Over the past decade, the majority of the Fortune 1,000 (and beyond) have realized dramatic savings by applying strategic sourcing principles to both their indirect and direct expenditures. Sourcing efforts frequently yielded remarkable reductions in cost; often in the range of 5 to 15% or even higher as spend was consolidated and purchasing was streamlined. What’s more, these efforts demonstrated eye-popping returns on investment of up to 100-x and higher due to their relative ease of execution and made many Chief Procurement Officers (CPOs) heroes of the boardroom, if only for a time. Despite these gains, companies today face intensifying competitive and global pressures and are responding by pushing the boundaries of outsourcing and low-cost country sourcing in a quest for further cost reduction.
Even as they seek new opportunities in sourcing, leading companies are finding themselves dependent on an increasingly complex supply base, with the need to drive further cost and performance improvements, manage supply risk, and streamline costs of Supplier interaction. These companies are developing a new set of Supplier Relationship Management (VRM) capabilities – including processes, governance mechanisms, and systems to manage suppliers on a day-to-day basis over the full relationship life-cycle.
Early adopters of VRM are realizing savings in existing relationships, remediating relationships that are not working, working with suppliers to build joint capabilities and improve joint processes, effectively managing supplier risk and reducing internal costs of supplier management.
Typical benefits include:
- Maintaining negotiated savings and driving incremental savings of up to 5% beyond the initial sourcing transaction;
- Streamlining relationship touch-points and processes to eliminate non-value-added work and reduce associated FTE’s by up to 10%;
- Creating real accountability and incentives for Suppliers to deliver business value;
- Maximizing relationship lifetime value, and gaining competitive advantage by effectively managing Suppliers that are truly strategic;
- Managing supply risks and challenges effectively to further decrease supply costs.
We describe the new supply environment, the challenges it brings, and the Supplier Relationship Management best practices that leading-edge companies are applying to deliver maximum value from their supply base.
The New Supplier Environment
Organizations continue to focus on applying strategic sourcing, outsourcing, and low-cost-country sourcing, the supplier environment has changed or is changing dramatically. These efforts will create more concentrated supply bases, probably with a handful of large suppliers playing a major role in supporting roles. Further, these efforts will shift business-critical processes and value chain activities that had previously been performed internally to outsourcers creating new major Supplier relationships that are often vital to operational continuity. Accelerated product and services cycles, rapid pace of process, innovation, competitive initiatives, systems change, and the need to work seamlessly with offshore Suppliers have made effective supplier relationship management more demanding and more critical than ever before.
Simultaneously, a large portion of spend has reached a mature state after one or more waves of aggressive sourcing. Spend consolidation, improved supplier selection, specification rationalization, and shrewd negotiation have yielded impressive benefits. However, in categories where these techniques have been applied, further year-on-year improvements through repeated sourcing are likely to provide diminishing returns – fundamental improvement in Supplier relationships and joint processes will be required to address remaining inefficiencies.
Sourcing is rarely the gatekeeper for all sourcing activities – far from it. Individual functional groups, such as IT, HR and Logistics, having gone through the sourcing process with the help of the sourcing organization, have now built their own sourcing skill sets and a better understanding of the supply market. Furthermore, Organizations have gained a high degree of competency in outsourcing and off-shoring services and development, often in a complex, multi-tiered supply environment.
Organizations have been successful at establishing new supply environments and obtaining savings through negotiation of new contracts. However, organizations could be more effective or prepared for managing the new set of Supplier relationships they have created.
Supplier Relationship Management Challenges
Increasing reliance on Suppliers and exposure to Supplier risks
- While risk management has received significant attention, Supplier risk remains largely unmanaged in multi-year contracts while reliance on Suppliers and exposure to Supplier risk continues.
With increased focus on strategic sourcing, outsourcing, and low-cost country sourcing, it will transfer to Suppliers many activities that were previously performed in-house and this could simultaneously drive consolidation in the supplier base, as well as expose the organization to perhaps significant third party risks. The result will be a dramatic increase and reliance on key Suppliers, often accompanied by development of more complex Supplier interactions with growing numbers of touch-points and dependencies. With this rapid deployment of sourcing, organizations have developed VRM and Risk Management mechanisms to enable visibility and management of these risks. This has resulted in a comprehensive view of the risks associated with the Supplier base, sometimes the Supplier’s Supplier base, and the basic elements of a well-thought-out, repeatable approach to managing these risks has been developed. However, it is not always clear who in the organization has the responsibility to evaluate and manage Supplier risks, especially in multi-year contracts, what risk conditions should trigger actions or, even what those actions should be.
Ill-defined post-contract Supplier management processes and roles
- Processes and roles post-transaction are ill-defined, often inhibiting further performance improvements, limiting value from Supplier relationships, and making performance gains difficult to sustain.
In my opinion, the sourcing discipline is well established and repeatable, enabling most organizations to lock in savings in category after category. However, while typical sourcing methodologies provide guidance leading up to execution of a Supplier contract, once a contract is signed and the relationship moves into ramp-up and operation phases, there is remarkably little clarity and definition around what management processes must be in place, who within the company is (and, equally importantly, is not) responsible, how and which executives should be involved, how Supplier relationship management activities can be conducted in an efficient manner, and how the relationship should be managed. Organizations risks that Supplier relationship activities will be little more than a series of reactive firefighting exercises with duplicated effort across the organization, with little management transparency of what actions have been taken or will be needed. The result is relationships that are inefficient and fail to harness the full capabilities of the Supplier translating into increased lifetime costs.
Suppliers might not be accountable for performance – the organization is left holding the bag:
- While hundreds or even thousands of Supplier metrics are tracked and reported, performance problems can persist and organizations often do not recoup resulting costs.
While contracting with a Supplier after a major sourcing effort might lock in significant savings, it also locks in a number of headaches and challenges. Organizations must ensure that they don’t treat sourcing efforts only as a series of “just” contracts as legal exercises or transactions. This results in contracts that do not hold Suppliers accountable, that do not motivate Suppliers to improve, and that omit actionable steps organizations can take to improve Supplier performance. As a result, organizations might have to deal with contractual Service Level Agreements (SLAs) that are not aligned with business value drivers, few, if any individuals that understand what suppliers are actually accountable for, and a lack of clarity in what actions should be taken when issues occur. The result might be significantly diminished value from the supplier relationships, lost opportunity in recouping costs from ill-performing suppliers, and frustrated employees who know that Suppliers are underperforming, but can not correct the problem.
Strategic Suppliers are not truly strategic
- Organizations ought to take care not to over-use the word “strategic” when it comes to Suppliers – but organizations should be proud to declare that they view some Suppliers as strategic. In those organizations that are ahead of the Supplier relationship management curve, VRM initiatives are typically underway to describe/illustrate the implications of making a supplier strategic. Organizations have usually formally spelled out a set of expectations for what makes suppliers strategic, how such suppliers will be managed differently, and what suppliers must deliver in return to maintain their strategic status. With this framework, organizations will avoid the pitfall of confusion: asking 10 individuals to name the strategic suppliers will not yield 10 different answers. As a result, organizations will manage strategic and non-strategic Suppliers in a differentiated fashion, resulting in no time wasted on non-strategic suppliers while optimizing strategic value, derived from strategic relationships.
Organizations, up to now, can not precisely identify which suppliers are truly strategic or even how such strategic supplier relationships should be managed, leading to an inability to effectively focus resources or realize strategic value from the supply base.
- With thousands upon thousands of suppliers in profile, the question becomes “where and how do we focus and why”? Strategic relationships can deliver impressive returns and competitive advantage to both organization and their suppliers. Through strategic relationships, the organization can drive lower total lifetime costs while allowing Suppliers to profit, reduce risk for both parties, help identify risk patterns in third party Suppliers, help create advanced joint capabilities not available to other competitors, and provide strategic options for additional value for both parties.
Organizations should manage Suppliers vs. having Suppliers manage Organizations to extract profits
- In the absence of a clear set of Supplier management processes and roles in the organization, Suppliers are often able to set the agenda and canvass the organization to build business.
Major supplier relationships tend to have multiple facets and touchpoints – operational, contractual, financial, executive-to-executive, etc. Through multiple touch-points, supplier account teams often “work the relationship”, seeking to protect their existing business with organizations and to make inroads into new areas to build further sales. While organizations can gain value from consolidating business with key Suppliers and forming strategic, multi-faceted relationships, the VRM framework will ensure that such relationships will be defined in a structured transparent manner rather than through a free-for-all sales frenzy, that could lead to poor procurement choices.
Diminishing sourcing returns
- While aggressive sourcing in multiple categories has for most organizations yielded dramatic savings and other benefits, sustaining those benefits and attaining further reductions can be difficult without effective VRM – and closed loop spend management systems.
I suspect that organizations, through effective sourcing initiatives, sourcing efforts have unlocked large savings opportunities, often delivering savings of 15% or more over baseline spend. However, re-sourcing categories where significant savings have already extracted often yields disappointing returns and often has a very poor ROI. This is because once spend is consolidated, specs rationalized, excess supplier profit margins removed, and work offshored (where applicable), sourcing offers little on-going opportunity. In order to unlock the next layer of savings, organizations might need to focus on addressing the structural and process inefficiencies in supplier relationships and collaborate with Suppliers to improve joint capabilities. Some of these mechanisms might include Supplier-initiated innovation, closed-loop spend management systems (ensuring negotiated savings are captured post-contract signature)
Employees are not equipped with Supplier management skills and knowledge
- Sourcing brings to bear resources with transactional or sourcing skill sets, operations brings to bear resources with functional and people management skills – none are a good fit for day-to-day Supplier relationship management.
In most organizations, the people responsible for on-going supplier management are the same individuals that drove strategic sourcing and those who managed internal functional departments before they were outsourced. In both cases, such individuals often lack both the knowledge and the skills required to manage Supplier relationships effectively. Sourcing personnel are trained in sourcing methodologies, negotiation, and other procurement skills. LOB personnel have a deep functional understanding and can be excellent people managers; however, they often lack the understanding of sourcing best practices. The result is that the best skills and knowledge are not brought to bear in managing Supplier relationships. In addition, these legacy skill-sets combined with individuals’ desire to do what is best for organizations can actually prevent suppliers from being held accountable for performance and can increase internal costs – employees that are accustomed to being responsible for a function’s performance will often take on the responsibility of solving issues and will apply internal resources even when the function has been outsourced. The result is that supplier accountability is diminished and internal costs can rise.
Formal Supplier development programs are lacking or ineffective
- Currently, at most organizations, there are no formal programs for Supplier development, limiting the organization’s ability to create win-win value improvements with the Supplier base.
When organization’s suppliers develop capabilities to perform valuable new services, expand coverage to regions where the organization has locations, improve processes and technology to deliver better performance and lower total cost, both the organizations and the Supplier benefit. Most organizations are thinking of – or establishing a framework for Supplier development. Without formal criteria for selecting the Suppliers for development, pre-defined development “tracks” that accelerate specific development techniques, and standardized Supplier development management tools, organizations will need to rely on the blunt instruments of contract negotiation and performance penalties to drive improvement.
Everybody has become a Supplier manager
- Without an effective VRM framework, organization’s risks introducing a level of inefficiency – too many employees spend time on unnecessary or redundant interactions with Suppliers.
As organizations accelerate their outsourcing activities, they must avoid that an alarming number of employees end up spending time and effort managing and interacting with the Supplier. This overhead is exacerbated by the duplication of supplier management effort that typically occurs across different corporate functions, business divisions, and geographies. Not developing an effective VRM framework, will result in internal roles and responsibilities are not being clear, many aspects of the relationship being ill-defined, Suppliers making every attempt to spread their relationship footprint, too many employees become involved in performing Supplier management tasks that are often redundant, inefficient, unnecessary, or even competing. In our experience, this can translate into dozens or even hundreds of employees involved with tracking Supplier activities, dealing with issues, interacting with Supplier personnel, etc. This “relationship creep” can lead to increases in retained cost of up to 10%.
Sourcing, what have you done for me lately?
Supplier Relationship Management (VRM) is a set of principles, processes, templates, and tools that will help organizations to maximize relationship value in an intelligent and justified manner, while minimizing risk and management overhead over the entire Supplier relationship lifecycle. VRM will enable organizations to effectively
- While the sourcing function has played a leadership role in sourcing and outsourcing activities, the objectives and value proposition of the sourcing function need to evolve.
At most organizations, the sourcing department has played a leading role in deploying strategic sourcing, outsourcing, and low-cost country sourcing. However, as sourcing has become mature, as the key categories have already been sourced, as sourcing practices have been institutionalized, and as many functions and business groups have become more or less self-sufficient when it comes to further sourcing, sourcing is finding that they must develop a new value proposition. One path is for sourcing organizations to champion effective VRM frameworks to become centers of excellence, not just of strategic sourcing, but of on-going VRM across the entire lifecycle of Supplier relationships.
- Stratify Suppliers based on importance and defined relationship expectations
- Leverage the established VRM governance structure and process for internal and Supplier interactions across the lifecycle of the Supplier relationship
- Define formal processes for management involvement in the relationship
- Clarify internal roles and responsibilities, and required skills
- Put in place processes to effectively manage performance and develop Supplier capabilities to continuously improve value
Ideally, a VRM framework should be comprised of five key elements:
- Supplier Segmentation: with almost thousands of Suppliers on the rolls, effective VRM requires a clear organization-wide understanding of which Suppliers are the most strategic to Organizations and which are less important. This is done through an assignment of material segmentation. In the absence of balanced, formal criteria for Supplier segmentation, Suppliers on which organizations spend the most are inevitably viewed as the most important and tend to capture the greatest relationship focus and effort. Factors such as business criticality, operational/technical integration, and long-term fit with the organization are often ignored, reducing the organization’s Supplier management effectiveness. In addition, effective segmentation requires a set of common definitions of how Suppliers in strategic and non-strategic tiers should be managed.
- Optimize resource allocation across a broad Supplier base
- Establish and manage relationship expectations by Supplier tier, providing a common reference point for what it means for a Supplier to be strategic
- Provide functional and business groups with consistent partnering strategies within their supply bases
- Provide functional and business groups with a fresh view of their Supplier portfolios based on relationship value, enabling improved decisions on further Supplier consolidation and leading to further strategic sourcing opportunities
- Motivate suppliers to strive for advancement across supplier tiers
This common set of definitions enables Organizations to:
- Governance and Organization: Once the importance of an individual supplier to organizations is established via Material Supplier Segmentation, the next step is for Organizations to define the team structure that will be required to manage the Supplier on a day-to-day basis as well as the roles involved in those activities and skills and knowledge that team members will be expected to bring to the table. Formalizing these definitions across organizations typically results in a dramatic rationalization of supplier management resources, typically. In addition, the streamlined structures eliminate many of the dropped hand-offs and help to make Supplier management more proactive. Once a team structure with roles and responsibilities is defined, the next step is to apply the on-going governance processes to make Supplier management repeatable, transparent to management, and consistent throughout Organizations.
- Schedules, attendee lists, and agendas for key Supplier relationship review meetings
- Templates for Supplier relationship reviews
- Detailed designs of day-to-day Supplier management activities such as contract management, financial management, and issue resolution
- Triggers and escalation paths for supplier issue resolution
For organizations, the established set of governance practices lays out:
- Supplier Development: Due to increasing Supplier consolidation, an organization’s overall performance and efficiency will become more and more dependent on the capabilities of its Suppliers. Organizations could benefit greatly when key Suppliers dramatically reduce costs, introduce new services designed to address organizations’ needs, expand their footprint to provide seamless coverage in multiple regions and work with the organization to streamline joint processes.
- Benefit to Organizations:
- Develop and leverage new services and products that can drive competitive advantage
- Closes capability and performance gaps
- Creates a reliable and long-term source of supply
- Provides access to new ideas and opportunities for improvement
- Prioritizes capability development and Supplier investment
- Benefit to Supplier:
- Creates additional revenue generation opportunities
- Enables the development of a long-term relationship
- Creates opportunities for joint investments
- Provides opportunity for Supplier to advance to next tier
- Gives insight into customer organization’s business needs
- Value Creation: VRM could introduce –
- Overall benefits can be quite high – eclipsing even strategic sourcing benefits by creating true partnering and by driving objective-based breakthrough capability improvements.
- Contracts to encourage Suppliers to identify opportunities to add value
- Establish process to identify new value creation ideas
- Create incentives for Suppliers to identify new opportunities
- Organizations can address these Supplier development needs with VRM: create a formal Supplier development program that first selects Suppliers where development effort will have the highest value to Organizations, determines the specific development need(s), and applies the appropriate development techniques. Sample VRM development techniques include:
- Joint investment in new capabilities
- Intellectual capital sharing
- Joint value creation opportunity identification
- Joint process mapping and improvement
- Capability acquisition by Supplier
- Multi-Supplier collaboration
- Joint personnel training
- Systems and process integration
- However, without pre-defined “tracks” for development, including guidelines for development trigger identification, toolkits for simplified execution of development activities and program management toolkits, organizations can find it difficult to scale Supplier development efforts across functions and business groups.
- Service Level and Performance Management: Effective management of supplier service levels and performance is a critical element of VRM. By measuring the supplier impact on business value drivers, hold Suppliers accountable for poor performance, and by providing incentives for outstanding performance, Organizations could benefit by:
- Enabling continuous improvement in Supplier performance and efficiency
- Ensuring adherence to contractually defined SLAs and performance targets
- Providing improved visibility and documentation to Supplier performance issues
- Supporting Supplier governance by providing data on Supplier performance and value-added to the organization To enable truly effective performance management, the resulting relationship agreement elements must be captured and presented in an integrated fashion. This is typically accomplished by creating a “performance map” that outlines what the Supplier is truly accountable for, what specific steps must occur as consequences of the Supplier’s non-performance, and so on.
- Supplier Relationship Visibility / Scorecards:
- In many cases, after examining existing SLAs and performance measures and developing a performance map for the relationship, it might be necessary for Organizations to re-define contractual SLAs. However, even where SLAs are already effective, developing and using a performance map ensures that all parties involved in the relationship understand how performance will be managed and who will manage it. The result is a dramatic improvement in performance.
- Supplier scorecards are encouraged, eliminating the risk that performance management falls short of achieving this ideal, and eliminating a mere tactical reporting exercise. If service levels and performance management are to maximize value to Organizations, the first step is to identify the function’s key business value drivers and to understand how the Supplier can impact those as well as the target performance levels and tolerance ranges. In some cases, it may even be advantageous to redefine the scope of the Supplier relationship to ensure that the Supplier can truly impact business value. The next step is to establish a contractual agreement that clearly defines Supplier performance expectations, target levels, and tolerance ranges. In addition, it is critical to formalize the consequences of underperforming or over-performing to an agreement, the specific trigger points and conditions for remediation once an SLA breach occurs, the process for remediation, and ownership of the Supplier performance within the organization.
- Availability of all relevant relationship information allows staff to manage and audit Supplier relationships more proactively
- Access to consistent reports facilitates executive and management reviews of Supplier performance and status across Supplier relationships
- Roll-up capability enabling visibility of overall relationship factors such as risk, performance, resource allocation, etc.
- Organizations Standardized Tools and Templates:
- Common VRM tools and templates facilitate VRM adoption across Organizations
- Common VRM model through an easily accessible system reduces reliance on individual development of VRM processes and tools and facilitates training Benefits of Effective VRM to Organizations: Improvements
By adopting VRM best practices, organizations will realize a number of important benefits:
- Focused, relevant and streamlined supplier management processes to reduce internal costs
- Improved ability to concentrate spend with “strategic” partners resulting in further leverage and efficiency
- Accelerated development of Supplier capabilities and improvement in value delivery
- Greater Supplier accountability for business results reducing non-performance and improving recovery of non-performance costs
- Alignment of Supplier agreements with business performance and cost objectives
- Performance visibility to allow for continuous improvement of Supplier relationships
- 5% – 15% improvement in ongoing supply costs
- 10% reduction in FTEs focused on partner / Supplier management
- Improved execution against delivery schedules and quality standards
- Improved joint objective setting, planning and collaboration with Suppliers
- Improved visibility and manageability of supply risks and information
- Access to Supplier-initiated innovation
- Risk reduction – both Supplier and third-party risk across a set of operational criteria (brand/operations/financials/environmental/etc)
To realize the full benefits of strategic sourcing, outsourcing, and low-cost country sourcing, organizations should adopt VRM framework to introduce the capabilities required to effectively manage the resulting Supplier base. To define a starting point and prioritize VRM activities, consider the following questions:
- What are the pain points and opportunities related to the organization’s Supplier base and Supplier relationships?
- With VRM on which Suppliers ought organizations to be focusing?
- Does the VRM framework as currently considered have a well-established definition/vision of VRM and a common understanding of the scope of needed VRM practices?
- Does the VRM framework establish a clearly defined, common set of processes, policies, and tools governing the on-going day-to-day management of Suppliers?
- Are the roles and responsibilities for the various aspects of Supplier management clearly defined to bring to bear the right skills and focus and to avoid redundant, non-value-added activities?
- Has the sourcing function evolved from having a transactional or sourcing capability-set to becoming a Center of Excellence for on-going VRM capabilities?
- Does the staff (sourcing / LOB) that interfaces with Suppliers on a day-to-day basis have the skills to manage Suppliers effectively to maximize value?
- Are strategic Suppliers delivering strategic value?
- Is there clarity around which are strategic, which are the non-strategic Suppliers, and how those groups should be managed differently?
- Does the VRM framework have the processes in place to develop the capabilities of important Suppliers to boost Supplier performance, direct Supplier investment in new services, etc.?
- Does the VRM framework and associated scorecards provide for an environment that holds Suppliers truly accountable for performance in areas that drive the most value for the organization?
- What strategic, operational and process benefits will fuel the ROI curve?