Supplier DevelopmentBonanza or Bust?

The Boston Consulting Group (BCG) is a global management consulting firm and the world’s leading advisor on business strategy. We partner with clients in all sectors and regions to identify their highest-value opportunities, address their most critical challenges, and transform their businesses. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advan-tage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 71 offices in 41 countries. For more information, please visit www.bcg.com.

Andreas Gocke, Nikolaus Lang, David Lee, Stefan Mauerer, and Arvind Pandey

March 2011

Supplier DevelopmentBonanza or Bust?

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 SuccessSeven 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.

AT A GLANCE

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Sourcing 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 per- cent 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 preci-sion 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.

Supplier Development4

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 ultra- cheap 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 suppli-ers in emerging economies to improve their capabilities so that they meet interna-tional 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.

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 manufactur-er, a shop-floor analysis revealed a series of shortcomings: operators had unbal-anced workloads and were often absent from their stations; workstations were poorly equipped; operations were often idle during production runs; some invento-ry was produced offline; and materials were poorly managed. A focused supplier-development 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 inventory-carrying 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 build-ing closer relationships can be well worth the effort. For instance, a biopharmaceu-tical 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 recom-mended changing how thermal shields were mounted on a steam turbine, which simplified assembly and reduced production lead-time, variability, and rework. For

Significant and measurable benefits

can be realized within as little as half a year by training suppliers

to meet specific performance targets.

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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 compa-ny, 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 SuccessMany 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 develop-ment programs should target other areas as well. These include process quality, R&D, tooling, logistics, capacity management, cost reduction, and project manage-ment. 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 deci-sions and activities typically include selecting suppliers for development; choosing the type of development program, training approach, and tools to be used; monitor-ing 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.

To achieve the quality standards of suppliers in developed markets, suppliers in emerging markets need proc- esses adapted to their own capabilities—which is why supplier development is often inevitable in emerging markets.

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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, 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 immedi-ate 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 depart-ment 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” ap-proach 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

Don't try to fix every-thing at once. Instead,

focus on a supplier's critical problems in

the areas of cost, quality, or timeliness.

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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 manage-ment 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 underperfor-mance; 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

Assigning full-time staff to the sites of 10 to 20 selected sup-pliers 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.

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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 track-ing 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 respon-sible for delivering specific improvements related to quality, cost, or volume, and benefits must be tracked over time to truly measure the impact of supplier develop-ment 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 perfor-mance, 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.

In 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.

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About the AuthorsAndreas Gocke is a partner and managing director in the Munich office of The Boston Consulting Group. You may contact him by e-mail at gocke.andreas@bcg.com.

Nikolaus Lang is a partner and managing director in the firm’s Munich office. You may contact him by e-mail at lang.nikolaus@bcg.com.

David Lee is a partner and managing director in BCG’s Shanghai office. You may contact him by e-mail at lee.david@bcg.com.

Stefan Mauerer is a principal in the firm’s Munich office. You may contact him by e-mail at mauerer.stefan@bcg.com.

Arvind Pandey is a partner and managing director in BCG’s New Delhi office. You may contact him by e-mail at pandey.arvind@bcg.com.

AcknowledgmentsThe authors would like to thank Gary Callahan, Martha Craumer, Kim Friedman, and Sharon Slod-ki for their contributions to the editing, design, and production of this report.

For Further ContactIf you would like to discuss this report, please contact one of the authors.

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© The Boston Consulting Group, Inc. 2011. All rights reserved.3/11

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