Integrated

supply management and

supplier certification

Here's how you can bring key suppliers
on to your team as partners and create a win-win strategy
for becoming more competitive.

by Nick A. Shepherd

In the future, our prosperity will depend increasingly upon our ability to sustain a sufficiently large base of companies competing in world markets, not on the basis of lower labor or raw material costs, but rather through technical innovation, skilled labor, adept marketing, and high productivity. Changes in the world economic system have forced this new reality upon us. As a small nation which must trade to survive, we cannot escape it's logic.¹

Every organization is facing the challenge to become more effective; whether it be a business attempting to compete in Canada or internationally, or a government department dealing with reduced resources yet greater demands on its services. Traditional approaches to competitive improvement have often included "cost cutting." This approach focuses on the assumptions that a) in many businesses the principal costs are labor costs, therefore reduced labor costs equal high productivity; b) the second higher cost is purchased materials and services and , therefore, lower supplier pricing equals greater profitability. It follows that a focus on these two areas will improve financial performance.

This set of assumptions have proven to be flawed for two reasons. the first is in the area of labor costs. In the majority of cases, cost cutting translates into staff reduction-- through downsizing" and pure "layoffs." Studies into this action have shown that there are three areas of concern. First, few organizations make these cuts as a part of any structured strategic plan. Second, it is reported that, in over 50 per cent of the cases, these reductions do not bring the desired results. Staff has to be added back, and the staff members who do leave are often those with the most valid knowledge. Thirdly, the staff members who remain after the down-sizing often have low morale, and little incentive to look for innovative and creative ways to further streamline operations.

Applying price pressure to suppliers can also have negative long-term effects. General Motors has admitted that an unplanned side effect from the price pressure on suppliers during the late 1980s and early 1990s (often in the form of the PICOS teams) resulted in suppliers either failing or in negative relationships.² The short term benefit of the $4 billions saved was critical to General Motors cash flow and survival; however, the longer term effect of losing supplier ideas, input and support could offset this short term saving. Suppliers have an impact on, and are heavily impacted by the purchasers' internal processes and procedures. A focus on price alone removes the opportunity to address other areas that can reduce overhead costs of both parties.

The conclusion must be that traditional approaches sub-optimize the potential benefits of lowering costs. In fact at a time when organizations need the commitment and support of suppliers and employees at every level, these approaches can be very destructive. How then can organization approach the need to increase effectiveness, without resorting to these approaches?

In simple terms, organizations have only two areas they can work with. They can increase sales (serve more customers, provide more revenue-generating goods and services, obtain higher prices) or they can focus on costs (increase output at the same cost input level. or increase balance sheet / investment effectiveness). In this article the focus is on the opportunity to decrease costs through changes in the process of supply management.

Organizational Waste

For years, managers (and every other employee) have recognized that waste exists in the organization. This waste comes in several forms, but in all cases it contributes to decreased profits, lack of competitiveness, difficulty in raising new capital, and lower employee morale. Studies have shown that 90 per cent of this wastes comes from process inefficiency -- not from the individuals working within the organization. Attempts to eliminate staff are therefore unlikely to deliver the desired benefits unless the underlying processes are also changed. Staff reductions are at best a "quick fix" to allow organizations to buy time while they address the real process problems and opportunities.

Process waste is also created by the traditional belief that suppliers must be dealt with on a "negotiate-to-win" basis rather than a win/win basis on both sides. There are several ways in which traditional supplier relationships reveal this practice.

* you need three bids to keep suppliers honest; treat suppliers at arm's length so you can "keep them guessing"

* have multiple suppliers so you can trade off one with the other

* evaluate suppliers on the main basis of product pricing

* focus on short term (one year) contracts

* involve the supplier after the design is complete.

These practices result in waste. The supplier has little incentive to look at the overall cost of doing business with the customer. The focus is to get the business at the lowest production cost possible. Minimal investment is made in looking for improvements. In 1987 the Massachusetts Institute of Technology (MIT) conducted a study that demonstrated that one of the top three causes of lower North American productivity was the traditional adversarial relationships between buyers and sellers.

Another key area of process waste in an excessive investment in inventory. This can occur in raw materials, in process inventory, finished goods, or support inventories such as maintenance parts. This waste can often be called "insurance" as it is used to balance operational process failures. Often this also equates to a lack of confidence in suppliers ability to perform. The automotive industry has made major improvements in these areas, but many industries have still not obtained the benefits from addressing this opportunity.

In many cases, excess inventory is caused by obsolete approaches to the purchasing function. Purchasing has traditionally been the focus of "lower prices"--without considering the impact of its actions on other functional areas. Rewards have been given for obtaining supplier cost saving yet, mysteriously, these savings do not show up in bottom-line improvements. Why? Because the savings have been consumed elsewhere through added costs - such as dealing with an added number of suppliers in accounting and receiving.

Purchasing, quality, and TQM

Quality management programs, such as an ISO 9000 series quality system or an integrated approach to total quality management, are being implemented by many organizations. Specific techniques may be employed to assist in the assessment of existing business processes and to identify areas of improvement. These can include flow charting, cycle time analysis, failure analysis, and eventually process re-engineering. Organizations implementing ISO 9000,

for example, need to address the purchasing activity. Purchasing can be considered a "gateway" to an internal quality system, and internal effectiveness. An organization may have the best internal quality system but, without high-quality, defect free raw materials, the process will be flawed. ISO defines certain requirements for purchased materials, therefore, implementation of ISO will require some type of supplier quality and performance measurements. However, ISO does not require that suppliers be registered. This is left to the discretion of the buying organization.

The Internal quality system

Measurement of supplier performance is a key goal of ISO; however, it is only the beginning of quality improvement in supplier relations. Total quality in supplier management will come from the development of a close working relationship between both buyer and seller where quality is just one element of value-added performance.

Making suppliers part of the team

The General Motors "Targets for Excellence" program is based on five key performance elements that each supplier is evaluated against. These include cost, delivery performance, quality, technology, and leadership. These five factors indicate that valued suppliers cannot concentrate on quality alone. Buyers wishing to develop close supplier relationships want their key suppliers to really add value, as well as continually focusing on competitive pricing.

Internal process improvement activity often requires supplier participation. Quality programs focus on the issue of conformance to requirements, but total quality focuses on continuous improvement on a wider scale. Buyer organizations incur waste in many areas of supplier performance. These include:

* Cycle time - this includes areas such as the supplier's impact on taking new designs and building the product, meeting delivery schedules, turning around individual orders, and being able to hit a 100 per cent fill rate every time.

* Cost - including the impact of paperwork, checking receipts, product cost, inventory costs, and nonconformance costs.

* Quality - the ability of the supplier to meet specifications 100 per cent of the time.

Improvement in these areas is key to buyers. Cycle times not only drive cost but have a significant impact on competitive advantage in the market place. Quality drives costs if it is not "right first time" every time. Cost is always critical both the need to continually drive down overall input costs, and to focus on the overhead process costs associated with overall procurement activity.

Developing the integrated supply strategy

In terms of production materials purchasing, integrated supply means focusing on the overall impact of supplier relations on the buying organization's operational effectiveness. To build an integrated approach to supplier management, organizations must address:

* The critical success factors (key processes as well as performance factors) that must be addressed and improved to gain competitive advantage. These may include: reduction or elimination of inventory, reduction in process cycle times from concept design to production, as well as from requirements planning to delivery of materials; reductions in process costs through simplification; and, design to cost/build to cost targets.

* These factors are then assessed in terms of current performance so that improvement strategies can be developed. This can include all areas of process analysis as well as the application of activity value-added and activity-based costing.

* The buyer establishes key areas that are impacted by, or can impact supplier performance. Issues such as supplier involvement in the design stage, improved communications, and automation of production schedule information can all be addressed.

* The buying organization assesses its existing suppliers against their ability to address the key performance criteria that have been established. Existing (and potentially new) suppliers are then invited to submit plans for longer term relationships that address these critical success factors. They are also requested to identify other areas for improvement that the buyer may not have identified.

* Submissions are assessed, and supportive suppliers areasked to attend meetings where more detailed discussions on approach, timing, and performance measurement are addressed. Those offering the best overall partnership approach are then selected as core suppliers.

* Core suppliers and buyers then select teams to address each of the specific areas of improvement. These teams work jointly, with the authority to identify and implement changes, in either organization's practices, that will result in a higher overall performance of the buyer/seller process. Standards of performance, target cycle times, quality plans, design goals, and target costing are often some of the measures established.

* Both parties continually monitor progress against the plans to identify further opportunity for improvements where mutual activity can bring benefit.

ONE OF THE TOP CAUSES

of low North American
productivity is the adversarial
relationships between
buyers and sellers.

The goal of this process is the creation of a long-term "partnership" type of arrangement where the total process of win/win is addressed, rather than buyer and seller each following an independent strategy. This process take time, trust, and commitment of resources. It requires a "change in the way we do business" rather than the traditional short-term efforts to "fix" quality or "drive down" purchased materials cost.

Integrated supply in the support areas

The term "integrated supply" is also used in the area of parts procurement for maintenance. This particular focus grew from the realization that maintenance parts purchasing is a highly paper intensive, low purchase item, value process.

Integrated supply in this area covers a situation where one supplier takes over as "manager" of the overall parts management and purchase process. This often reduces the number of parts suppliers significantly, reduces parts inventory levels, and, hence. reduces both investment and process costs.

Those implementing this approach have seen parts inventory reductions of over 50 per cent, and significant reductions of paperwork through supplier consolidation and process automation.

Benefits from integrated supply accrue to both buyer and seller. Buyers are able to allocate their time to value added activity, rather than areas such as quality problems, contract renewals, request for proposals (RFP) evaluations and expediting. Investment of time and support is given to the lower number of key suppliers where long-term benefits and payback targeted.

The seller is able to concentrate on performing the work more effectively, through a higher awareness of the buyer's needs, and a level of confidence that the supply contract is a long-term commitment and will not be "pulled" every 12 months. Both parties are able to invest in cost saving process improvements, with a payback window that exceeds the life of a traditional supply contract.

Past studies have shown that buyer/seller partnership can improve supplier sales, lower the cost of doing business, and significantly improve operational productivity.

RESULTS CAN BE SIGNIFICANT:

cycles times slashed;
inventories eliminated;
process costs reduced, and
cash flows improved.

While the benefits of building buyer/seller partnerships and integrated supply are proven, the path is difficult and should not be embarked upon lightly. Suppliers who believe this approach will "guarantee them" the business and "lock up the contract" may misunderstand the high performance levels required. Building trust takes time, and will only come from continually focusing on improvement and delivering results. Suppliers have high level of responsibility to the committed buyer; buyers often need to act as coaches and supporters - especially to smaller, less sophisticated suppliers who may have limited resources to commit to areas such as quality and design improvements.

Key to success is the clear understanding between both parties of the mutual expectations. Specific goals must be established and monitored. Targets will continually be upgraded; buyer and seller will start to share information at a new level of trust.

Central to the process, is the commitment to a long-term relationship, and integrity between both parties.

Results from those implementing this approach show the potential for significant improvements. Cycle times have been slashed both for new product development and for production lead times; inventories have been reduced or eliminated; process cost have been reduced significantly; cash flows therefore improve, Quality and service levels increased to and unprecedented level. Problems are solved without requiring the major involvement of management.

Improvements can only come from re-addressing "the way things are done." Organizations wishing to become more competitive cannot do so by just "trying harder." Real change in the organization and process through which work is done is a key to continuous improvement. In most organizations, integrated supply management offers the opportunity to bring the key supplier partners "on to the team" and have them contribute their wealth of knowledge to the improvement efforts of the buyers. Through this approach, both parties win.

CMA

Nick Shepherd is president of Eduvision Inc., based is Oakville, Ont. He specializes in the areas of ISO 9000, as well as the economics of quality and supply channel management through supplier partnering.

1. "Competing in the new global economy" Report of the (Ontario) Premier's Council; Province of Ontario, 1988. Introduction to Volume #1

2. Fortune, November 1993, "GM gets a tune-up"

Reprinted from CMA MAGAZINE