Chapter 2

The Supply Chain Index

TYPES OF ORGANIZATIONS WHERE THIS METRIC IS APPROPRIATE

This is one of the rare metrics in this book that is appropriate for just about any size and type of organization. Some big government organizations are run by mostly contractors. Savannah River, a huge Department of Energy (DOE) site in Aiken, South Carolina, has a handful of federal government employees overseeing the work of thousands of contractors. The same is true of Knolls Atomic Power Laboratory in New York, which is run by Bechtel but overseen by the Navy, Nuclear Regulatory Commission, and DOE. The government even has an acronym for this (imagine that!): GOCO—government owned, contractor operated. My friends Dino and Lia, who own my favorite Italian restaurant and a pizza place by the beach, have to rely heavily on their suppliers. They have big company Sysco deliver some of their food items, but buy other foods from local fish and produce suppliers. They send out the staff uniforms for laundry services and have a company that helps with advertising. Even though they are a small business, they need to regularly monitor supplier performance.

My client AltaMed is the largest community health care system in California, with 44 clinics in Los Angeles and Orange Counties and about 2,000 employees. After doubling in size in just six years, the organization decided to manage its growth in demand by setting up a division called the Independent Practice Association (IPA). This network of independent providers has its own doctors and clinics willing to see AltaMed patients. This greatly expanded the organization’s capacity to deliver health care without its having to open more clinics and hire more people. Of course, for the quality of service to be as good as what patients get in the AltaMed-owned and AltaMed-managed clinics, IPA physicians, clinics, and staff have to be carefully selected and monitored on a regular basis.

In summary, if your organization spends at least 25 percent of its operating expenses on outside partners or suppliers of any type, you need to consider this metric. Even if suppliers make up a minor part of your costs, you might also consider this metric if the goods and services you buy from suppliers have a huge impact on the quality of your products, services, or outcomes.

HOW DOES THIS IMPACT PERFORMANCE?

The customer does not care about your supply chain and who is responsible for what. All they know is that you sold them something bad. If I buy something at Target that breaks as soon as I get it out of the package, I’m taking it back to Target and blaming them for buying such junk and selling to me. If I get food poisoning from a restaurant, I am blaming them, not their fish supplier. The product or service customers are buying includes whatever you had to buy to make the product or deliver the service. When I fly to Chicago and then take a puddle jumper to Norfolk, Virginia, I don’t really care that the commuter aircraft is operated by another carrier and is not really United. It says “United” on my ticket and it is painted on the plane, so from my point of view as a customer it is United Airlines.

The suppliers you choose to partner with directly impact just about every measure of performance in your company. They certainly impact key financial metrics like sales, cash flow, and profit margins. Suppliers also impact your costs and productivity if a late shipment delays your manufacturing schedule. Suppliers have a big impact on employee engagement. Having to constantly monitor and threaten poorly performing suppliers causes a lot of stress for employees, and they may have to take the heat for it. Switching cheese suppliers at my favorite pizza place elicits a complaint and a small tip to the delivery person, who had nothing to do with picking the supplier. Only after owner Larry got enough negative feedback from customers and employees did he agree to go back to his original cheese supplier.

COST AND EFFORT TO MEASURE

If you are only going to track a few operational metrics like delivery and defects, this will be really simple and low-cost, but also of limited value. Many of the metrics I propose for this analytic are currently not being tracked by many large organizations, so that means that it will require some time and effort to come up with reasonable and practical data collection strategies. The more challenging metrics will be those that assess supplier relationships, risks, processes, and the health of your portfolio of suppliers. Of course, even though the cost is high, so is the value. Being able to better manage the performance of your suppliers with good data can have a huge positive impact on many aspects of your performance and prevent many downside risks.

HOW DO I MEASURE IT?

A good supplier performance or supply chain index includes the following types of data:

• Supplier engagement and relationships
• Supplier portfolio
• Supplier performance
• Supplier processes

Supplier Engagement and Relationships

Just as relationships with employees and customers need to be measured and managed, so too do relationships with suppliers. Many large organizations don’t even think about this, given that they are the customer and have the upper hand on suppliers. However, as I mentioned earlier, suppliers can fire you just as you can fire them. Sometimes a customer is just not worth the effort. I had one client that decided it was not worth it to sell to Walmart even though it meant giving up a huge volume of sales. I know of a number of companies that refuse to sell to the government—too much red tape, scrutiny of their work and invoices, low margins, and long wait times to get paid. There are two parts to a good supplier engagement index. The first part is a scale of 1 to 10 or 1 to 100 where you rate the supplier based on its importance and desirability to you. Some of the factors that determine how you score a supplier include:

• Importance of the supplied good or service to your business
• Availability of good or service from others
• Ease of working with the supplier—factors like flexibility
• Location of supplier
• Stability and success of supplier
• Capacity to handle your needs
• Knowledge of your business and needs
• Minimal risks
• Performance history—how well they have done in the past at meeting your demands
• Rank against their key competitors in quality and brand strength

This attractiveness rating is typically done on the top 20 or suppliers that make up 80 percent of your external costs. It is also important that the ratings are done at least quarterly, because the status of suppliers changes, as does their business performance. Building a new plant that increases capacity might increase their attractiveness to you, whereas filing Chapter 11 would definitely lower their rating.

The attractiveness ratings are going to be used later to set specific targets for the level of engagement or relationship that is desired. The second part of this metric is an assessment of the level of your relationship with the supplier. Again a 1–10 or 1–100 scale is used, with a 100 or 10 indicating a true business partner that you have worked with for years, and a company that is almost part of yours. The highest rating also means that you give a lot of business to this supplier and have done so for years. They may be your only supplier for this good or service or are certainly your biggest one. A lower-level relationship score would indicate a backup supplier that you only buy from when you can’t get what you want from your tier-one and tier-two suppliers. Factors that go into assessing the relationship with suppliers include:

• Satisfaction levels on both sides
• Amount of business given to a supplier
• Supplier dependence on you as a big customer and you on them as a big supplier
• Length of time your two firms have worked together
• Stability of key personnel on both sides (turnover means a lower engagement level)
• Availability of suitable alternatives—how many customers are there like you and suppliers like them that could do as good of a job?
• Growth or decline in revenue or units you purchase from the supplier
• Price of divorce for either side—how hard would it be for them to find a customer like you or for you to find a supplier like them?

The concept of the last factor is that it is sometimes smarter to stay with the partner you have if divorce will be expensive and you know the alternatives out there are much worse than your current husband or wife. The same may be said of suppliers and customers. Part of the reason to work on a relationship rather than end it is that it is easier and less expensive to stay with an existing supplier and there may not be alternatives out there that are as good. Just like the attractiveness factor, relationship or engagement level needs to be assessed at least quarterly and preferably monthly. Keep in mind that you are not doing this with thousands of suppliers, just the top 20 or so.

Supplier Portfolio

A measure that is important for managing your risk is the makeup of your portfolio of suppliers. Diversity and risk minimization are what is important here, just like in your investment portfolio. The number of suppliers you have for key goods and services is also a factor to consider when assessing your portfolio. You never want to have just one, and many organizations have primary, secondary, and tertiary suppliers so that they always have a backup plan. If you work for a government organization, different categories of diversity are also important for your portfolio. Small businesses, women-owned businesses, disabled vet–owned businesses, and minority-owned businesses are important for a government to make sure it is balancing its dollars and providing some advantage to more disadvantaged or underutilized supplier types. You need to set individualized targets for all the different diversity factors important for your suppliers, and then measure the extent to which you have achieved the perfect portfolio by balancing all of these factors.

Supplier Performance

This is the type of data most organizations track on a daily and weekly basis, and these are typically fairly objective metrics for which specific targets can be set and agreed on. Some of the metrics to consider for this section of the supplier index are:

• Order cycle time
• On-time delivery
• DPMO (defects per million opportunities)
• Fill rate
• Inventory turns
• Stock outs
• Backorders
• Accurate orders
• Unit costs
• Warranty claims
• Come-backs—repeat service work
• Change orders
• Cost increases

Ideally you will develop a standard set of metrics that are used for all suppliers from which you purchase raw materials, parts, and components, and a set of metrics to assess the performance of service suppliers.

Supplier Processes

Some organizations do not inspect supplier products but ask to monitor key process variables while the supplier is manufacturing the product or performing the service. These process measures have been proven to correlate to output and outcome measures, so it saves the buying organization time and money that would have to be spent on inspections. Other process measures might focus on social responsibility, like not using pesticides, paying growers a living wage, and using renewable farming techniques. Process metrics might also focus on using environmentally responsible approaches, or on ethics and governance. Process measures might also examine factors like capacity utilization, screening of their suppliers, and managing the business so as to ensure profitability and survivability. Partnering with a bank or insurance company that is taking too many risks makes it less likely that your financial partner will be around next year. Process measures are the most individualized types that will vary greatly depending on what you are buying. Labor contracts where you are buying contracted staff might look at the processes the supplier uses for recruiting and selection as well as for managing the people.

FORMULA AND FREQUENCY

Calculating the health of your supply chain involves assessing a variety of different supplier performance factors as well as the relationship between your firm and theirs. Partnering with the right suppliers is also an important factor to consider in the index. The following formula is a straw man supply chain index that can be customized to match your own situation:

VARIATIONS

One variation is simply to spell out everything that both sides will do in a detailed service level agreement, or SLA. The metric is then simply a degree to which the targets in the SLA have been achieved each month. Each SLA has different metrics and targets, but there is just one overall metric that senior management looks at that tells them how key suppliers are performing. Another variation is just to measure the last two categories of measures—supplier processes and supplier performance. This is a good alternative for a smaller firm that does not have the need or the resources for a more complex metric. Both factors would be weighted at 50 percent so that the index is a good balance of leading and lagging indicators.

TARGETS AND BENCHMARKS

Individual targets need to be set for individual suppliers and individual submetrics. With one supplier you might expect better than Six Sigma performance on a key quality measure, and with another, 2 percent returns or quality problems could meet your standards. Targets for engagement levels depend a lot on what your desires are. You may have one supplier that is currently on probation and is a level 2 out of 10 on your scale. Your goal might be to get rid of the supplier entirely and replace it with someone new. On the other hand, your goal with another supplier might be to move it from a level 7 to a 9 on the 10-point relationship scale. Targets for your portfolio measure are also going to vary depending on mandates by the government and other factors. Deciding on how to set targets for the supplier chain index will require detailed analysis and collection of both baseline data and some comparisons on key submetrics that you can benchmark with others.

BENEFITS OF DATA

The benefits of having frequent and comprehensive data on supply chain performance are enormous. Not only will this information help you to better manage your suppliers and partners, but it will help improve their satisfaction with you as a customer. Getting frequent measurement of predictive factors such as supplier processes and the relationship between your two firms will also allow you to take a proactive role in managing that relationship to ensure your continued business success.