How Should Suppliers be Penalized for Late Deliveries or Poor Quality?

A recent Linked In Discussion generated a massive amount of response by Global Purchasing Professionals. The following is a summary of the discussion.

Global Purchasing Professionals Agree:

“Late delivery and poor quality destroys brand equity and customers satisfaction index in the supply chain continuum.”

Steve IghorimotoDirector of Logistics-East & Central Region at NBC(Coca-Cola Hellenic Nigeria)

Main Discussion categories

• Assumptions for Using Penalties• Can They Be Used• Should penalties be used• Alternatives to Supplier Penalties• Suppliers Point of View• Framework for How to Use Penalties• Specific Penalties or Incentives

Assumptions for Putting Penalties in Place

• Buyer and Seller relationship has adversarial element

• Buyer has given seller clear expectations

• Seller delivery and/or quality problems are the result of their problems.

• The failure of the Seller to meet the Buyers expectations has resulted in actual and measurable damage to the Buyer

• The Seller values the potential of ongoing relations with the Buyer enough to consider payment of a penalty

Can Penalties Be Used

• Concept of penalty's beyond actual cost of item purchased are legally difficult to enforce

• The extent of damages is limited to actual damages

• If pre negotiated and agreed to then liquidated damages may be enforced.

• What good will a penalty bring to you and your customers if you will have to face consequences, not providing at the exact time table

Should Penalites Be Used

• Late deliveries and Poor quality are the symptoms and not the root cause

• Service has evolved over the last decade The bottom line is that you are paying the bill, and if the service or product you received is not what you agreed, you need to negotiate the invoice.

Should Penalty Clauses Be Used

Yes• With Non Critical Suppliers

with many options• Where there is No trust is

Buyer Supplier relationship• Determination of problem

cause not important• Certified Supplier• If mutually agreed to as

incentives in a collaborative relationship

No• Critical Supplier with no option• Supplier Relationship is

important• Problem Root cause is important• Un Qualified Supplier• On-boarding a new supplier is

expensive, and the cost to switch is high too.

• Helping the supplier is a good gesture and this can transform into a bargaining chip when the contract is due for renewal.

Alternatives to Penalty For Consistently Poor Performing Supplier

• Introduce a system of vendor rating for fairness and transparency.

• Exclude them from your approved list of suppliers• Collaborative root cause analysis• Timely planning reviews and call off strategies to

solve late delivery problems• Continuous vendors evaluation stage as part of

the company procurement risk mitigation process.

Alternatives to Penalty For Consistently Poor Performing Supplier

• Going out there and meeting your suppliers on a regular basis

• In addition to the initial qualification audit, suppliers' capabilities should be verified within a certain frequency (i.e. once in every 3 years or so) by conducting "reinstatement audits

• Conduct product-specific "delivery capability audits" to determine suppliers' readiness and capability to commence volume production for NPI products

Suppliers Point of View

• Anytime you have a penalty it should also include a bonus clause for performance as well.

• I have no issues with accepting a order with penalties but that order should also include performance bonuses.

• Supplier is only as good as the suppliers rep on your account. If your rep is hands on and follows your orders through from start to finish poor quality and late deliveries are virtually eliminated.

Suppliers Point of View

• It is vital that there is both Carrot as well as stick. Suppliers should be rewarded for excellent performance as well as penalized for poor delivery

• Be wary of where you stand in your suppliers eyes. A single supplier may be critical to your supply chain but are you critical to their turnover? Talk of penalties may just leave you high and dry quicker than you think.

Suppliers Point of View

• Quality Issues can be down to the standard of raw materials that the supplier is using (probably to ensure they can supply at the low cost you've already hammered them down to)

• If you know a supplier struggles to deliver on time, try to discuss a more realistic lead time to avoid delays.

How they Should be Used

• Differentiate between Critical and non critical suppliers

• Trust levels with the supplier have to be the highest, which will allow you to incorporate the late delivery or so called penalty clauses with mutual agreement.

• how to get the peanalties caused by the late delivery or quality from the not certified

How Should They Be Used

• Add clauses pertaining to penalties for late deliveries or poor quality in your RFQ

• Key is to make sure you're on the same page about the expectation - ie delivery date, quantity or quality

• Include in your SLA'S (Service Level Agreements) penalty clauses dependent upon criticality of goods service

Specific Actions with a Poor Performing Supplier

• Delay Payment until Acceptance. • Require a deposit from the supplier• Develop alternative suppliers• Switching suppliers next order to low value/low

margin items.• Closed loop process in which deficiencies in

performance from the capability shown in the original audit are reexamined through a new audit

Specific Actions

• Set up a mechanism/system that improve your suppliers' performance in which penalty is portion of the procedure?

• Set up the process of quality and delivery issues upfront and be confident that supplier can financially handle the penalty

Performance Incentives and Penalties

• Contract with the supplier that each week delay is a certain % of money deduct from the final balance

• 50% in advance and 50% upon acceptance on delivery. If everything is ok we issue the 50% balance, if not we adjsut the parts or we reject them and we give less money to the supplier. Of course the supplier wants proof, so you should make a report and able to open a discussion with the supplier.

Performance Incentives and Penalties

• Have supplier make all future shipments to you at his expense over night next day delivery

• Pass on any late fees you incur by your customer

• 2% per week penalty to purchase orders• Holding at least 50% of the total amount while

working on the root causes with OEMs

Performance Incentives and Penalties

• Payment deduction rules on purchase agreement's, there should be % of payment deduction agreed by supplier.

• Add a clause stating "for subsequent orders, in case of quality or delivery issues vendor will pay all expenses for buyer "man-in-plant" if quality or delivery does not conform to original agreement. Duration of man-in-plant is negotiable

Performance Incentives and Penalties

• Quality damages for production items: – issue discovered at incoming inspection has a true

total cost of 10X the value of the part. – A defect that is discovered in production test

incurs a penalty of 50X the value of the part– A defect that manifests itself in the field should

incur penalty of 100x the cost of the item.

The exact multiplier can be debated but the idea is to encourage delivery of good parts and recognizes that latent defects cost more.

Summary

• Improving and maintaining supplier performance is an important topic for global purchasing professionals.

• There is a continuum of approach's to supplier management ranging from adversarial penalty based to collaborative based using formal continuous improvement methods.

• There is general agreement regarding the importance of qualifying suppliers, sharing expectations upfront, monitoring supplier performance and having a process to address issues