An article in today’s WSJ, “Companies More Prone to Go Vertical,” discussed the current trend for some companies such as Oracle, Pepsi, IBM, General Motors, Boeing and Apple, to cite a few,  to return to the practice of vertical integration. Vertical integration can be defined as the degree to which a company owns its upstream suppliers and downstream customers and distribution channels. Some of the main reasons why companies may want to become vertically integrated are to mitigate supplier risk, control distribution channels, increase barriers to entry from competitors.  Boeing, for example, acquired Vought’s Dreamliner operations out of necessity to gain control over troubled suppliers and parts that were having an adverse impact on its Dreamliner program.

While companies don’t seem to returning to the old Henry Ford style of vertical integration, they seem be trying to use it as a method of controlling assets and exerting more control over critical parts of the supply chain. Vertical integration seems to wax and wane over time. Perhaps the global economy with its growing supply risks and increased competition is spawning this new wave.

There are, however, many drawbacks to vertical integration. One is decreased flexibility and potentially higher costs. Once a supplier is captive, there may be more control.  However, there is a cost to increased control, including reduced supplier competition and opportunities to engage with potentially more capable suppliers in the future.  And as business needs evolve, some of the integrated businesses may not evolve, may no longer fit or even be a drag on the bottom line. Vertically integrated companies may find themselves with less attractive overhead and cost structures. And they may be entering industries either upstream or downstream that they have less knowledge of and that may not really mesh with or add value to their real core competencies.

The regulatory environment may determine how far firms are able to go this time with vertical integration. And the competitive environment will ultimately help shape and influence the success of this approach.

-Sherry R. Gordon

Many people struggle with getting senior management support for supplier performance management initiatives. And, according to the editor-in-chief of Supply Chain Digest in his July 2^nd editorial, many people don’t even know what senior management support means.  Most know that you’re supposed to need it or you might not get very far with implementing supply chain management or procurement initiatives. If management is not convinced that, for example, supplier evaluation is more than just goodness and “the right thing to do”, then they may not give you resources to make it happen.

So how do you go about getting that support? The approach may vary, depending on the level of awareness about the importance of supply management and overall support for it. But one approach that usually gets senior management attention is financial — cost savings and avoidance as well as  revenue enhancement. Here are a few ideas for presenting the business case, which, by the way, are described in more detail in my book, Supplier Evaluation and Performance Excellence:

• Quantify the elements of the cost of poor supplier quality and performance failure in your organization.
• Read research reports (for example, such as those from Aberdeen Group and Accenture) that describe and quantify the benefits, cost savings, value add, and ROI of evaluating, building relationships with and developing suppliers and use the findings to bolster your arguments
• Examine some of your big internal problems, such as, for example, customer complaints and quality rejects, and analyze what part of those costs is caused by supplier issues and the value or cost savings from fixing them.
• Identify one or two supplier problems that you are currently aware of and calculate the cost savings to both your firm and to the supplier from fixing the problem
• Demonstrate the risks to the company of not understanding and improving supplier performance or of not knowing whether the company has the right suppliers such as increased risk, increased costs, and potential impacts on customers.

To get support, make the business case as real and quantified as possible. Show not only cost savings and risk avoidance, but also the value that high-performing suppliers can add.

Robert Handfield’s recent article in the Wall Street Journal, “United They’ll Stand,” promotes the idea of working with financially-stressed key suppliers to avoid pushing them over the brink into insolvency. The author is not advocating bailing them out, as suggested by Debbie Wilson’s in her post, Vendor Vulnerability – Handfield’s Flawed Recommendation. But rather, Handfield advocates several measures to help them get through these difficult times — ways that are also favorable to the customer firm.

The Wall Street Journal article points out that should critical suppliers fail, the ripple effect can end up costing the buying company far more than it anticipates, potentially millions of dollars in service failures and bankruptcies that could adversely impact the customer company. To avoid these catastrophes, Handfield suggests, for example, giving suppliers shorter payment terms. In stretching out payments to help their own cash flow, customer firms appear to suppliers that they are using them as a bank. In return for quicker payment, the buying firm should ask for better pricing. Customers could give reputable suppliers longer-term, fixed contracts with more favorable pricing linked to agreed-upon market indices, suggests Handfield. This could give the supplier the opportunity to stabilize and get additional lines of credit. Suppliers may be willing to give on pricing in exchange for long-term stability.  Handfield makes a number of other suggestions, such as the buying firm not only having its own contingency plans in place and identifying alternate sources, but working with key suppliers to do the same (and of course, choosing the suppliers that you work with in this way very carefully).

Handfield is not suggesting that customers bankroll failing suppliers nor is he suggesting giveaways to suppliers. He is advocating that customers work as a team with key suppliers on creative ways to make it through tough economic times with both sides giving up to get something in return. Critical supplier failures are the outcome to be avoided. This requires communication, give and take, and creativity.  Working with key suppliers in this way is not done just out of the goodness of your heart. The commitment and loyalty engendered by working with suppliers during tough times will pay off financially.

I have personally seen and been the recipient of the philosophy of stretched out payment terms to support the customer’s financials. Those suppliers that can withstand this practice in the short-term will be gone (if not gone, as in bankrupt) as soon as they are able to find customers with reasonable payment terms and performance. I have also worked hard to “go the extra mile” for a customer who paid quickly and to win more contracts from them.  Companies that have reasonable payment terms engender supplier loyalty. T.J. Maxx, for example, has had a practice of paying suppliers quickly as a way to get the best fashion brands to sell them their excess inventory.

In a blog post, Ethical Payment Ethics: The Cost of Squeezing Suppliers, Rajesh Chhabara describes the situation further.  He quotes Tim Cummins, president and chief executive of the US-headquartered International Association for Contract and Commercial Management, a global body with 5,000 members from 1,600 companies: “Our members are under increasing pressure from their [senior] management to renegotiate and extend payment cycle times in view of the ongoing financial crisis.” But he says that smart managers should tell boards that doing so is a threat to the reputation of the company and it may also threaten the security of supply chains. “It is not smart to put your suppliers out of business.”

Using suppliers as bankers can get firms out of financial jams in the short term. But it is neither ethical nor sustainable as a long-term practice. Especially when there are many alternative win-win approaches.

My previous post about why supplier scorecards fail generated a lot of interest. So today I’m going to write about one of the biggest reasons for failed supplier scorecards: There is little or no action or follow through that results from the scorecards.  Supply managers get so focused on the idea of having a supplier scorecard and on the content and the mechanics of the scorecard that they lose sight of just why they are developing a scorecard in the first place. By that I mean that they don’t focus on the business outcomes of having the scorecards. Scorecards for the sake of scorecards are another way of collecting data for the sake of data. You can tell the boss that yes, we’re measuring our suppliers’ performance now. Check. But so what? Have the scorecards produced any results?

 What kinds of actions can and should result from a supplier scorecard system? Here are a few examples of possible actions:

• Provide performance feedback to suppliers
• Identify supplier continuous improvement opportunities
• Develop corrective actions
• Help suppliers develop a better understanding of and compliance with your performance expectations
• Rationalize current supply base
• Disengage with low performers and risky suppliers
• Recognize high performers
• Give more business to high performers
• Work on development projects with suppliers
• Create preferred or certification program
• Set criteria for new supplier on-boarding
• Establish criteria for an approved supplier list

Supplier scorecards need to show results or lose their reason for being. Suppliers should be improving their performance and your company’s as well in the process. And if suppliers are not improving, you’ve got some evidence as to why not and some information on potential improvements to pursue. The scorecards should be providing the information you need to identify and disengage poor performers and of course give your higher performers the recognition and potentially the extra business they deserve. The scorecards should facilitate measurable supplier performance improvements, be a positive business driver, and add value to the company. Otherwise, they can become an empty, bureaucratic exercise. Senior management will lose interest and will not see any reason to provide the resources required to deploy them.

The failures at Peanut Corporation of America are tragedy in every way. This supplier failed to meet both regulatory and customer requirements. Its customers failed either to uncover or report the failures, and people died as a result. Now a healthy, everyday product is suspect, and faith in the U.S. food processing industry has been shaken by tainted product. Food contamination isn’t just a Chinese problem any more. According to Lora Cecere, an analyst at AMR Research and a food supply chain expert, food safety has ranked low in the U.S. as a supply risk concern (12th out of 15 in AMR surveys). However, in China it is ranked second. The peanut scare has been a wakeup call and confidence buster about U.S. food safety.

This situation illustrates an order-of-magnitude regulatory failure, compounded by lack of state inspection resources and lack of oversight. It also illustrates a worst-case scenario of supplier risk and abdication of responsibilities.

Why did this failure occur? In quality terms, the food industry relies more on inspection than prevention (and even inspections don’t always occur or are poorly done). And it is well known that quality inspection is far more expensive and far less reliable an approach than problem prevention. Preventive versus reactive is basic when it comes to quality.

While inspection is important in the food industry, preventive actions need to be institutionalized and enforced to avoid food contamination in the first place. Inspection, in fact, should focus on assessing preventive measures in the area of quality and safety. Do we want to know how many contaminated batches of food are found? Or worse, do we want the food industry to leave quality control in the hands (or stomachs) of the customer? Or would do we want verification that that all food safety rules and cleanliness standards are in fact followed to prevent contamination?

And when supplier evaluations and inspections are outsourced to third parties, how do customer firms assess those third parties and ensure that they are not, in fact, just the foxes guarding the chickens? The complexities of the supply chain no longer allow a reliance on good intentions or lackadaisical supply chain management practices downsized in the name of cost. Since second and third-tier suppliers, often invisible or barely visible to the customer, can adversely impact our food supply, understanding their operations and performance becomes essential. Food contamination falls into the category of supply risks that can be prevented (preferably) or mitigated. They are not an unavoidable natural disaster. Not only should companies consider these risks in their sourcing strategies, but they should also have robust supplier assessment systems, including regular site visits to higher risk suppliers, to prevent the occurrence of such failures. The costs of food contamination in illnesses and deaths, lawsuits, brand damage, consumer confidence – and even company bankruptcies and job loss – are far higher than the basic sourcing and supplier management activities needed to prevent them.

Scorecards have become the Holy Grail of supplier performance management.  I find that most companies have some kind of supplier scorecards. And if not, they are in the process of developing them or want to develop them. Expectations for results are high. However, very few firms are satisfied with either their scorecards or the results that they are getting from the scorecards. When asked if the scorecards are providing results and whether supplier performance has improved, very few respond positively. While the supplier scorecard practices that I see are not comprehensive, the challenges of scorecards that firms are facing appear to be fairly common.

Why is developing an effective supplier scorecard such a challenge? Here are 11 reasons why supplier scorecards fail:

1. Metrics or KPIs (key performance indicators) are not meaningful since they measure what is easily measured rather than what is important to the business.

2. Some firms try to measure too many KPIs or too many suppliers to be effective

3. Metrics are borrowed from other companies and are not sufficiently meaningful to the borrowing firm.

4. Metrics do not support or are not aligned with a firm’s business goals.

5. Scorecards lack credibility and thus are subject to doubt and dispute.

6. Scorecards require too much data cleansing and manipulation to produce.

7. Internal stakeholders don’t provide input on a timely basis or not at all.

8. Scorecard results are not regularly shared with suppliers.

9. Suppliers are unclear of customer performance expectations

10. There is little or no action or follow through that results from the scorecards. (i.e., suppliers do not see recognition, rewards, corrective actions, or disengagement as a result of their performance)

11. Scorecards do not get to the root causes of problems, making it difficult to take corrective actions.

In future posts, I will discuss some of these reasons for failure and what you can do to improve your chances of supplier scorecard success.

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What steps can you take to avoid supply risk? Be methodical and be proactive. Segment the supply base for risk. And look beyond just the obvious categories. First, look at all types of suppliers who have risk potential, depending on your type of business, such as: direct material suppliers, suppliers providing important services, and transportation suppliers. Often companies look only at the big dollar volume items. But this can be short-sighted.  As evidenced by the now infamous fastener shortage at Boeing, a small-dollar-value part can stop a manufacturing line. And worse, it is an example of outsourcing run amok in the machinist strike at Boeing.  However, not all risks lie in direct materials. For example, if disruption of transportation is a critical risk, then look at 3^rd party logistics and carriers. Or if loss of intellectual property is a risk, identify the most likely segment of suppliers. Examples are by geographic location – countries where IP protection is weak or by type of supplier, such as suppliers who help develop products or information technology. If you are using single sourcing, look at the categories where you are using single source suppliers and assess the potential risk from those suppliers and whether you need to find backup sources. Another potential area of risk may be just-in-time deliveries using kanbans. This does not mean that you need to rush out and start stockpiling inventory. If your just-in-time suppliers have truly adopted lean practices, they may be flexible enough to adapt to changing demand. Unexpected disruptions such as geopolitical and natural disasters are more worrisome, but not impossible to plan for. Lean suppliers – and all strategic and critical suppliers – should have risk and business continuity plans in place.  But you may need to review the tradeoffs between supply disruption and using additional sources or carrying additional inventory.

Some additional sources of information include my book, Supplier Evaluation and Performance Excellence, and these excellent articles: “Coming to Grips with Supplier Risk” from the Supply Chain Management Review and the Marsh study, “Supply Chain Risk Management” (available by registration on the site).

Like many challenging areas of supply management, reducing and mitigating supply risk is not rocket science. It just takes a lot of planning, organizational discipline and hard work – which may be why supply risk is often in the talking and not the action stage in many companies.

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The recent article in Purchasing, “Allegheny Technologies Designs a Broad Risk Strategy”, (8/14/2008) is one of the rare glimpses into how some companies are actually dealing with supplier risk. Rather than just talking about risk or not acting on Sarbanes Oxley directives to address supplier risk, some companies are taking action. What I found particularly positive was Allegheny Technologies’ cross-functional approach to supplier risk mitigation. As in many supplier issues, more than the procurement function needs to be involved, as the impact typically reaches beyond the procurement department. Other functions may have knowledge of risk areas that procurement is not aware of and thus need to be part of the risk planning process. Another contributor to supply risk can be a lack of information or poor information for making decisions. For example, if the results of supplier performance scorecards are not shared or are inaccurate, appropriate action cannot occur and supply risk can increase.    Senior management support, often in the form of resources, is much more likely when procurement is looking out for the best interests of the entire company and involves the appropriate parties. Another important reason to involve other functions in the company is that other functions may, in fact, be making decisions that increase rather than reduce supply risk. SOX-mandated risk planning is here to stay. Linking supplier risk planning to overall corporate risk planning is a logical and essential step.