Using penalties and incentives to boost supplier performance

25 July 2011
Michael Koploy, ERP analyst, Software AdviceWhile software has helped revolutionise the supply chain over the past few decades, a recent conference call with members of the Strategic Sourcing & Procurement group on LinkedIn emphasised an important point: no amount of technology can replace the need for building mutually beneficial relationships between suppliers and buyers. The question posed was: do supplier penalties and incentives make for a better supply chain operation? I would argue they can, but only if used systematically and effectively. Here are five ways this can be done: 1. If you use penalties, also use incentives. Penalties cannot effectively be used without incentives. Use penalties to keep suppliers on track, but also incentives to encourage suppliers to strive for success, beyond what’s expected. It will benefit both parties and help nurture a lasting relationship. 2. Visibility and communication are imperative. Ensure that metrics and goals are visible to suppliers. This helps suppliers realise their importance and focus on what is asked of them. Regular communication between two parties helps avoid a potentially awkward scenario where a supplier (and purchaser) goes extended periods without knowing their performance has been below par. 3. Establish that expectations will escalate with time. You don’t want suppliers to become comfortable with their success and perform only as required or expected. While a programme laced with penalties and incentives encourages suppliers to perform to the status quo, escalating expectations helps combat any complacency. Incorporate the fact that expectations will escalate according to the suppliers’ success into service level agreements. This will create an incentive to perform, reward suppliers accordingly, and keep raising the bar. 4. Focus on suppliers that are high-risk If this is all unfamiliar, don’t try to apply penalties, incentives, escalating clauses and visibility imperatives to all your suppliers. If you have a large supply chain, start by focusing on the vendors that are the highest risk. By narrowing down your scope, you stand to make big gains toward your bottom line. Plus, the added attention will help foster and support an ongoing relationship with the suppliers, too. 5. Create different goals for suppliers based on sector If you source from suppliers across industries, don’t use the same key performance indicators (KPIs) for vendors of perishable goods that you use for telecommunications suppliers. Low defect rates may be key for semiconductor suppliers, but do you want to emphasise speed of delivery at the expense of quality for perishable goods? In this case, penalties for late deliveries may send the wrong message. Taking a deeper look at each industry and establishing what’s important will help you align your KPIs and penalty programmes accordingly.   ☛ Michael Koploy is an ERP Analyst for procurement, SRM and wms software comparison firm Software Advice. Click here to read Michael’s regular company blog
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