Supplier Development
Bonanza or Bust?
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Supplier Development
Bonanza or Bust?
Andreas Gocke, Nikolaus Lang, David Lee, Stefan Mauerer, and Arvind Pandey
March 2011
AT A GLANCE
Sourcing from low-cost countries can generate big savings, but subpar suppliers
keep many industries from gaining the full benefits. For instance, sectors with
highly complex products or stringent safety requirements often find that the risks
of using poor-quality inputs far outweigh the potential cost savings. A targeted
supplier-development program may be the solution.
Why Bother?
Done right, a focused supplier-development program can deliver results in as little
as six months—and provide an enormous return on investment.
Guidelines for Success
Seven guidelines can help ensure success: target a small number of suppliers;
focus efforts on what matters most; align the organization; choose the right
development approach; engage and motivate target suppliers; develop a progress
road map; and measure and track results.
S
ourcing from best-cost countries can generate enormous savings, but not
all industries are gaining the full benefits. Sectors with highly complex products
or stringent safety requirements, for instance, are finding that most suppliers in
developing economies fall far short of the quality standards and process excellence
of suppliers in the developed world—and that the risks of using substandard inputs
far outweigh any potential cost savings.
Supplier shortcomings are risky for companies in many industries. For example,
pharmaceutical companies must ensure the safety of their products’ ingredients
and an uninterrupted supply of life-saving drugs. Toy companies must make sure
that their products are safe for infants and children. Automakers need a wide range
of inputs—from simple pieces of tin to gearboxes with dozens of different parts—
and must adhere to tight schedules, safety standards, and emission controls. Food
and chemical companies need to know that their ingredients are pure and that
formulas are strictly adhered to. A problem with just one of a product’s parts or
ingredients, which can number in the thousands, can lead to recalls, public relations
nightmares, and brand erosion—all of which extract an extremely high cost. Recent
headlines underline this ongoing risk.
As a result, although many foreign companies have set up plants in China, India,
and other rapidly developing economies, many of those with rigorous engineering
or safety needs are still sourcing very little from local suppliers—usually less than
1 percent of their worldwide inputs—despite an extensive push over the years to
“buy local.” The majority of even best-practice companies source only 3 to 5 percent of their worldwide inputs from low-cost countries. In addition, a large share
of their purchases comes from foreign suppliers with local operations but high-cost
overhead structures instead of from truly “indigenous” suppliers with generally
lower prices. As a result, the actual cost savings are minimal or perhaps even
nonexistent.
This reluctance to purchase from local suppliers is due partly to internal resistance.
Engineers and R&D groups often have a strong bias toward suppliers that adhere to
international standards, even though the cost may be higher. But the shortcomings
of the local suppliers themselves are the biggest obstacle. Typical problems include
parts and components that fail to meet strict specifications in areas such as precision sizing, corrosion protection, or rigidity, and an inability to deliver on time,
which wreaks havoc with tight R&D and production schedules. So OEMs continue
to buy from suppliers from developed countries—and to miss out on significant
cost savings.
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But as global competition heats up, established companies will need to fight harder
to maintain market share. Emerging challengers from rapidly developing economies
and other low-cost competitors are creating new buyer expectations with ultracheap products. Examples include Tata’s $2,500 car and Vodafone’s $16 cellular
phone. Producers in both developed and developing countries must squeeze out
costs to meet the necessary price points. The solution may be to work with suppliers in emerging economies to improve their capabilities so that they meet international standards.
Why Bother?
For most companies, the idea of developing local suppliers is a daunting one. A key
concern is that once trained, these suppliers will use their new skills to work with
competitors, which will benefit without having made any investment. Moreover,
many companies believe they lack the skills and resources needed for supplier
development, preferring instead to use their engineering capacity for R&D or
quality management within their own plants. Finally, from a practical standpoint,
many companies see development programs as too time-consuming and costly to
undertake, and the results too difficult to evaluate or too long-term, especially if
their focus is on meeting quarterly earnings targets.
Significant and
measurable benefits
can be realized within
as little as half a year
by training suppliers
to meet specific
performance targets.
BCG’s experience shows that significant and measurable benefits can be realized
within as little as half a year by training suppliers to meet specific performance
targets. Improvement potential is often considerable and can lead not only to
quality improvements but also to cost savings and the related potential for price
reductions. For example, at the Chinese supplier of one worldwide toy manufacturer, a shop-floor analysis revealed a series of shortcomings: operators had unbalanced workloads and were often absent from their stations; workstations were
poorly equipped; operations were often idle during production runs; some inventory was produced offline; and materials were poorly managed. A focused supplierdevelopment program led to productivity improvements of about 25 to 30 percent.
Benefits such as these extend beyond quality improvements or simple reductions in
direct costs. Suppliers with developed capabilities are more reliable and timely in
their deliveries, so scheduling and project management are easier and inventorycarrying costs can be reduced. For example, we worked with a supplier of packaging
materials to determine the optimum order quantity to hold in inventory on the
basis of variables such as production costs and demand levels. Once implemented,
our economic order quantity (EOQ) calculations delivered savings of €0.9 million to
€1.2 million annually and reduced inventory by 33 percent.
Local suppliers can also be a source of innovations and cost-saving ideas, so building closer relationships can be well worth the effort. For instance, a biopharmaceutical company set up a supplier workshop to generate a series of ideas for managing
the supply chain more effectively. One idea was to make forecasts more accurate in
order to improve production management and predictability. This change resulted
in cost savings of more than 19 percent. A supplier to a turbine producer recommended changing how thermal shields were mounted on a steam turbine, which
simplified assembly and reduced production lead-time, variability, and rework. For
4
Supplier Development
a one-time investment of about €45,000, the company was able to reduce costs by
almost €300,000 per year. Another supplier recommended changes to the turbine’s
steel structure, which delivered savings of €3 million by reducing size, weight, and
materials needed.
Without a supplier development program, companies often run into a frustrating
cycle: supplier shortcomings lead to production interruptions, workarounds, or
costly rush orders from alternative suppliers, followed by a flurry of firefighting to
fix the problem—but no attempt to address the underlying need for supplier
training and development, which would prevent the recurrence of problems.
According to the China-based chief procurement officer of one automotive company, this firefighting took up two-thirds of the team’s time every day—an investment
of effort and cost far greater than what a supplier development program would
have involved. Many supplier problems can be fixed with a one-time training effort.
For example, one supplier had ongoing problems with capacity constraints and
manufacturing backlogs, which caused frequent line stops. By training the supplier
to analyze and correct bottlenecks, the company solved the problem. Two half-day
workshops conducted by its production planning experts were sufficient.
Guidelines for Success
Many companies make the mistake of transferring their home-country quality systems
to their offshore production facilities, assuming the formula will deliver the same level
of quality. But different quality processes are often required because of differences in
suppliers’ capabilities. For example, companies may have little or no need to check the
quality of incoming parts at their European, U.S., or Japanese operations if they buy
from suppliers in developed countries. In developing countries, however, that same
system of minimal checking would be very risky, given the relatively high defect rates of
local suppliers’ parts. While suppliers in developed markets may have the skills and
insights to improve their own operations, the same may not be true of suppliers in
emerging markets. Because of these differences, achieving the quality standards of
suppliers in developed markets requires different processes that have been adapted to
the capabilities of local suppliers. For these reasons, supplier development is often
inevitable in emerging markets.
Although product quality issues receive the most media attention, supplier development programs should target other areas as well. These include process quality,
R&D, tooling, logistics, capacity management, cost reduction, and project management. Capabilities in these areas are uncommon in most developing countries, even
though they are the norm in industrialized nations.
Strategic decisions about how to approach a supplier development program are
best made centrally to ensure consistency and gain alignment. Centralized decisions and activities typically include selecting suppliers for development; choosing
the type of development program, training approach, and tools to be used; monitoring performance; and communicating to suppliers, service providers, and the media.
But tactical execution should be decentralized so that local branches can take
ownership of the development program and adjust it as needed in consideration of
local differences.
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To achieve the quality
standards of suppliers
in developed markets,
suppliers in emerging
markets need processes adapted to their
own capabilities—
which is why supplier
development is often
inevitable in emerging
markets.
In our experience with global manufacturers, we have identified seven guidelines
for success.
Target a small number of suppliers. Not every supplier should be developed, so
it’s important to choose carefully, using well-established criteria. The best choices
are key suppliers whose inputs are critical to the quality of the finished product and
that provide a high volume of inputs, sell very little to the competition, have a large
need for development, and don’t have the ability to help themselves. Suppliers that
do not meet these criteria or will soon be phased out should be eliminated from
the candidate pool.
Focus efforts on what matters most. Don’t try to fix everything at once. Instead,
Don't try to fix everything at once. Instead,
focus on a supplier's
critical problems in
the areas of cost,
quality, or timeliness.
focus on a supplier’s critical problems in the areas of cost, quality, or timeliness. For
instance, one supplier of exhaust systems took too long to fix sizing problems. A
development team observed the supplier’s engineers in action and discovered that
the remote location and a lack of manpower at the supplier’s maintenance and tool
shops were the root causes of the problem. A new plant layout helped improve
turnaround times.
Most companies have no need to hire outside resources to evaluate suppliers and
determine areas for development. Representatives from the quality, R&D, and
purchasing functions typically have the necessary capabilities.
To build momentum and credibility, look for “quick wins” that will deliver immediate cost savings. To increase the odds of a positive outcome, assign people with the
needed skills to the development team. Focus on parts-related experts (such as
suspension specialists), but use topic experts for non-parts-related areas such as
logistics or capacity management.
Align the organization. The best place for the supplier development group to “live”
is usually within purchasing, not within the quality function. There are several
reasons for this. First, purchasing has more power to motivate suppliers to improve
their performance. The threat of losing business is usually a convincing incentive.
Second, purchasing must work closely with supplier development teams to ensure
that cost savings from supplier performance improvements are translated into price
concessions through negotiations with the supplier. Finally, the separation from
quality ensures that the supplier development group doesn’t get caught up in
short-term troubleshooting instead of long-term performance improvements. For
instance, if a pharmaceutical company has set a target date for the release of a new
drug but a problem with a key ingredient threatens the launch, the quality department must draw on all of its resources to fix the problem in a timely manner. If
supplier development is under the quality roof, its members will often be caught up
in this type of short-term firefighting.
Choose the right development approach. We’ve identified three types of supplier
development programs, each requiring different capabilities. The “check in” approach involves dropping in on target suppliers every 6 to 12 months, evaluating
process and product capabilities for two to three days, and providing assignments
or recommendations for improvement. This approach can cover a wide range and
6
Supplier Development
number of suppliers—as many as 60 to 80 per year. It works best for motivated
suppliers with strong project-management skills that can work independently on
their assignments.
The second type is a “SWAT team” approach, which entails visiting 20 to 30 critical
suppliers with specific issues every three to six months for one or two weeks at a
time. An improvement plan, timeline, and audit schedule are jointly developed and
agreed upon with the suppliers. This approach is best for suppliers that have
significant deficits but also the project management capabilities to implement
improvement plans.
The third type is a “dedicated team” approach that involves assigning full-time staff
to the sites of 10 to 20 selected suppliers per year on an extended basis. The teams
analyze the root causes of key problems and provide hands-on support to help
solve them, using predetermined improvement plans. This approach requires an
average of two to four specialists per supplier for a period of three to six months,
along with regular follow-up audits. We tend to recommend this approach because
it’s faster, leads to more sustainable results, and doesn’t require project management skills on the part of the supplier. But it’s more expensive and can address only
a small number of key suppliers. One company took this approach for its operations
in China, using external agencies and strict performance targets to avoid breaking a
ban on staff increases and to ensure a quick payback.
Engage and motivate target suppliers. Suppliers are often worried that if a pro-
gram yields cost savings of, say, 10 percent, then the next time prices are negotiated
the buyer will demand a 10 percent discount. Similarly, suppliers often fear that the
cost transparency of a development program will prevent them from building
margins into future price quotes. Finally, shop-floor managers may be very skeptical
of any type of change program, so engaging them may be difficult. In China, India,
and many other rapidly developing economies, most suppliers have never gone
through any kind of performance improvement program.
So it’s important to devise incentives and penalties to encourage true commitment
and participation, not just lip service. Many companies have found that gain
sharing—such as sharing a portion of cost savings that a supplier identifies—is an
effective motivational tool. Other incentives include giving improved suppliers
greater purchasing volume or awarding them a higher rating. For many suppliers,
the positive experience of developing new skills is a powerful incentive. Penalties
such as price cuts, delayed payments, or the threat of a bad rating can also be
effective.
Develop a progress road map. A structured approach to implementation is critical
to success. We recommend using a disciplined, computer-based reporting system for
tracking and monitoring key milestones and accountabilities. Such a system must
meet five criteria: the objectives must be feasible; specifics such as measures,
timelines, milestones, responsibilities, and key performance indicators must be
explicitly established; there must be clear consequences for delays or underperformance; the road map must provide a clear, high-level overview of progress; and it
must be generated and agreed upon by a specific date. Signed program plans or an
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Assigning full-time
staff to the sites of 10
to 20 selected suppliers per year on an
extended basis is
faster, leads to more
sustainable results,
and doesn't require
project management
skills on the part of
the supplier.
agreement ceremony can be an effective way to signify alignment and mutual
commitment. However, any pragmatic solution that works well will do the job. For
example, one financial-services provider used an easy-to-handle Excel-based tracking tool that linked templates for individual initiatives to summary dashboards at
the business-unit and corporate levels, allowing for automatic report generation.
Measure and track results. Lack of follow-up is often a major obstacle to success.
At one company, the main reason why several development programs failed was
that its own staff members had neglected to closely track measures and milestones,
and had failed to take corrective action the moment suppliers fell short of the
commitments outlined in the agreement. Development teams must be held responsible for delivering specific improvements related to quality, cost, or volume, and
benefits must be tracked over time to truly measure the impact of supplier development efforts.
It’s important to start with a baseline of a supplier’s current performance, using
KPIs against which to measure the supplier’s improvement. These KPIs typically
center on cost and quality metrics and must be tailored to individual suppliers and
their specific problems. For instance, if a supplier’s fixed costs or inventory-carrying
costs are too high, the KPIs would be designed to track improvements in those
areas. But the results of these improvement measures must be meticulously
tracked. This high transparency—along with monthly check-ins with the head of
purchasing—put pressure on development teams to deliver results.
Although a development program can ensure that suppliers improve their performance, it doesn’t guarantee that they will lower their prices in line with the cost
savings they’ve achieved. So it’s equally important to work closely with purchasing
to track changes and ensure that this final step is taken. Supplier development can
lead to significant price reductions—typically in the range of 2 to 5 percent but
sometimes as much as 10 percent. These reductions add up, especially when
applied to a large volume of purchases, and thus can have a major impact on
earnings.
I
n today’s fiercely competitive global economy, companies must reduce costs
and improve the quality of their products in order to compete. But using suppliers
from low-cost countries can result in high-cost problems: quality issues, production
delays, and an inability to meet product specifications. For manufacturers in a wide
range of industries, the solution is to invest in developing key suppliers. Done right,
a focused supplier-development program can deliver results quickly—and provide
an enormous return on investment.
8
Supplier Development
About the Authors
Andreas Gocke is a partner and managing director in the Munich office of The Boston Consulting
Group. You may contact him by e-mail at [email protected].
Nikolaus Lang is a partner and managing director in the firm’s Munich office. You may contact
him by e-mail at [email protected].
David Lee is a partner and managing director in BCG’s Shanghai office. You may contact him by
e-mail at [email protected].
Stefan Mauerer is a principal in the firm’s Munich office. You may contact him by e-mail at
[email protected].
Arvind Pandey is a partner and managing director in BCG’s New Delhi office. You may contact
him by e-mail at [email protected].
Acknowledgments
The authors would like to thank Gary Callahan, Martha Craumer, Kim Friedman, and Sharon Slodki for their contributions to the editing, design, and production of this report.
For Further Contact
If you would like to discuss this report, please contact one of the authors.
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