Need for measuring supplier performance

Price-based metrics

The most fundamental aspect of assuring value is making sure that the supplier hits your price requirements. These can be gleaned through simple interactions as well as formal negotiations. This metric is most applicable when you are looking at inter-period changes. Expressed in a measurement tool would be something on the line of ‘percentage price change year-on-year’. So, if quoted price is $100 in year one and $106 in the second year, the recording change would be +6%.

If you are looking to be more sophisticated, many organizations use to price avoidance metrics. This is an aim to measure the impact of a negotiator on an exchange. For instance, if the first quoted price if $100 and the buyer haggles it down to $95. That is $5 saving per unit. A potentially large sum when scaled to industrial volumes.

Cost-based metrics

A more potent measurement tool is to gauge the impact on the running of the business, namely through cost. Here, we see real money leaving the business and, as such, anything that measures the outflow of cash from the organization will address a genuine pain point. Here, reducing spend on suppliers can positively impact budgets of the business. A simple cost-reduction target looks at the historic cost baseline for a good and compares the current cost impact. The percentage variance yields the savings figure (or cost increase percentage). So, in simple maths, the equation proceeds as the new cost minus the baseline cost, with the difference divided by the baseline cost. If the baseline is $100 and the new amount $95, the resultant $5 saving represents 5%. Where we have the advantage of absolute monetary values as well as percentage figures.We can aggregate total cost savings to report on the supplier annual performance, plus check the average savings percentage.

A second degree of sophistication is to explore the total cost of ownership (TCO). This examines a much wider range of costs incurred by the business. In the above example, we looked at only a single budgeted area. But the business will incur costs elsewhere to process the good, either in operational costs (delivery and storage) or fixed overheads. Often these are hard to quantify and difficult to attribute to a single activity. But TCO aims to look at the cost sustained from the point of delivery to the final conversion into a saleable good. The ‘baseline’ in this case would look to accumulate all the costs related to a purchase, that is the invoiced cost, plus (potentially) costs relating to delivery, storage, security, internal movement, machine processing, processing time, waste parts, disposal, packaging and final delivery. Each of these elements is subject to change but by incorporating these into your cost calculations you have a more accurate picture of supplier cost performance. For instance, a TCO calculation may find that buying at a higher invoiced cost may be more cost-effective, once other business operations are incorporated.

Quality-based metrics

At the simplest level, quality relates to performance to contract. You will ask yourself: ‘Has the supplier provided the goods or service to the specified level?’ This can be measured in terms of defects per part or rejected parts per order or through some either technically defined amount. These are fairly standards metrics and should be incorporated into the automated components into the receiving process. Within a contract, these can be built into a service level agreement.

A more advanced practice is to measure a variety of value-adding activities that the business wishes to encourage. Would you like your suppliers to improve their customer service to your clients? Build in customer satisfaction into the contracts and make payment partly based upon review. A certain contract percentage, for example, for example, if the supplier hits a 90% approval rating within stakeholder reviews. This is a means to ensure that the supplier activities are strictly in line with the requirements of the business.

The first step to measuring performance is to determine which activities are critical for the success of the contract and what are the characteristics of good supplier performance. From this understanding of the dimensions of a good performance, Key Performance Indicators (KPIs) should be developed.

Develop KPIs

KPIs should meet the following criteria:

• Completeness: all significant aspects of the goods/service should be included in the measurement of performance.
• Clarity: both parties should have a clear understanding of the performance measures to be used.
• Measurability: performance requirements should be expressed in measurable terms and should be based on data which it is possible to gather.
• Focus: specifications should be focused on the agency’s procurement objectives (which translate to outputs and outcomes), not on processes.

Some of the aspects of the contract that are usually measured are:

• On-time delivery.
• Correct quantity.
• Number of customer complaints.
• Product/service cost.
• Service/product quality (against agreed terms).

Determine which measurement approach to use

There are many approaches for measuring supplier performance. Some are more complex than others and they all have their advantages and disadvantages. Here, some commonly used approaches will be mentioned:

• Categorical system: this method is easy to use but it is subjective. The aspects being measured are weighted equally and it relies on a person’s perception about performance and not on quantitative data.
• Weighted-point method: this method assigns a weight to each aspect being measured depending on its importance. This is considered a reliable and flexible method.
• Cost-based system: with this method it is possible to quantify the additional costs incurred if a supplier fails to perform as expected. This is a very objective but complex method.