The power of supplier collaboration & rapid supplier qualification.
It is indeed an ill wind that blows nobody any good. Fruit company Chiquita found that out to its benefit in 1998, when Hurricane Mitch ripped through Honduras, where much of the well-known banana brand's produce came from. The company actually increased its revenue by 4 percent while its competitor's revenue dropped by exactly that amount.
The hurricane destroyed about $900 million worth of crops--including four-fifths of the nation's banana crop. More than 70 percent of Honduras' transportation infrastructure was washed away. Chiquita's fruit was affected of course, but its rival, Dole, was hurt much worse; Dole lost 70 percent of its banana supply. What was Chiquita's smart move? It was much more nimble, qualifying and signing up alternative suppliers in areas unaffected by the storm and activating deliveries from them. By being far more responsive than Dole, Chiquita was able to outperform its more powerful competitor.
Chiquita's fundamental master stroke was to approach relations with its suppliers in a collaborative way. On top of that, it had built supplier qualification processes that enabled it to bring the new suppliers online in very short order.
This article will look at current best practices in collaboration (across value drivers beyond disruption risk management)--a field that is undervalued and generally underleveraged. It will also shine a spotlight on one "must have" capability that can help to maximize the value of collaboration: rapid supplier qualification. If there are managers in your organization who think that collaboration is not applicable to their value chain, or that they have finished the collaboration journey, we urge that they take a second look.
A Fresh Look at True Collaboration With the Supply Base that Goes Beyond Lip Service
Most people learn the value of cooperation in the home, the schoolyard, or on the sports field. Most companies recognize the need to promote cooperative and collaborative working in their organizations, too. Many have made strenuous efforts to break down internal barriers and foster closer working relationships, both inside and outside their four walls. As more and more of the value of products and services moves out (e.g., up from 10 percent to 25 percent in pharmaceuticals in five years) into the extended supply chain, however, companies are finding it much harder to extend their collaborative processes across corporate boundaries. We define supplier collaboration as the joint development of capabilities by both the customer and supplier for the purposes of reduced cost, process improvements, and innovation in products or services.
In 2012, McKinsey surveyed more than 100 large global companies on supplier collaboration practices. The survey distinguished traditional sourcing tools (such as clean-sheet cost models, RFP-based negotiations, etc.) from strategic investments and long-term projects with suppliers for co-development.
The results were fascinating. Although over a third of the respondents said they collaborated with suppliers, fewer than 10 percent could demonstrate systematic efforts on supplier collaboration. More importantly, among those who did collaborate, the EBIT growth rate was double that of their peers. (See Exhibit 1)
Do suppliers benefit from such relationships, too? Yes, they can. Their business is more stable, they become more cost competitive, and they improve their core capabilities. The suppliers can then deploy these capabilities to win more business externally. In a 2010 survey of the auto industry, we found the suppliers that gave Toyota and BMW the highest cost reductions also rated the two OEMs as their best customers. That is the mutual benefit of long-term collaboration.
Several companies have tried supplier collaboration with only limited success. Others believe they have run out of room in their collaborations. We believe that most companies can get more from supplier collaboration if they start again from first principles--that is, if they rethink the nature of their strategic supplier relationships. Further, we believe that many companies impair their collaboration efforts because they don't have strong systems for qualifying new suppliers.
Our experience shows there are three keys to developing profitable supplier collaboration.
1. Build the foundation of internal collaboration first Before embarking on a new program that demands a significant amount of time and resources, it's important to know if the company has the internal capabilities and strategy alignment to make the external collaboration a success. Under-investing in these internal activities is one of the top reasons that supplier collaborations fail.
So how do you assess or determine whether your organization has the capabilities to make this kind of collaboration a success? First, consider the skills required for the particular type of collaboration desired (described in more detail in the next section). For example, do your buyers have a solid foundation in clean-sheet modeling and sourcing strategy development? Does your team have access to internal expertise in lean, supply-chain management, and product development on what would become the future supplier collaboration team? Do you put you're A-players on the collaboration team? Only after you've addressed these needs would your organization be ready for supplier collaboration.
As an example, take a procurement function that is comprised primarily of tactical buyers who spend much of their day fulfilling orders. They may not have the expertise to identify joint cost-reduction opportunities or to work with suppliers to improve the product development processes. Organizations in this position are better served by investing in traditional sourcing and leadership capabilities first. Until this happens, suppliers have little incentive to try anything more ambitious. One pharmaceutical company went through a three year journey to strengthen strategic sourcing fundamentals, establishing a contract manufacturing organization, and finally establishing full-time supplier collaboration teams. The collaboration teams have sourcing, supply chain, quality, and R&D members (full time), with each team aligned to a specific "technology" or "dosage form." The company has become the industry benchmark.
Companies that have the fundamentals in place need to focus on more advanced, collaboration specific skills, such as value sharing mechanisms and joint developmental agreements. Value sharing models need to be simple, and properly incentivize performance for both the customer and the supplier. Common incentives for suppliers range from extending contract length, to splitting cost savings 50/50, negotiating a pre-determined benefit to the buyer (5 percent cost reduction per year, for example) with the rest going to the supplier, or to joint investment in capital projects for further capacity. Joint developmental agreements (JDAs), recommended in cases where IP (intellectual property) might be created, must clearly define the scope of the work, confidentiality obligations, intellectual property rights, exclusivity terms, and release criteria, to name a few.
Building momentum with small wins is important and a recipe for long-term success. Ultimately though, supplier collaboration teams should work on large and ambitious projects if they expect to see maximum impact--having an aspirational vision over a two to three year horizon is critical. To do so, the collaborating companies must align on which suppliers, products, or service lines they intend to invest in, and it's important to do this with the input and alignment of relevant cross-functional leaders internally such as manufacturing, R&D, engineering, and product line leadership.
Together, those internal teams need to answer the following questions:
* Which business units, product, or service lines should be prioritized based on factors that include potential profitability, urgency, risk, and cross-functional leadership support?
* Which suppliers are providing critical components or services?
* Is the spending for prioritized products or service lines growing?
* Is it specific to a particular geography?
* Is the opportunity to reduce cost, improve performance, or conduct product innovation big enough to justify the resources required?
* Will this help to gain a competitive advantage? What would be the advantage?
As you answer these questions, the next step is to segment the suppliers in a more granular way.
A large North American industrial equipment manufacturer wanted to unlock the potential of supplier collaboration. To determine which suppliers to invest in, it took a three-point approach. First, the manufacturer ranked its suppliers' strategic value, by mapping the importance of the products they supplied versus the ability to obtain them. Second, it reviewed each supplier's performance versus expected or best in class capabilities. This helped the company to define what the supplier could bring to a developmental program. Finally, the manufacturer evaluated these results to determine which suppliers to partner with to increase collaboration (see Exhibit 2). A side benefit of this exercise was a clear understanding of the relative value (or lack thereof) of their different suppliers, leading to insights on which ones needed to be replaced, motivated, or rewarded.
In this formative phase, you must clearly outline the goals of the program as well as the roles, responsibilities, and time commitment of the teams. Business and functional leaders will need to provide support from the outset, and cross-functional leadership teams must be committed to the program for the long haul.
2. Design the program to meet a specific business imperative
We have identified three types of supplier collaboration programs. Each meets different business objectives and requires varying levels of expertise to execute.
* Collaboration for cost reduction. This type of program focuses on cutting costs for both sides beyond traditional sourcing levers and sharing value. Typically, this type of program is also a first step in the collaboration journey. Suppliers are treated as partners, not as cost centers, necessitating the development of long-term, trusting relationships. Some examples of how interactions change: negotiations are based on full transparency into costs, with healthy margins and growth guaranteed; specifications are jointly optimized to eliminate unnecessary features; and demand transparency is created based on production patterns to optimize inventories. This kind of cost-based program requires mature procurement competencies, but is also the least complex compared to other collaboration options. A company with no or minimal experience in supplier collaboration programs may choose to begin here and work its way up.
* Collaboration for value beyond cost. This could be the right program for companies that want to improve safety or the quality of products, develop additional sources of supply for a new or capacity-constrained component, or work with a supplier on financial health improvements. In other words, joint risk management with the supply base is the typical area of focus when companies start going beyond cost. While these changes can and will reduce costs, the work is focused on value beyond purchase price, and requires a greater degree of cross-functional expertise to execute. (See sidebar 1.)
When companies are collaborating for value beyond cost, it makes sense to rethink processes for qualifying new suppliers. Fast, effective qualification of new material suppliers can be essential in a crisis--if a supplier suffers from a natural disaster or is otherwise unable to meet requirements due to quality issues--and it can help guard against the risk of supplier concentration. But a disciplined process for qualification is also extremely useful in the everyday operation of many companies, allowing them to take advantage of new material technologies or lower cost sources of supply as they emerge. (See sidebar 2)
* Collaboration for innovation. This is the practice of working with suppliers to improve the pace and quality of product or process innovation. It creates value in areas like design, speed-to-market, and consumer insights. In the case of a chemical company, supplier innovation led to rapid development of a new material for the CPG value chain (See Exhibit 3) This form of collaboration requires the most time, money, and trust; it also carries the most risk because of the experimental nature of developmental work and the need for more two-way trust than ever before. The two partners may have to negotiate sophisticated agreements on IP rights, licensing agreements, and warranties. Supplier qualification capabilities can also be critical for supplier innovation. The payoff, however, can be significant in the form of a better, more timely and competitive product.
In the case of a leading freight railroad, a new program was started to de-specify head-hardened rail steel (a type of treatment designed to improve wear) with an existing supplier and design a new rail steel specification. The end result was tens of millions of dollars in value creation per year through better total cost of ownership (TCO). In order to embark upon the project, the railroad company needed advanced skills on supplier qualification to prove to the incumbent that alternatives can be brought in quickly.
3. Build transparency and trust
Transparency and trust are essential for sustained success. A survey of 35 strategic suppliers to a large, global medical device company dealing with both quality and growth issues found that the majority of the suppliers did not trust that their innovative solutions or ideas were consistently and seriously considered by the customer. They considered this to be a primary reason for poor collaboration. The survey signaled to the company that it needed to restart its relationships on the basis of transparency (for instance, more clear, two-way feedback and follow-up on ideas from suppliers), with the expectation that greater trust would follow from better follow-up.
On the contrary, successfully creating transparency and trust, however, can deliver remarkable value. One company in the financial services sector used this approach to address persistent poor performance in its network of collection service providers. It did this by first changing the way it interacted with the vendors, simplifying lines of communication and establishing regular weekly calls with them to problem solve the most critical issues. Then it introduced a transparent and dynamic performance management system, tracking results and error rates, and discussing them with each vendor in monthly reviews. The company supported these efforts with changes in its own organization through the creation of dedicated teams for vendor performance improvement and collaboration.
Finally, the company modified its working processes in ways that addressed key pain points and allowed both it and its vendors to benefit. For example, it gave strategic vendors power of attorney to sign documents on its behalf, reducing frustrating delays as documents were sent back and forth, and showing a base level of trust in the strategic partners. It also changed the way work was allocated, so higher-performing vendors got more work and percent fees (and of course vice versa), and it collaborated with its vendors to identify and eliminate unprofitable lines of work (e.g., closing high risk files early). The result of this effort was a startling shift in vendor performance. The cash recovered through collections rose by nearly 80 percent, while the company found that it needed a third fewer staff to manage its vendors, and saved even more in filing fees and expenses. Even more importantly, the relationship between the company's line teams and vendors was transformed, with free, open communication and a constant exchange of ideas. The strategic vendors were able to grow their business by 10 percent to 30 percent within a year.
Creating successful partnerships like this one is complicated, with a number of requirements. Some are preconditions that must be in place before the collaboration kicks off; others follow through the collaboration itself.
Preconditions: Write Them Down
* Spell out the parties' different commitments, including, at a minimum, capital expenditure and personnel investment (on both the leadership and working levels)
* Align to standard contract terms on the length of the agreement, renewal terms, and volume and price ranges (as covered earlier under value sharing mechanisms).
* Specify the product or service range covered and the scope of the development effort. Options and agreements on the use of alternative suppliers and use of the capabilities developed by the supplier with any other customers must be explicit, though not necessarily discouraged.
* A value-sharing model must detail the targets of cooperation, defining the benefits and agreeing on how to share those benefits. Too many times the customer proposes a model that does not offer enough value or the right value over the right timeframe to its suppliers, stalling the program before it even begins.
As an example, lithography equipment manufacturers for the semiconductor industry deal with extremely short product lifecycles, new technologies, and wildly fluctuating demand patterns. To motivate suppliers to partner with them, a leading lithography system manufacturer offered high margins (as a volatility buffer), equipment financing, and purchase guarantees with narrowing windows from systems to components. This value-sharing mechanism sustained the supply chain through the cycle, jointly reduced costs, dealt with wild swings in demand, and stabilized throughput and delivery. Both the customer and suppliers benefited. In the end, some of the tightly knit suppliers became equity partners as well (similar to the Keiretsu concept of interdependency from Toyota).
Ongoing Work Through Collaboration
These are matters that need to be co-developed and refreshed throughout the collaboration. For instance, supply chain management and operations teams must work out how to deal with exceptions to the agreement, such as through a joint review board. Similarly, for the collaboration to grow and sustain, there needs to be a mechanism to generate, evaluate, and prioritize new ideas vs. investment criteria. If there is a foundation of trust and transparency, the collaboration will continue to grow.
The expression "win-win" is often overused. But highly effective collaborations between suppliers and purchasers are just that. The best collaborations result in competitive advantage for all players, and drive innovation and growth, typically at a pace of times that of competitors. GSD
Acknowledgements: The authors would like to thank Jan Wuellenweber, director in the Cologne office, Philipp Radtke, director in the Tokyo office, Firas Alkhatib, consultant in the New Jersey Office, and Gerardo Guzman, consultant in the Houston office for their contributions to our research efforts and to this article.
Getting Smart About Supplier Qualification
Most companies lack clear, structured processes for qualifying new suppliers. Often, the qualification process is driven by the function or business unit that identifies the need for an alternative source of supply, and different functions, business units, or teams may conduct their qualifications or contribute the necessary resources in sub-optimal ways. This situation manifests itself in two common issues.
First, the qualification process can take too long, because those responsible for conducting tests on potential substitute materials are not clear about what tests are required, when those tests need to be conducted, or which materials are the most urgent. It is not unusual for the qualification process to take between six and nine months, even for a relatively straightforward "like-for-like" substitution, by contrast with best practice of two to four months.
Second, qualifications can cost too much, because unclear success criteria mean that companies conduct superfluous tests, or discover late in the process that important tests have been missed or critical specifications have not been checked. Tests are also often duplicated when a qualification effort for one product category or business unit repeats tests that have already been conducted for another.
Recognizing such difficulties, leading companies are pushing for more rigorous and systematic qualification processes. We have observed that their approaches typically rely on three basic elements.
1) Establish a standardized process for qualifications. This element includes defined activities, success criteria and timelines, with defined roles and responsibilities for all process stakeholders, including external suppliers. The process encompasses the end-to-end qualification process, from supplier and material selection, through lab, plant and fitness-for-purpose testing, to final sign-off by customers and regulators.
At each stage, the process specifies the actions required by different functions, including R&D, purchasing, manufacturing, and technical services, and allocates responsibility for completion of those activities to a specific individual within each function. By establishing who needs to do what, and when, and by giving a single process leader overall responsibility for management of the qualification from end to end, these companies reduce rework and redundant or missed activities, and minimize the downtime between process steps that typically cause so much delay. Because material qualifications can differ in their complexity--from straightforward like-for-like substitutions to the evaluation of totally new technology--these companies segment their processes accordingly, allowing more time for lab tests and trial production runs, for example, where uncertainty about a substitute material is greater.
2) Define a robust prioritization mechanism. This is based on the direct financial value of the potential substitution and its impact on other strategic factors, such as reduced supplier concentration risk or improved environmental performance in manufacturing. Prioritizing qualifications in this way ensures that highly valuable or strategically critical material substitutions are not delayed by less important ones. It also resolves disputes about access to limited resources such as material test labs.
One advanced materials company developed a prioritization scheme for its own qualification processes. In emergencies such as natural disasters or industrial accidents that resulted in immediate risk of disruption to more than a quarter of the available supply of a material, the company would immediately divert all available resources to facilitate a rapid qualification of alternatives. If there were concerns about the financial viability of a supplier, potentially putting future supply at risk, qualification of alternatives was given fast-track status, with attention paid to eliminating bottlenecks that might delay the process.
Where there was no risk of supply disruption, but there was an identified opportunity to realize savings or broaden an overly concentrated supply base, qualifications were allocated to one of two "standard" priority levels, according to the size of the potential savings and the importance of the material in question. Finally, qualifications with the smallest savings potential, less than $100,000 per year, were given "at will" status and conducted only when excess capacity was available.
3) Support the qualification process with appropriate cross-functional resources and clarity of roles. This element might include dedicated lab and plant testing capacity and a central database to facilitate the sharing of test data and other relevant information between different business units or product teams. They also make changes to staff incentives, for example, by tying the incentives of qualification teams to the savings they achieve. They change the management of their qualification processes too, by establishing a qualification center of excellence (COE) within the procurement or quality function if there is sufficient scale to support multiple qualifications. One basic materials player defined scale as having 50 or more supplier qualifications annually across the organization and established a dedicated COE staffed by one or two specialists. The COE helps qualification teams design and customize process maps to support the needs of particular parts of the business, to ensure the smooth running of those processes, and to disseminate best practice across the organization. The COE staff also work with suppliers and customers to identify ways to streamline communication and interaction during qualification efforts.
The overall impact can be 50 percent to 100 percent of both lead time and cost of qualifications in future state.
A leading freight railroad had outsourced the repair of its railcars to a sole supplier. Despite high rates of idle time and waste, the supplier continued to win the annual contract. The railroad company wanted to partner with a competitive supplier that would also work with it to reduce the operational and capital costs, the benefits of which would eventually be shared with a changing split over time. The railroad approached multiple companies, including the incumbent, with the carrot being a long-term contract in exchange for competitive pricing as well as a collaboration program to improve the supplier's operations.
The result was a significantly more competitive bid price from the incumbent, and identification of 15 percent additional savings through joint lean initiatives focused on operational efficiency and capital cost reduction. The supplier kept one-third of the savings and applied the same capabilities to the rest of its customer base, seeing a 10 percent uplift in its earnings before interest and taxes inside of 12 months. For its part, the railroad, once it had mastered the basics of supplier collaboration, began working with suppliers to innovate in scheduling and dispatch process--a more complex lever, and a trend setting move in the industry.
In the oil and gas sector, many operators are expanding to emerging regions in Africa, South America, and Far East Asia. Supplier availability and capability becomes a critical constraint. In addition, local content requirements for materials and services can hamper "time to oil." A select set of oil and gas majors and suppliers have started investing in supplier development, and some are outperforming. The best supplier developers have increased local content from about 25 percent to close to half of their total third- party spend, increasing the speed and cost efficiency of exploration.
JehanZeb Noor is an associate partner in McKinsey's Chicago office, where Aurobind Satpathy is a director (senior partner). They can be reached at email@example.com and firstname.lastname@example.org respectively. Jeff Shulman is a partner in the Dallas office; he can be contacted at email@example.com. Chris Musso is a partner in the Cleveland office, reachable at firstname.lastname@example.org.
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|Author:||Noor, JehanZeb; Satpathy, Aurobind; Shulman, Jeff; Musso, Chris|
|Publication:||Supply Chain Management Review|
|Date:||Sep 1, 2013|
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