Collaboration

Getting closer to key suppliers

Global research reveals that a lack of alignment between customers and their most important suppliers is restricting long-term value creation

Spring 2007

by Jonathan Hughes and Jeff Weiss

As strategic sourcing efforts mature at many companies, the pressure on procurement organisations to deliver new value, including incremental cost savings, is increasing. In practice, most strategic sourcing initiatives have focused on improving the way goods and materials are acquired. Not surprisingly, with a "find it and buy it" mindset, efforts have been orientated largely around leverage and the use of competitive pressure to motivate suppliers to reduce costs and deliver better performance. While the discipline of strategic sourcing has yielded significant value, it has also revealed itself as insufficient.

According to research we conducted in 2004, only 8 per cent of sourcing and procurement executives were extremely satisfied by the value they realised through their key supplier relationships, and just under a third were fairly satisfied. The remaining 60 per cent reported various levels of dissatisfaction. Despite a large quantity of literature on the topic, and a great deal of interest on the part of executives inside and outside procurement, companies struggle to realise the potential for value that they believe resides in many of their supplier relationships. Why?

Over the past year, we have undertaken an extensive research project involving both buy-side and sell-side executives and relationship managers in more than 300 companies in North America, Europe and Asia-Pacific, supplemented by dozens of interviews. Our goal was to augment our experience working with clients over the past 20 years, and to generate new insights about the barriers to, and enablers of, effective collaboration between companies and their most important suppliers.

What we found can be summarised as follows. Procurement executives (and their counterparts at suppliers) believe there is tremendous value to be gained, and are frustrated by the sense that it is going unrealised. At the same time, companies generally treat their most important suppliers in ways that are only marginally or intermittently different from the way they treat their arms-length commodity vendors. They may sporadically work with key suppliers to develop new technology or jointly analyse opportunities to improve supply chain efficiency, but they have not institutionalised new ways of working with these suppliers as partners rather than vendors. As will be discussed later, suppliers often reciprocate by continuing to align their efforts, policies and incentives around sales objectives, rather than maximising the value they deliver to key customers.

The collective behaviour exhibited by most companies suggests significant ambivalence, and a certain degree of split personality, when it comes to close collaboration with suppliers. While there is a recognition of, and desire for, the benefits this can bring, efforts to enable robust collaboration at most companies are generally half-measures at best. Very few have made the changes in organisational culture and policies required to systematically transform the way they and their key suppliers interact. That is not to say that many companies have not begun to implement new tools for supplier collaboration and relationship management. They have. Rather, they have not changed or eliminated old policies, procedures, metrics, incentives and - perhaps most fundamentally - old ways of thinking that, while well aligned to traditional purchasing relationships, constrain, and in many cases actively undermine, effective collaboration with their most important suppliers. 

Collaboration defined

Definitions of collaboration tend to be fuzzy, but usually involve some aspect of working closely together and some aspect of doing so in a co-operative (as opposed to adversarial) manner. We propose the following definition:

"Collaboration occurs when two or more companies work together to achieve one or more common objectives, and/or when they work actively to help each other achieve their respective objectives."

Collaboration is a fundamentally different way of working with suppliers. In situations where there is little opportunity to create value beyond efficient, low-cost procurement of goods and services, true collaboration is probably not worth the effort. Almost every company, however, has a number of suppliers - often more than they realise - with which true collaboration is the key to unlocking tremendous incremental value. Such relationships are subject to the following caveats:

•  close co-operation between customer and supplier (eg, extensive sharing of information, integration of processes, co-ordinated decision-making) is required;

• both sides need to make significant investments (in time, effort and/or capital);

• efforts to realise potential value also entail a high degree of risk - notably the risk of opportunistic behaviour from the other side, and various forms of competitive risk.

Capitalising on the power of collaboration is a function of two major changes: first, broadening the scope of interactions with key suppliers; and second, transforming the way that customers and suppliers deal with one another. On both the substantive and procedural dimensions (see figure 1), the important thing is for companies to consistently treat their key suppliers differently. Most efforts aimed at increasing the value realised from key supplier relationships focus primarily on the substantive dimension.

However, those companies that are most successful also spend significant time focusing on the procedural dimension of their relationships - building trust and mutual understanding (strategically, operationally and culturally), and on ensuring that the interpersonal interactions so crucial to effective inter-firm collaboration are characterised by mutual respect, creative joint problem-solving and a commitment to fairness.

Figure 2 suggests the enormous value at stake in attending to the procedural dimension of relationships with key suppliers. What customer and suppliers believe about one another, and how they conduct their interactions, has an enormous impact on value realised by driving:

• the scope of substantive interactions in which they engage;

• the efficiency or inefficiency with which they conduct their interactions;

• their willingness to make investments in each other and their relationship (be it time or capital equipment).

Expanding the scope of interaction

The greatest untapped opportunities to realise value from key suppliers require a quantum leap beyond traditional purchasing and fulfilment transactions. It is worth noting, in figure 3, that the most significant differences of perception between customers and suppliers in our research tend to be areas in which the latter believe they can contribute in ways that are most different from traditional customer-supplier interactions. Of course, the data itself can't confirm whether suppliers are correct in their assessment of such opportunities, but our experience suggests this is often the case, and that procurement leaders should at least question assumptions about where to focus their efforts to create greater value with and through suppliers.

When interactions between customers and suppliers occur primarily or exclusively between sales and procurement, significant value is bound to be lost. Not surprisingly, broadening supplier access to stakeholders beyond procurement emerged as a top priority from the research, with roughly 60 per cent of buy-side respondents and 70 per cent of sell-side respondents noting this as a critical means of increasing the value customers derive from their key suppliers (see figure 4, below).

Engaging in joint product development, sharing and aligning technology roadmaps and re-engineering business processes for greater efficiency are all modes of interaction that require perspectives and competencies from across the enterprise (R&D, manufacturing, logistics, marketing, and so on), at both customer and supplier. At the same time, complex interactions involving multiple functions require effective co-ordination. Procurement organisations are in an ideal position to play this role, but to do so they will need to adopt a more strategic outlook and a more entrepreneurial mindset. They will also need to become expert in facilitating collaboration among multiple parties with different ideas, goals and ways of operating.

At Kraft Foods, significant incremental revenue and cost savings have been achieved by systematically expanding the scope of interaction with suppliers beyond sales and procurement, though such efforts are facilitated by the supplier relationship management (SRM) team within procurement. Rather than continue to rely primarily on in-house solutions to technical challenges and then source to defined specifications based on price, Kraft has adopted what it terms a non-prescriptive approach - engaging its suppliers as true partners in jointly developing optimal solutions.

For example, technical staff from Kraft and a key supplier, along with one of its own suppliers, worked closely from the outset of a major development project. The result was the commercialisation of Snack 'n' Serve, a patented packaging system with an innovative re-close feature. Beyond the initial patent granted, five additional patents are pending. Benefits for Kraft included 5 per cent incremental sales growth for Chips Ahoy! chewy cookies, and exclusive rights in perpetuity to the technology in the cookie category. The supplier was granted an initial price increase - with both sides agreeing to an aggressive plan for next-generation cost reductions - and gained significant opportunities to commercialise the technology with other customers in different market segments.

Kraft has also successfully strengthened and expanded the scope of senior management interaction with key suppliers. Joint strategic planning with these partners has enabled Kraft to co-ordinate, and thereby enhance, efforts to expand its footprint in Latin America. Again, supplier knowledge and expertise has been leveraged to introduce new products through joint innovation sessions held in Costa Rica, Brazil, Mexico and Argentina. New affordable packaging formats have been developed that enable Kraft to be more cost-competitive.

Successful efforts such as these depend on engaging a broad range of parties at both customer and supplier, open exchange of information about plans, capabilities, technology and cost structures, and joint investment. Such cross-firm collaboration requires a high degree of collaboration and co-ordination internally at both partners. Our research indicates that both buy-side and sell-side see lack of alignment and internal co-ordination as a major barrier to effective collaboration (see figure 5).

A powerful, and all too common, example of how poor internal co-ordination undermines customer-supplier collaboration occurred at a large consumer products company. Desiring to tap into the R&D expertise and patent portfolios of key suppliers to develop new and innovative products, the company asked its suppliers to contribute ideas and assign researchers and engineers to joint development teams. A number of suppliers enthusiastically agreed to do so. On the customer side, such efforts were driven and managed by R&D.

Before long, these efforts yielded some notable successes. New products were brought to market that incorporated novel and proprietary supplier inputs. No sooner did this happen, however, than the procurement organisation noticed areas of sole-source spend. Seeking to commoditise what it identified as high-priced inputs, the function immediately searched out or tried to develop alternate sources. Before long, it too was successful - at what it was rewarded for, namely reducing costs.

Soon afterwards, R&D found itself with some very unhappy suppliers complaining about breaches of faith and goodwill, and refusing to participate in further joint development efforts. R&D and procurement were completely out of sync in their respective goals. Collaboration with key suppliers was largely shut down for years as a result, with the lost opportunities on just one critical relationship estimated by key executives to be in the hundreds of millions of dollars.

Steve Rogers, a former purchasing executive at Procter & Gamble and co-author of the recently published book On-Demand Supply Management summarises these dynamics well. "Too often the sales and procurement organisations worry that they will lose control of the relationship, and so want all the communications to go through them, creating an enormous amount of inefficiency. Given the growing importance of speed and agility in the market, the more gates information must pass through, the longer it takes and more likely miscommunications become.

"Still, losing control of the relationship is a real risk," he adds, "so internal alignment on roles, responsibilities and when to bring additional functions to the table become vital. Procurement has a critical role to play in this regard. The key is not to try to make decisions for other functions, but rather to co-ordinate and co-operate with each other to get the job done well."

Risks that constrain collaboration

The case for greater information sharing and the formation and management of longer-term relationships is clear and compelling, but it is hardly new. The more interesting story emerges in analysing what stops leaders and decision-makers at many companies from acting to ensure that such principles consistently guide how they work with key suppliers. After all, if nearly all buy-side and sell-side respondents believe creating longer-term relationships and sharing more information would produce greater value, why aren't they doing it already?

One sourcing executive at a microchip manufacturer described a situation where his company had entered into a closer, more collaborative relationship with a key supplier. "They had great technology and talented engineers. We saw potential to move beyond a traditional purchasing relationship into one where we actually worked together on the design and development of new technology. We did so with initial success, and then found ourselves very dependent upon them. Sure enough, once we gave up competitive leverage and lost the ability to switch them out, their prices began to rise precipitously."

While opportunistic behaviour by suppliers was cited by a majority of buy-side participants in our research as a barrier to greater collaboration, it was rarely cited as a frequent occurrence. Nonetheless, it is common enough that the fear of being extorted acts as an enormous barrier to sharing information, entering into long-term contractual arrangements or working with suppliers in ways that reduce leverage and create greater dependency. Moreover, incentives and management systems at most companies are generally biased in favour of limiting downside risk, rather than maximising upside opportunity. Missed opportunities are, by their nature, intangible and hard to quantify, and as a result typically have limited impact on executive decision-making and day-to-day employee behaviour.

We repeatedly encounter concerns that by sharing information a company will enable a key supplier to evolve into a direct competitor. Such risks should not be discounted, but neither should they be allowed to escape, as they often do, reasoned assessment. At many companies, simply raising the possibility of creating a competitor is sufficient to prevent joint research or development efforts. By contrast, companies such as Kraft Foods and Procter & Gamble that regularly and successfully engage in such efforts have codified ways to analyse and manage the attendant risks. Most fundamentally, they systematically analyse the likelihood that a supplier would want to, and be able to, move into a competitive position.

More often than not, the answer turns out to be negative. The probability-adjusted risk is then weighed up against the upside benefits of collaboration. Such companies also expend the time and effort required to put in place innovative contracts that go beyond the traditional purchasing boilerplate and address issues of intellectual property ownership, exclusivity and non-compete obligations, and risk and reward-sharing provisions. More subtly, they focus less on avoiding loss of leverage and more on ensuring that dependence is mutual and that clear opportunities for future joint gain act as a strong disincentive to opportunistic behaviour.

Long-term value vs short-term gains

According to a recent survey by McKinsey, a majority of managers said they would forgo an investment that offered an attractive return on capital if it meant missing quarterly earnings targets. This pervasive dysfunction is arguably more prevalent within sales and procurement than other functions, and has an especially toxic effect on customer-supplier collaboration. Building and sustaining collaborative relationships requires a willingness and ability to consistently avoid actions that create short-term benefits but undermine long-term value. Unfortunately, few procurement leaders actively focus on identifying and eliminating the drivers of such dysfunction as they affect the management of key suppliers.

The overemphasis on short-term and overly narrow measures of value is endemic to both customers and suppliers. This is not to say that short-term results don't matter; they do. But focusing only on this quarter's, or even this year's, numbers is like trying to drive on a windy road by keeping your eyes firmly fixed 10 feet in front of you.

Figure 6 is particularly striking for two reasons. First, the responses are focused not on all customer-supplier relationships, but on those that buy-side and sell-side respondents considered their most important relationships. Moreover, the questions posed were not about price, but specifically the extent to which focusing on price trumps considerations of overall value. That over 90 per cent of both buy-side and sell-side respondents report that interaction with key suppliers is driven to some extent by price rather than total value is a devastating indictment.

An interesting example was relayed by a senior sourcing executive at a Global 2000 high-tech manufacturing company. Despite having a relatively mature and sophisticated procurement organisation, he acknowledged: "We are often driven by short-term savings targets orientated around price measures to do things we know do not make sense. For example, we have regularly switched out key suppliers when we found a new supplier (often in a low-cost region) offering a significantly lower bid price.

"Despite serious reservations about its ability to deliver required volumes at required quality levels, we made the switch. Then, as we suspected, it failed to deliver. The costs of finding new suppliers, certifying them and negotiating new contracts far outweighs the original cost savings. And that's before we even try to estimate the lost sales that occur during the transition.

"Perhaps even more disturbing," he continued, "we have periodically negotiated so aggressively with our key suppliers that we knew we were depriving them of the margin they needed to operate a healthy business. Sure enough, a year or two into the contract, they're out of business; and again we incur losses that dwarf the negotiated price savings we achieved on paper. We can see it all coming, but we can't stop ourselves. Somehow, we haven't found a way to explain this to the executive suite. We do our best, but we feel caught between a rock and a hard place. We're rewarded for doing what we know is not the best thing for the business long term."

Of course, procurement is not solely to blame. The typical sales organisation is focused on hitting quarterly and annual revenue numbers with at least as much single-minded intensity as the average procurement group is focused on price reductions and short-term cost savings. This is not surprising inasmuch as the management of key customer relationships is generally owned by sales organisations that are structured, equipped and motivated to drive sales. Even strategic account management groups are typically part of the overall sales organisation and reporting line, and subject to similar short-term revenue and margin pressure.

The bottom line is simple. Metrics and incentives drive behaviour, and behaviour drives results. Metrics and incentives at the vast majority of companies are strikingly similar for their most strategic suppliers (and customers) as for the rest. They systematically act to limit collaboration and constrain the investments (of time, effort and capital) without which major opportunities to realise incremental value cannot be realised.

Even those companies that have implemented scorecards as part of their SRM programmes generally focus on short-term objectives and easy-to-measure indicators. And efforts to realign incentives tend to lag significantly behind efforts to put in place more balanced supplier scorecards. Until companies radically change not only what they measure, but also how they reward the people who interact with, and make decisions that affect, key suppliers, they will keep treating those suppliers like vendors rather than partners, and continue to be disappointed by lost value.

From leverage to fair dealing

As shown in figure 7, buy-side and sell-side executives and relationship managers do not believe that their key suppliers and customers are consistently and reliably committed to their success. Our research indicates that the perceived lack of commitment is rooted, to a significant degree, in reality. Respondents note similar levels of commitment (or lack of it) on the part of their own companies to their key customers and suppliers. As companies continue to outsource more non-core activities, and as the need to rely on external expertise to drive innovation is increasingly recognised, such findings should be cause for grave concern. After all, what would happen if an employee survey found that less than a third of employees were strongly committed to the success of their company?

Without a high degree of confidence in their key suppliers' commitment to their success, customers are reluctant to share information to the degree that would enable greater collaboration and lead to significant value being realised. Suppliers are similarly reluctant to invest in relationships with their key customers in the absence of a genuine commitment to their success. Consequently, both sides find themselves locked in a self-perpetuating cycle where the imperative to avoid loss of leverage limits collaboration and constrains the realisation of value.

Achieving breakthrough value requires new ways of thinking about, and working, with key suppliers. Consider the example of KLA-Tencor Corporation (KT), the leading manufacturer of inspection and metrology equipment for the semiconductor industry. It worked with the CEO of a key supplier to brainstorm ways that the supplier could grow and improve its overall competitiveness. This was one of the factors that led the supplier to make an acquisition, with KT's support, to expand both its capabilities and geographic reach.

Scott Paull, KT's CPO, concludes: "It is in our long-term interest to actively help our key suppliers be successful. We get the benefit of their improved competitiveness and capabilities, and they get to grow their business and leverage that with other customers as well. The resources KT invests in their success can pay dividends later on."

As is often the case with collaborative efforts, it will take years to fully evaluate the benefits. Nonetheless, in an early sign of success, the supplier achieved a high growth rate in the market overall and with KT, yielding benefits to both parties.

Overcoming short-termism and promoting information sharing and joint investments of this kind is a hard problem to solve. Indeed, some would argue that it is a breach of fiduciary responsibility to shareholders not to seek to maximise value for one's own company. And yet such an approach leads to significant value going unrealised.

The answer is not simply to put greater emphasis on creating joint value (though that, in itself, is useful). At the end of the day, prices must still be set and gains from collaborative efforts like joint product development must still be shared according to some formula. Questions of value allocation cannot be avoided or rendered insignificant simply by expanding the pie. Companies that are most successful at engaging in collaboration have found that the key is to change the question away from "Should we try to maximise value for ourselves or not?" - since both yes and no are unsatisfactory answers to the question as framed. Instead, they ask themselves "How do we assess what is the most fair and appropriate way to allocate value between us and our key business partners?"

Of course, this is more difficult than trying to squeeze the last dollar out of the other side. Instead of adversarial and coercive tactics, many of which revolve around explicit or implied threats to terminate the relationship or reduce its scope, both sides work together to find a mutually acceptable solution based on objective criteria.

This is one of the animating insights behind the procedure known as "target-costing" (or "should-cost") analysis, most notably employed by the automotive companies Honda and Toyota. Rather then demand arbitrary price concessions or use cost-plus formulae, or rely on competitive bidding to try to force the lowest price, Honda and Toyota work backwards from estimates of what the market will bear for the final product (for more on Toyota's approach, see feature The Toyota Way). They then work closely with key suppliers to determine what various components and sub-systems can and should cost. Obviously, such an approach does not eliminate contention. But it does transform inevitably difficult negotiations over value allocation into a joint endeavour. Conducted in a spirit of true commitment to a fair outcome, it also opens the door to creative problem-solving in a way that more common and adversarial approaches do not - and, in fact, actively shut down.

Towards a collaboration competence

Most companies that have implemented SRM or strategic account management programmes have done so through half measures. And through these they have achieved half results. They have been unable or unwilling to fully transform the way they deal with these business relationships. As unsatisfactory as this may be, it is understandable. There are real and significant risks to close collaboration with suppliers. Moreover, true collaboration is exceedingly difficult because it:

• runs against the dysfunctional short-term bias that afflicts many companies;

• requires a degree of internal co-ordination and collaboration that is rare in most companies today;

• requires people to have new knowledge and technical skills;

• requires new soft skills and behaviours;

• requires a new way of thinking about, and attitude toward, suppliers.

Measuring the value of collaboration to both customer and supplier is a more complex task than measuring a price reduction from last year (regardless of whether that price reduction actually led to a reduction in the cost of goods sold) or measuring the revenue from a sale closed last quarter. Data generally trumps intuition - even when the data is not especially meaningful, and the reasoning behind the intuition is sound. Consequently, the lack of effective metrics related to the broad spectrum of collaboration opportunities has deadly consequences for the decisions companies make about how to deal with their key suppliers.

Likewise, issuing (and responding to) RFPs is much simpler than investigating fundamental cost drivers and engaging in effective should-cost analysis. But reaping the rewards of collaboration involves replacing efforts to maximise one's own share of value at any given point in time with a recognition that the only plausible alternative is to work jointly with suppliers to find persuasive and non-arbitrary criteria by which to determine fair and reasonable allocations of value. Only by institutionalising such a way of thinking and behaving can a company enable consistent collaboration, and do so in a non-naïve fashion that is not an invitation to be taken advantage of by suppliers under tremendous pressure to extract the last possible penny from their customers.

There is great deal of good advice available on how to manage strategic suppliers and strategic customers. But companies have attempted to implement such advice as an overlay to existing sales and procurement policies, processes and incentives. Addressing the underlying barriers to collaboration means significantly changing these, since they tend to be aligned with arms-length purchasing arrangements.

Procurement is best positioned to lead the way. But to do so, it will need to unlearn the very habits that made it successful in reducing costs with the majority of suppliers. This is a daunting challenge, but the potential rewards are immense - not least, the ability to emerge as a truly strategic function within the enterprise. 

CHECKLIST: Enhancing relationships with key suppliers

1. Increase the two-way information sharing.

2. Expand the scope of interaction.

3. Create a context conducive to mutual investment in the relationship.

4. Develop a culture of respect for supplier capabilities.

5. Maximise consistency and predictability of behaviour towards suppliers.

6. Focus on making the key suppliers successful.

CHECKLIST: Overcoming the barriers to collaboration

1. Define and use scorecard metrics that capture the full range of (potential) supplier value.

2. Realign the incentives of those who make decisions about, or interact with, suppliers

3. Invest in developing technical and soft skills required for supplier collaboration - for individuals both inside and outside procurement.

4. Implement long-term contracts with key suppliers that address the specific issues of collaborative relationships and that incorporate risk and reward-sharing mechanisms.

5. Clarify roles and define or adjust processes and policies to increase internal co-ordination.

6. Ask for suppliers' input in doing all of the above, and require them to undertake symmetrical efforts in their own organisations.

Jonathan Hughes (jhughes@vantagepartners.com) is a partner and head of the sourcing and supplier management practice, and Jeff Weiss is a partner at Vantage Partners, a relationship management consultancy based in Boston, Massachusetts