15.4 Managing and Incentivizing Supplier Quality

Incentives can accomplish great things. For instance, implementing economic reforms using financial incentives has helped China to transform into a modern manufacturing powerhouse. Pico Iyer reported for Time magazine in 1984 that capitalistic reforms have changed China from a “drab and sullen nation” into one where “giant billboards that once displayed Mao’s quotations now bear gaudy advertisements.”1 This gets us to the first point:

• Reward Drives Behavior. Rewards that are associated with specific measures tend to provide extra motivation. However, the key here is that you must link rewards to not just outcomes that you desire but specific behaviors linked to the outcome. In other words, when you try to get suppliers to do something, you can bet that suppliers are usually thinking, Just what’s in it for me?

But improperly designed reward systems can actually drive misbehavior! For example, executives of publicly traded companies are routinely rewarded with stock options. The idea here is that their behavior should be driven by their desire to maximize the value of their stock options by making good decisions on behalf of the company’s owners and stockholders.

However, a singular focus on driving up stock price also gave us infamous examples of accounting scandals such as Enron, HealthSouth, and MCI WorldCom: executives of these companies committed fraud by artificially inflating earnings for the sole purpose of increasing the price of their company stock. So here’s our second point:

• Improperly Designed Reward Systems Drive Misbehavior. Often, the outcome that we want can be accomplished in a variety of ways. As illustrated by the examples of executives that defrauded investors, how a supplier reaches the desired outcome matters! In other words, your reward system should be linked to both specific outcomes and the specific behaviors that will lead to those outcomes.

To encourage suppliers to adopt lean and implement quality improvement programs, your job is to figure out the following:

1. What exactly do you hope to get your supplier to do?

2. How exactly do you hope to get your supplier to do it?

3. What can you offer to your supplier as extra motivation?

To do that, we rely on the balanced scorecard.

Supplier Qualification

To incentivize higher quality among your suppliers, you need to tell them what you want to buy. In other words, you need to share detailed information with suppliers regarding the component you want and its specifications in terms of both design and expected levels of quality. This information usually follows these forms:

• RFI – Request for Information: The initial step toward identifying qualified suppliers. Ask suppliers for information regarding their capabilities in terms of their product catalog and production capacity.

• RFP – Request for Proposal: The step to connect to potential suppliers. Using an initial set of information you gathered either through a third-party source (e.g., Panjiva) or prospective suppliers, you send out some basic information related to your needs and wait for interested suppliers to send back proposals concerning what and how these suppliers may potentially fulfill your order.

• RFQ – Request for Quote: The step to finalize details with a potential supplier. Send the most detailed information regarding your needs to the suppliers that you are most interested in, and wait for them to reply with price quotes and possibly bids on your order.

When you are qualifying suppliers, you must keep in mind that all you are looking for is a group of suppliers that appear to be capable of fulfilling your order. Because up to this point, all you are doing is exchanging increasingly detailed information with prospective suppliers, you are not ready to select a supplier just yet. The vetting process continues with supplier scorecards.

Tool: Supplier Scorecard

To incentivize supplier quality—and the right approach to quality—you need to tell the suppliers exactly what aspects and levels of quality you want from them.

In fact, a supplier scorecard works very much like a balanced scorecard that companies commonly use to explicitly link their strategic visions with specific metrics that impact stakeholders such as shareholders and customers.

While it is obvious that a supplier’s quality directly influences your own production process, how else would a supplier’s approach to quality impact your company? For example, a supplier may verify every single product it makes before sending it to you, taking out defective parts as they are identified; the process will likely take so long that the benefit of zero-defect quality is far outweighed by the costs associated with shipping and production delays.

Developing a supplier scorecard involves several steps. First, reward systems should never be about just a single outcome while neglecting behaviors. That is why a properly designed supplier scorecard comprises multiple dimensions that collectively represent the input from different parties, each with a stake in the impact of the supplier’s involvement with your company. Commonly, supplier scorecards are developed through the process below:

One of the main purposes of a supplier scorecard is to help suppliers understand how they are doing and what aspects of their products you truly value. For instance, Figure 15.1 shows a scorecard that is commonly used by the electronics industry:

In this scorecard, you’ll see that quality and delivery represent 50% and 30% of how a supplier is evaluated. Each criterion also has its own metric. For example, for Quality to be rated a 5, the supplier must have fewer than 650 defective parts per million (ppm). For Delivery to be a 5, the supplier needs to ensure that orders are delivered on time at least 95% of the time. It’s also important to remember that not all criteria can be objectively measured. Customer satisfaction is inherently subjective.

For a scorecard to be reliable, it’s usually best to ensure that most of your criteria can be objectively assessed.

As you develop the supplier scorecard, you need to keep in mind the following:

1. General dimensions such as quality can be further broken down into subdimensions. For instance, aesthetic quality can be different from conformance quality. For delivery, speed and reliability may also be considered as separate subdimensions. You must decide when increased complexity associated with the use of subdimensions is justified.

2. While a scoring system of 1 to 10 may allow you to gain finer differentiation among suppliers, determining the difference between points (e.g., 8 versus 9) also forces you to split hairs. In contrast, you may have an easier time determining the difference between points when you use a lower total point system. Of course, doing so may also mean that companies with the same score may still have different capabilities.

3. Different criteria in your scorecard will change over time for various reasons. For instance, if your company chooses to adopt a strategy focused more on quality, then your supplier scorecards must also increase weight on quality dimensions. After all, the supplier scorecards should reflect what your company rewards.

In general, supplier scorecards are especially important for establishing just what measures and outcomes you want from a supplier. Remember the relationship between reward and behavior: for a supplier to know what aspect of quality it needs to improve, it first needs to know what you, as a customer, want. Having the right metrics in a well-rounded supplier scorecard allows you to tell suppliers what aspects of quality you value and presents them with goals to meet.