Supply Management Policies: Consensus Building and Communication

The concept of “supply management policies” was introduced in the previous blog, "Supply Management Policies and How to Manage Them." To recap, they provide guidelines of practice for scenarios that are likely to occur during the normal course of doing business. These policies are usually seen as a tool for facilitating communications between an OEM and its supply base. Among other things, they explicitly lay out OEM commitments as well as expectations for supplier capability and performance. Consequently, supply management policies are an important asset in a Next Generation Supply Management toolkit.

It is a mistake, though, to think that supplier communications are their only function since the act of policy development in itself is also very beneficial. How? Next Generation Supply Management Policies don’t just lay out interaction guidelines between an OEM’s procurement function and suppliers. They, in fact, define such interaction guidelines between suppliers and the entirety of the OEM’s enterprise.

In order to construct these guidelines, then, Supply Management must engage and gain buy-in from the other affected functional areas in their own organization. The value of doing so cannot be overstated in terms of both aligning supply chain performance with the needs of the market as well as educating OEM personnel on the parameters of supply base capability.

For purposes of illustration, I’ll discuss in very general terms the basic internal alignments that were needed for the development of an actual OEM supplier order fulfillment policy. By means of introduction, supplier order fulfillment quantifies the parameters governing the ordering and delivery of material across an entire supply chain (including the last link of the supply chain, the OEM). Planning for this usually starts with marketing, whose responsibility is to provide a demand forecast that the OEM attempts to satisfy through coordinating supplier production/delivery with internal factory operations. The more accurate the marketing forecast, the easier it generally is to support customer demands.

When forecasts are not 100% accurate, established schedules and orders are updated and need to be responded to. In my era, most marketing people did not have a background in operations and consequently didn’t understand the chaos that “drop in” requirements could introduce to operations nor the costs associated with that chaos. Rather, they tended to expect operations/supply management to take heroic actions and otherwise do “whatever it takes” to produce in a timely manner whatever they think they can sell.

Along these lines, I once had a discussion with a marketing vice president who told me “my” suppliers needed to be prepared to instantaneously respond to unlimited changes in schedule. I’m not kidding! Rather than immediately pushing back on this, I responded that I could, indeed, make happen exactly what he had just asked for. I then asked him how much of a purchased material increase marketing would be willing to accept in order to have this supply chain capability. When he sputtered out, “well, none,” saying, “we can’t afford to increase the price to our customers and couldn’t afford to reduce our own margin,” I brought the conversation back to reality.

I explained to him how purchased parts were made on machines and that the more machine capacity that was needed, the more production equipment—hence, capital expenditures—would be needed, increasing the supplier’s fixed costs. I also explained that the desire for instant supplier response to an increase in orders meant that suppliers would likely need to rent out and stock warehouse space near our factory, which would also add to their fixed costs. And finally, that since suppliers would be just as eager to protect their margins as we were, they would expect to recover their increased costs by increasing what they charged us. To his credit, the marketing VP then asked, “What type of supplier reaction would be possible without necessitating a price increase?”

This was the start of a rational conversation in which data was used to define what type of supplier order fulfillment capability was needed to satisfy the bulk of—but not necessarily all—demand when forecast error had led to underestimated demand planning. Below I outline a supplier flexibility requirement that needs to be part of any supplier order fulfillment policy. The parameters used in this will depend on the volatility of market demand:

• A Firm-Zone (usually lasting a couple of weeks) where supplier schedules won’t change but after which an increase (or a decrease) in shipments would be expected.
• A subsequent Trade-Off Zone (usually lasting a month or two), during which suppliers would be expected to ship a certain percentage above what was in the previously issued quarterly forecast.
• After this, a Forecast Zone where suppliers need to be able to support changes in orders up to the consuming OEM’s factory capacity.

So in defining a Supplier Order Fulfillment Policy, a discussion was enabled on realistic purchased part order fulfillment expectations between Supply Management and Marketing, with the result being a realistic policy statement.

The next discussion in developing a supplier order fulfillment policy needs to be between supply management and operations. Believe it or not, many OEM factories don’t have a handle on their own maximum capacity and, as seen above, this is a critical element in managing order fulfillment. Capacity is not always a simple question to answer but it needs answering if you want your suppliers to be able to plan for successfully supporting un-forecast customer demand.

The “Final Assembly” for many OEM factories typically defines overall capacity, and this can usually be defined without too much trouble. Translating this capacity back to fabrication and sub-assembly is usually not quite so cut-and-dried but needs to be done nonetheless. Remember, you’re not trying to coordinate a schedule between primary operations and final assembly. Rather, you’re defining maximum possible purchased material needs. The ultimate goal is to define maximum capacities back to individual purchased part levels such that these can be communicated to suppliers.

I’ve found that most factories have the ability to define maximum capacities using their factory scheduling system, though since it is not something done routinely, it will likely require contemplation by internal MRP/ERP gurus. The collaboration between supply management and operations required to quantity these values for inclusion in the supplier order fulfillment policy provides data that contributes to a better understanding of overall manufacturing capability. And it sets an important supply management capability target.

Of course, no policy—no matter how rational—can be supported without understanding individual supplier capability. For order fulfillment that means understanding part-specific lead-times and capacities, something most suppliers have a very loose handle on. To address this you’ll need to define exactly what you mean by lead-time and capacity, and provide your suppliers with templates for measuring and reporting them to you. I of course recommend Manufacturing Critical-path Time (MCT) for your lead-time metric. It may seem a lot to ask suppliers for individual part-specific lead-times and capacity capabilities but, when you think about it, this information is fundamental to optimization of their operations and something they really need to understand.

The upshot may be that your suppliers—at least out of the chute—may not have the capability of supporting the Firm, Flex and Forecast Zone requirements you outline. But they now have rational business-based targets to shoot for. To accommodate the gap between their capabilities and the standards outlined in your policy, suppliers may count on “built-ahead” contingency inventory. This reflects an increased cost but one that can be anticipated and planned for, as opposed to those involved in having to react to schedule “drop ins.” An unanticipated output will likely be that suppliers can use the costs associated with their contingency inventories to justify new equipment that either increases their capacity or shortens their lead-times.

Contingency inventory, however, presents another problem. While most OEMs will not commit to purchase raw material built due to lack of adequate supplier order fulfillment capability, it does seem fair to guarantee that suppliers relying on pre-built contingency inventory to support a customer’s order fulfillment needs should be able to count on it not becoming obsolete (or require rework) due to discretionary design changes. Because of this, the next conversation supply management will need is with product engineering. To address the above, a design change policy similar to the one discussed in the last blog entry but with the additional order fulfillment caveats should be considered:

• The OEM would have to pre-agree to maximum amounts of supplier part-specific contingency inventory. These amounts should not be a “blank check” since, in the end you want to encourage suppliers to invest in the capability to minimize contingency inventory needs.
• Design changes needed to address safety issues will be implemented immediately, but there would be a cost sharing between the OEM and the supplier on the out-of-pocket costs incurred as a result of them.

With all of the above you end up having a Next Generation Supply Management Order Fulfillment Policy which defines supply flexibility expectations both within an organization and with your suppliers. It sets both standards for suppliers to shoot for and realistic supplier performance expectations within the OEM organization.

Another significant impact, though, is a better understanding of the relationships between the various functional areas within an organization. Supply management understands better the issues and needs of the other departments, and the other departments get a better grasp of the realities of managing a supply chain. This increased internal collaboration is to the betterment of the business.

While the focus of this blog was on something important to Next Generation Supply Management, the next one will focus on practices common in procurement today that are counter-productive to working effectively with suppliers.