Measuring indirect spend via KPIs
William Atkinson -- Purchasing, 10/7/2004 2:00:00 AM
For most manufacturing companies, indirect materials represent about half of the company's total spend. And while many companies have comprehensive supplier performance programs for direct material supplier performance, few have an equivalent program for indirect.
One way to address this shortfall is to create key performance indicators (KPIs) to measure the performance of indirect suppliers, which can help identify opportunities for supplier improvement, determine suppliers worthy of receiving more business, as well as those suppliers that may need to be replaced.
One company that has implemented an extensive KPI program for the indirect spend is Boston-based Gillette Co. Prior to coming to Gillette, Tim Dolan, manager of strategic sourcing and supplier diversity at Gillette was a consultant with A.T. Kearney, where he specialized in strategic sourcing.
"I realized that one of the key elements of strategic sourcing is contract management and supplier management," Dolan says. "This involves understanding and managing supplier performance." According to Dolan, implementing KPIs is the last step of a complete strategic sourcing initiative, without which it cannot function properly.
Using KPIs on the direct side to measure supplier performance is typically less complicated because it means gathering objective data in the areas of quality, delivery, and price. Companies that implement KPIs on the indirect side want to measure the same things, but it can be more difficult, according to Dolan.
For example, in direct materials, the exact delivery time can be tracked to determine if it meets the qualitative requirements. But with many indirect spend areas, though, it can be more difficult to identify qualitative requirements and whether the supplier is actually meeting these. "For example, if a consultant provides services, it can be difficult to measure how well that consultant performed," he adds.
Another challenge can be trying to rope in maverick spend, which is more common on the indirect side. And until all of the indirect spend is computed, it is impossible to measure supplier performance accurately.
Getting started
To get started on KPI measures for a specific service or material on the indirect side, Gillette creates a cross-functional team composed primarily of sourcing professionals and IT professionals, such as program managers and others who can help define the company's requirements. "We also involve some end users—those who will be using the products or services being provided by the suppliers," reports Dolan. The team's first task is to identify its requirements for the service or product. "Next, we determine what value we will obtain by measuring supplier performance and then we create the actual measurements."
The value component is extremely important, according to Dolan, and an aspect that some companies may overlook. "When we create KPIs, we focus on identifying opportunities for increasing value, then ask where it makes sense to create KPIs that can help us make sure suppliers have the opportunity to add value in these areas."
In other words, Gillette measures suppliers so it can work with them to improve in areas that will add value to the company. Gillette uses a combination of the following criteria to measure indirect suppliers:
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Contract compliance addresses actual cost versus budget, performance against service level agreement (SLA) or statement of work (SOW), delivery performance against SLA and SOW, return rates, and order and invoicing accuracy.
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Customer satisfaction addresses customer service performance and technical support performance.
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Cost competitiveness addresses supplier pricing compared to industry averages, as well as supplier pricing compared with other benchmarks (such as pricing quoted by another supplier).
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Continuous improvements addresses supplier partnership initiatives, cost reduction targets, and cost reduction recommendations suggested by the supplier (measured by the number of suggestions received, the number of ideas implemented, and the resulting cost savings).
Dolan emphasizes that Gillette's KPI metrics are tightly defined, controllable (things that suppliers can actually have an impact on), and communicated clearly to the suppliers. Conversely, they should not be overly complicated or extensive.
"Too many metrics result in a scorecard that is difficult to create and understand," he explains. Gillette also weights the various criteria to emphasize to suppliers which areas are the most important to the company.
Prior to rolling out the final KPIs in a commodity area, Gillette discusses them with suppliers to get feedback on what it plans to measure and how and modifies them if needed.
Currently, Gillette measures supplier KPIs in three areas of indirect: MRO, travel, and IT. In IT, supplier performance is measured not only from the product standpoint, but also from the service standpoint. In MRO, Gillette measures things like: promised data compared with when suppliers actually deliver, number of rejects and reject rate, response time to calls from the company, the cost saving ideas they suggest that Gillette implements, and the ultimate value of those ideas.
While it can be difficult to create the appropriate metrics, actually collecting the data is the most challenging and time-consuming activity, Dolan says. Whenever possible, the company tries to gather objective data electronically from its various databases, such as delivery information. To measure customer satisfaction in general, it often obtains information via customer (user) surveys. When appropriate, such as when company-generated data is unavailable, Gillette may rely on supplier-generated data.
"We prefer, as much as possible, though, to collect our own data, because it is objective," Dolan says. In some cases, though, the company will ask suppliers to either provide data or provide support in its collection of the data.
Sharing the data
Once KPI measures are tallied, Gillette shares the results with suppliers. When doing so, it also makes the effort to identify its source or sources of information, to ensure the credibility of the report in the suppliers' eyes. In addition, the reporting process is not a one-way street. That is, when it shares results with suppliers, it also gives them the opportunity to explain their performance and provide feedback, such as disputes they may have with the data or its interpretation. Two years ago, as a result of its KPI process, Gillette began to provide supplier awards for indirect suppliers, after doing so on the direct side for the past 20 years.
Dolan emphasizes that there are costs associated with creating KPIs. For example, there are costs associated with the time required to generate, gather, and evaluate data on supplier performance. As long as the benefits (added value) outweigh the cost of the KPI program in each area, Gillette will continue to use the process in that area.
"We constantly compare the costs to the benefits we receive, which we measure by the additional value we receive," he says.
It also uses the same criteria in deciding which new areas to explore for KPI inclusion. "As we determine that KPIs can be cost-effectively implemented in other commodity areas, we will do so," Dolan concludes.
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