. Even starting with a simple repository and then incorporating proactive alerts and post-contract management are key benefactors and justify the low monthly fees.
For its part, while a large portion of Selectica’s contract management business continues to come from procurement contract management (customers like PepsiCo and Covad have focused on this area), the vendor views contract management from an enterprise perspective (both buy-side and sell-side from a single instance). There is immense value in having a one solution to do this (lower total cost of ownership [TCO], lower audit costs, fewer systems to maintain, reduced training costs, etc.). To be successful in enterprise CLM, companies need functionality to support both types of contracts.
Selectica cites a few more capabilities that best-of-breed enterprise contract management solutions should have:
• Support of mobile devices—Procurement teams often have a reputation for being bottlenecks in the process. This capability dramatically cuts overall cycle time.
• Employee self-service contract kiosks—These outlets let anyone in a company (i.e., not just procurement contract management users) access contract info, request new contracts, and check the status of a contract. This facility helps reduce maverick contracting and lets legal teams focus on higher-value work.
• Sell-side specific functionality—This feature is important for companies to standardize on one contract management system enterprise-wide. Capabilities like salesforce.com integration and sales configuration, pricing, and quoting links are key here.
Selectica is not a big proponent of the aforementioned “mass contract update” functionality. Namely, exceptionally few companies (Wal-Mart might be the exception) have the market power to unilaterally make changes to an agreement and force suppliers and customers to immediately accept them. The vast majority of the time, particularly with complex agreements, suppliers simply reply “no” to such heavy-handed tactics, or demand some kind of concession. A lot of contracting professionals the vendor talks with think that this feature is of little use and simplistic at best.
Instead, Selectica prefers the idea of an “effective view” of contract amendments. Just about every company today has at least a basic contract repository. Finding a contract is often a trivial matter. However, understanding what the prevailing language and terms are over dozens of amendments is a major challenge. The ability to collapse this information in a single version of truth is exceptionally important.
Is Sophisticated CLM for Everyone?
In TEC’s previous blog series on SRM and spend management needs of mid-market companies (see Are Spend Management (or SRM) Apps Suited for the Mid-market? – Part 3) we asserted that smaller companies do not deploy contract management en-masse. It is not that they don't need contract management, but rather that they have a lot of other applications that they might need more than that.
Mid-market companies tend to get by with less because they have to. The more adept ones make really good decisions on where to invest in technology so they can do more with less and beat their competitors. Contract management, while important, doesn't make it to the top of the list. Moreover, for some of these companies, basic purchase contract and sales contract capabilities within their enterprise resource planning (ERP) systems might suffice for the time being.
How to Start with Supplier Management?
We concur with the takeaways from Gartner’s recent Outsourcing & Vendor Management Summits. It comes down to the following three steps:
1. Formalize the activities and responsibilities for vendor management in your sourcing strategy.
2. Map out the responsibilities for key vendor management functions, such as contract, performance, financial, relationship, and risk management.
3. Determine which vendors are truly strategic and which are not, then focus more vendor management attention on your strategic vendors.
But Emptoris believes that there is a more practical approach on where to begin, which tries to align with one of five specific strategies. Each strategy has three to five generic steps to execute. Emptoris prefers this approach because it is tied more to business problems than to general process steps; the above approach might appeal more to line of business (LoB) owners.
The supplier management game plan strategies are as follows:
1. Reduce costs wherever possible, by wringing cost savings out of not just indirect spend, but every possible cost category across the global business
2. Maximize working capital by implementing a total cost model that provides a complete view of total cost beyond price—and a better understanding of the relationship between price, risk performance, and non-cost factors—deliver more cash to the business by being armed with the information and tools to negotiate better price and terms on capital and equipment spend
3. Manage volatility with a new set of capabilities to better manage supplier/price and economic variability and adapt more quickly to organizational change—and pro-actively manage the down-swing and be better prepared for the upswing.
4. Mitigate risk by using supply management capabilities to better understand supplier and price risks and better governance to keep on top of the exposure—and know the complete impact of your procurement and supplier choices
5. Get more performance out of supply management: squeeze more value by going beyond simple focus on price, and manage an optimal mix of suppliers based upon performance, risk and other factors. Plus, deliver a new, higher level of service to buyers and value to your organization
For more thoughts on these and related matters, see my blog post A Couple of “Five Procurement Commandments” in a Down Economy).