Supplier Performance Management – Supplier Incentivisation Programs, what works best?
Buyers are getting more innovative in how they incentivise their suppliers. There are many ways in which buyers can either obtain performance improvements and / or cost reductions from their suppliers. In the past buyers often adopted a more forceful even gun to head or shitty stick approach to negotiation, win-win was not part of the negotiation process. Put simply the supplier is offered the business or contract renewal if they agree to reduce their prices. Although this and other similar ‘gun to supplier’s head’ type approaches appear still to work some of the time, they more than often result in negative outcomes including, lower levels of supplier service, decreased quality, decreased supplier morale and increasing administrative costs. In essence removing any notion of the buyer being a ‘customer of choice’.
The alternative is the dangling carrot incentive approach where by the supplier is encouraged to reduce costs / improve performance on the basis of being awarded more business from the buyer.
“Incentivisation or incentivization is the practice of building incentives (financial or other forms of reward ) into an arrangement or system in order to motivate the actors within it”.
Incentivisation if used right as a win-win partnering technique can often be applied to achieve superior or improved performance for both supplier and buyer and leads to benefits such as lower cost, early delivery, inventory reduction, increased sales, reduced costs, improved labour utilisation, better technical solutions, safer product or higher quality product. This can be achieved through introducing rewards financial or otherwise and mutually agreeing on targets in relation to cost, schedule, quality, safety, inventory reduction, increased sales, reduced cost, improved labour utilisation, or better technical products or solutions
In today’s environment buyers can partner with suppliers and implement a wide range of incentive-based cost reduction programs that are beneficial to both parties. Such programs are designed to offer rewards for increased innovation, flexibility and creativity, improved quality and safety, improved time to market, displayed by suppliers when striving to or exceeding KPI expectations.
Traditionally, incentive-based cost reduction programs were nothing more than clauses in contracts which stipulate rewards based on obtaining expected levels of performance or cost savings. When suppliers meet or exceed these levels, they are rewarded with additional business or a percentage of the cost savings. However the benefits of a well structured incentive based program to both parties can often significantly outweigh more than just the financial cost savings.
Rather focus on the penalties based approach to driving performance improvement lets remain focused on positive / win-win incentivisation programs. Here are a list of some incentivisation initiatives / programs that I have come across that are being adopted among some of the leaders in the field of incentivisation.
Future Business / Contract Extension
This goes without saying that if performance levels meet or exceed agreed KPI targets then getting awarded more business is somewhat expected, but often suppliers don’t tie that condition when agreeing to the targets being set.
Preferred Supplier List
Getting on any buyers preferred supplier list is also a big win for a supplier. Some companies have over 100’000 suppliers so finding a way into the preferred list is important.
References / Testimonials
Not all Buyers are willing to give references or testimonials to suppliers. When discussing targets try and factor that in to the agreement as it could help in winning another client. Being able to use that testimonial is in marketing material is also an even bigger win for the supplier.
Case Studies / Success Stories
Having a well written case study that can reference a client by name makes a big difference in a supplier’s ability to market their products or services. Often you may have to agree to settle for a case study / success story that is worded somewhat ambiguously like :
“ …an implementation of our solution for a major Oil & Gas Operator Client resulted in a 35% reduction in costs …”.
Suppliers that constantly meet or exceed KPI targets should push for named references from their customers. Even better if you can get a ‘named contact’ providing a direct quote as well.
Supplier Award Programs Initiatives
Over the years I have seen many Supplier Performance Management initiatives that have been very successful. The Initiatives that faired best extended the performance management through to recognition, in that they have full implemented a well-structured an publicised supplier awards programs in place. The key here is the fact that the supplier gets recognition of winning a particular category of an awards program and uses this to their marketing advantage. The cost of award programs is relatively low yet some even have pushed the boat out ‘Oscar style’ with an annual supplier awards dinner with trophies. This type of incentive is worth a lot to the supplier as they get recognised among not alone competitors but also other areas of the client business that they are not yet doing business with.
Joint Buyer / Supplier Collaboration Plans
Supplier collaboration is a growing area of the relationship management process. Buyers will want to collaborate with suppliers on things like new products or services, even sharing the cost. The reason here is that the buyer can contribute resource and in some cases financial contributions to help reduce risks on the innovation in order to help make it a success. Buyers are more likely to move to collaboration with a supplier that has a good performance track record.
Preferential Payment Terms for Performance
Most companies get paid on either 30, 45, or 60 days. That said there is no reason why suppliers could not get better or improved terms of payment if they were consistently performing and meeting or exceeding KPI targets. By this I mean categorizing suppliers into payment brackets so for example an excellent performing supplier who consistently beats targets gets paid in 15 days, a good performer that meets targets gets paid in 30 days a poor performer in 60 days etc. Once you reach a Payment for Performance Band you stay there for the following Quarter. If your performance drops you drop back a band. At times of high interest rates the improvement on terms can have very significant impact on cashflow. Even when interest rates are low improvement of 15 or even 30 days on DSO takes pressure off suppliers and reduces liquidity risks.
NOTE: I termed this PfP (Payment for Performance ) in an article I wrote last year available here.
Importance of Stakeholder Agreement and Adequate Budget for your Supplier Incentivisation Program
Best practice on Supplier Incentivisation from CIPS states that despite its benefits, incentivisation should only be used where appropriate. For example, it is important that (1) the cultures within both the supplier and client organisations are compatible; (2) there is wide acceptance across organisations, stakeholders and all management levels; and (3) the buyer has the ability to pay. The latter point highlights the importance for buyers to carefully assess all steps and the likely cost of incentivisation. If incentivisation is open-ended and does not have some form of cap, there is a risk of exceeding the funds allocated for incentivisation purposes. This could have negative consequences, particularly if incentivisation is associated with budget constraints.
In addition, procurement must ensure that it has the budget to run such a programme. This requires in-depth analysis of all potential outcomes and costs. The latter point is generally dealt with by inserting a cap on rewards, which is in-line with any budget constraint.
Management of the Incentive Program – Cost V Benefit Challenges
The implementation of any successful incentivisation program is dependent on maintaining an on-going dialogue with the supplier(s) in question. This type of approach can deliver wide reaching benefits, but needs both supply chain and procurement functions to spend more time monitoring and analysing supplier performance metrics than would be the case on a more traditional contract. It is easy to get caught up in an incentivisation project and lose sight of the benefits vs costs of running the incentivisation program.
Don’t over complicate your Incentivisation Program
Likewise, as incentive-based cost reduction and performance improvement programs can take many forms it is very important to be aware of the fact that the success or failure of such incentivisation programs often come down to the complexity of the product or service being supplied or performed and how easy it is to manage the performance and the incentivisation program. So, don’t over complicate the supplier Incentivisation program. Keep it Simple.
Summary : 10 Golden rules for any Supplier Incentivisation Program
Whatever sort of incentives you end up putting in place here are 10 golden rules:
- Make sure you have a Supplier Performance Management System in place first. Preferably one that reports progress quarterly. Suppliers will see themselves getting closer to the bar / next tier each quarter.
- Make sure that your incentive tiers / levels are linked to performance bands and only review or change these bands as a last resort. If you are planning to change the tiers or bands. communicate the change well in advance. Preferably a year or at least 2 quarters ahead of any change taking effect.
- Make sure you have done a cost benefit analysis for your Incentive initiative. Likewise make sure you have a budget agreed to support the initiative for the years ahead.
- Make sure you have internal buy-in from all stakeholders including; Procurement, Supply Chain, Operations, Finance, and also with your suppliers. Set the rules clearly and be transparent with all on the bands.
- The incentive type / initiative may differ by category line. Case studies may work better for some categories while payment term improvement may work better for others. Choose wisely the one that will drive supplier performance improvement.
- Be aware that incentive levels / bands may differ by both category line / region.
- Make sure that you give the incentive program the support / continuity it needs. The worst thing would be to roll out an initiative and kill it again a year later. Suppliers working hard to hit the KPI targets and get the incentives, may not get there in the first year, but rest assured they will be working harder and harder each quarter to get there.
- Encourage and promote competition among suppliers by promoting the initiative as this will drive up performance.
- If your incentives are financial promote that also in your supplier charter.
- Promote your supplier incentive initiatives and awards (where appropriate) . Internally, externally, on website, and also Social media. Everyone likes trophies and no one likes missing an awards dinner. Its amazing how many supplier companies are promoting awards they received from clients on social media, and how many other suppliers finally get their ass in gear to be in the running for the next year.
|Article Statistics since published:||Share this article by email or Social media:|
View a list of all our SRM / SPM / P2P Best Practice Articles on the OutPerform Best Practices Blog
About : Daryl Fullerton
Daryl is a Supplier Performance and Relationship Management Specialist at Outperform SRM. He provides guidance and consultancy on the design, development and Implementation of various Supplier Performance & Relationship Management Systems for Global Oil & Gas Operators and Service Companies across Upstream, Midstream and Downstream Sectors.
Specialism’s include Supplier Performance & Relationship Management, Supplier Risk Management, Supplier Enablement, Operational Risk Management, Contract Compliance Management, Scorecards, KPI’s, P2P Process Automation, PIDX Standards, and Management Information & Reporting Systems.
A keen promoter and believer of the importance and focus on his ‘partnering to solve approach‘ in improving Operator / Supplier Relations in 2015 Daryl was awarded the honor of “Supply Chain Pros to Know” in recognition of the leading supply chain professionals and experts worldwide.
About : OutPerform SRM
OutPerform SRM is a management consulting firm that helps leading Oil & Gas businesses establish value added solutions for effective Supplier Relationship Management (SRM). We help our clients reduce inefficiencies, reduce costs, and make lasting improvements within their Supplier Relationship Management (SRM), Supplier Performance Management (SPM), and many more important business critical Supply Chain Initiatives . Through our hands on experience with Major Oil and Gas Operators over the last 17 years we’ve now built a firm uniquely equipped to this task across all Major Category Lines.
Our Experts have Experience of working with a wide range of internal and external stakeholders with the ability to build relationship and influence outcomes. Our Experience of supplier performance management includes detailed knowledge of processes and frameworks including commercial performance management of contracts and knowledge of supplier risk management techniques.
For a Free 20 minute (no obligation) discussion call click here to email us and we will contact you to arrange a suitable date and time for a brief tele call to discuss best practices in SPM & SRM.
Alternatively simply complete the below details and area of interest and we will send the relevant information to you by email :