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Business Effectiveness

Balancing
supplier risk
versus reward
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1 / Balancing supplier risk versus reward

In the wake of constant demand and


supply market changes driven by recent
economic crises, procurement and
supply chain professionals are facing
higher expectations from management
to drive down costs. But what potential
impact does this singular focus on cost
savings have on supply and supplier risk?
Because it can result in the unintended
consequence of diluting the total value
delivered from that supplier relationship,
the key is to balance supplier risk with
reward to obtain the greatest benefit from
your suppliers while minimizing your risks.

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss
entity. All rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are
registered trademarks or trademarks of KPMG International. 23095NSS

Balancing supplier risk versus reward / 2

While it can be difficult to find this balance, there are some


approaches and tools that leading companies are adopting,
which include:

Define and prioritize


supplier tiers

Defining and prioritizing supplier tiers

Most companies have critical suppliers that will significantly


impact their revenue and profit. However, these suppliers
and/or supplier tiers are not always formally defined nor have
tailored programs been developed. Companies that adopt a
one size fits all approach to managing suppliers run the risk of
conducting less rigorous assessments of the critical suppliers
and overassessments of noncritical suppliers. This can produce
a number of false positives or false negatives which
results in inefficient allocation of scarce procurement resources
and ultimately decreases the value the procurement function
delivers to their internal customer.

Utilizing risk assessment processes for new product/service


requests
Incorporating initial and ongoing supplier due diligence;
Utilizing balanced category scorecards
Adopting robust supplier performance reporting and issue
resolution
Developing and regularly updating category market research
profiles
Implementing a supplier Six Sigma program
The following is an in-depth look at these approaches and tools
and how they can be effectively applied.

The following table is an example of defining and prioritizing supplier tiers:


Example Supplier
Category Tier

Example Definition

A significant spend supplier whose products/service are critical to a companys revenues and require:
Complex contracts that drive continuous improvement
Proactive supplier relationship management
Detailed monthly supplier performance reporting
Proactive forecasting

A moderately high spend supplier whose products/service are important to a companys revenue
and require:
Complex contracts
Proactive supplier relationship management
Detailed quarterly supplier performance reporting

A supplier whose products/service are not critical to a companys revenue but requires:
Complex or basic standard contracts
Annual performance reporting

A supplier whose products/service are not critical to a companys revenue and:


Falls within a non-procurement managed category
May utilize standard purchase order terms & conditions

After creating a tiered approach like the above example, companies can then develop targeted and differentiated programs to
adequately identify and manage risks based on the category and supplier.

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

3 / Balancing supplier risk versus reward

Risk assessment processes


for new product and
service requests
Many companies have some kind of process to identify risks
related to new supplier requests but may not review the risk
for additional products/services from that same supplier at a
later point in time. This can lead to a false sense of security,
since although the initial assessment of that supplier was
positive, it now may not reflect the higher risk of that same
supplier due to potentially new and higher-risk products/
services being acquired.
By incorporating a risk assessment activity at the beginning
of each product/service request for both new or existing
suppliers, companies can ensure they identify and manage
new risks effectively. The trick is to make the risk assessment
process simple and streamlined enough so that it does not
become onerous or non-value-added. In addition, one wants to
make sure there are steps in the process where there is some
appropriate procurement or strategic sourcing subject matter
review. This subject matter review ensures the information
provided and risks identified make sense. Also, this helps
reduce requestors from gaming the process in order to get
requests through the process as quickly as possible.

1. Request new
supplier
product/service

5. If risk is now higher,


amend contract with
appropriate terms &
conditions

4. If risk is now higher


complete additional
due diligence if
applicable

2. Complete risk
assessment form

3. Assess if suppliers
risk higher than before

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

Balancing supplier risk versus reward / 4

Initial and ongoing supplier


due diligence
Companies usually complete some high level of initial supplier
due diligence but may not go to the appropriate detail level. In
addition, companies dont always conduct ongoing supplier due
diligence, or again, not at the appropriate detail level.
The degree of supplier due diligence and frequency of
assessment should be commensurate with the supplier tier
and product criticality. For example, if a company spends a
significant amount with a supplier, and that supplier provides
critical products/services that directly impact that companys
revenue, then that supplier should be subject to a significantly
more robust initial and ongoing due diligence program then
compared to a supplier or category with much lower spend
and/or no/little impact to a companys revenue. In certain
categories, there may be cases where even spending low
amounts still requires a high amount of due diligence due to
the overall risk with that supplier. Some examples can include
payment processing, hazardous waste, and IT offshoring.

Audit report
Subcontractors to be utilized (if applicable)
Vendor management policy and program of subcontractors
(if applicable)
Past and current references
Country risk assessment (if supplier is supporting you
outside the United States)
Management turnover
Product or plant closures
Requests for payment term adjustments
Deep discounting, etc.
In addition, when dealing with critical suppliers who have
access to highly sensitive data (e.g., information technology,
financial service operations, etc.), companies should also
consider the following supplier due diligence items:
Physical security policy
Asset management policy

It is important to define the right set of indicators to get early


intelligence on a suppliers financial health. A common mistake is
to rely exclusively on publicly available company financials. While
necessary, that is not sufficient. The following are examples of
some items to monitor for a critical supplier or category:

Background screening process

Supplier financials

Incident management program

Insurance certificate

Business continuity test results

Business continuity plan

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

Access controls
Information security policy
Information security breach history

5 / Balancing supplier risk versus reward

Balanced category scorecards


may be impacting just one or two suppliers, so companies
can make a distinction between broader, emerging risk trends
and supplier-specific risks. A balanced category scorecard
should also highlight the amount of supplier diversification and
concentration a company has across various categories, which
can also help companies respond quicker to emerging risks and
help drive toward greater value.

A balanced category scorecard is an effective tool to get a


holistic perspective on total value delivered. A category is a
common grouping of suppliers by a particular product/service. By
developing a scorecard with appropriate categories, a company
can better understand the value its suppliers are delivering.
This can also help in identifying and mitigating risks. Some
risks identified may be common within a category, while some

Category: How do we describe


the expenses in this area?

Category Profile: Contingent Labor

11%

Spend by Major
Subcategory

13%
41%

IT
Admin
Finance
Legal
Marketing

$40.0
$30.0
$20.0

17%

$0.0

18%

Category
Characteristics
What have been the
internal (the Client) and
external (industry)
events in this category?

Spend by Vendor
How much do we spend
with the key vendors?

$10.0

Vendor 1

Category Characteristics

Vendor 2

Vendor 3

Vendor 4

Vendor 5

Areas of Potential Focus

Due to current market conditions, good time to


source labor related categories in developed
countries

Currently excess supply of skilled workers

Forecasted unemployment rate over the next X


months expected to stay relatively high

Opportunity to consolidate vendors currently


have XX vendors

Opportunity to renegotiate with Vendor 1 as labor


subcategory B contract expires in 20XX and no
other contract for labor subcategory B exists

Opportunity to negotiate and incorporate volume


discounts with Vendor 1, Vendor 2, and Vendor 3

Recommendations
and Considerations
What would you
recommend
we do or change?
What else should
we consider
exploring?

Category Summary

Major
Subcategories
What does this
category consist of?

Subcategory

20XX
Spend#

#Suppliers

Amount Total
(million)

80%
Spend

Potential
Savings %
Low

High

Potential
Savings $
Low

Potential Opportunities
(Low, Medium, High)

High Volume Mark


Req.
Process
leverage up optimization improvement

IT

$XX.X

XX

X%

XX%

$X.X

$YY.Y

High

High

High

Med

Admin

$XX.X

XX

X%

XX%

$X.X

$YY.Y

High

High

High

Med

Finance

$XX.X

XX

X%

XX%

$X.X

$YY.Y

High

High

High

Med

Legal

$XX.X

X%

XX%

$X.X

$Y.Y

Med

High

Med

Low

Marketing $XX.X

X%

XX%

$X.X

$Y.Y

High

High

High

Med

XX

YY

X%

XX%

$X.X

$YY.Y

Totals

$XXX.X

# of Suppliers by
Subcategory
How many suppliers
do we use for this category?

Recommended
Sourcing Strategy
How would you
suggest we go about
obtaining the savings?

Savings Estimates
On a percentage basis
and in $s, how much could
we save on this subcategory?

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

Balancing supplier risk versus reward / 6

Robust supplier performance reporting and issue resolution


For a companys key strategic suppliers, utilizing a robust
supplier performance reporting and issue resolution process
is a critical component to help balance risks and rewards.

Companies should consider utilizing a multistep reporting


and issue resolution governance approach like the following
example for key strategic suppliers:

Example Frequency

Example Activity

Daily

Supplier daily report is developed and reviewed between supplier first level management and
companys first level management
Majority of key questions and tactical issues are resolved in the daily meetings

Weekly

Supplier weekly report is developed and reviewed between supplier first and second level
management and companys first and second level management, and procurement
Some of the remaining key tactical issues are resolved in the weekly meetings

Monthly

Supplier monthly report is developed and reviewed between supplier first, second, and third level
management and companys first and second level management, and procurement
Any escalated tactical issues are resolved at this level
Majority of strategic related issues are identified and resolved at this level

Quarterly

Quarterly monthly report is developed and reviewed with supplier senior management and
companys senior management
Any escalated strategic issues are resolved at this level

For nonstrategic suppliers and categories, less reporting and governance may be appropriate.

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

7 / Balancing supplier risk versus reward

Category Packs
A Category Pack is a collection of external market research
about a particular industry or sub sector including supply
and pricing trends, competition, risks, and key suppliers.
Developing and regularly updating a Category Pack provides
insight into new information and trends within the marketplace.
This can include emerging products/services, price changes,

and new risks. Because risks can arise from various


causesincluding inflation, government regulation, supplier
consolidation, supplier bankruptcy, suppliers supply chain
issues, and supplier fraud or quality issuesgaining insight
sooner to new information and trends enables companies to
shorten their reaction time to new risks.

Relative Cost Drivers


2%
2%
4% 2%

Hours Worked
Base Labor Rate
Travel, Per Diem & Incentives

6%

Fringe Benefits

8%

Insurance & Taxes

53%
8%

Supplies & Tools


Overhead
Contingency
Profit

15%

The primary cost driver for the industry is based on the


variable cost of hours worked.
From a margin perspective, the overhead, profit, and
contingency numbers are relatively low.
Primary opportunities are to:
Reduce demand for higher skilled resources
Focus on process efficiencies to limit hours worked
Constrain travel to minimize obligation to per diems

Supplier Market
15.6%

Supplier 1

25.9%

Supplier 2

4.2%

Supplier 3
Supplier 4

7.6%

Supplier 5

8.7%

Historical market conditions were trending up until 20XX.


20XX had a significant decline in overall industry demand
and caused deflationary pressure on pricing as well.
Projections for 20XX and 20XX are an increase in price, but
pricing is still expected to be below the 20XX peak.

Supplier 6
Others

25.6%
12.4%

10.00%

80

8.00%

60

6.00%

40

4.00%

20

2.00%

00

0.00%

20
0
20 5
0
20 6
07
20
0
20 8
09
20
1
20 0
11
20
1
20 2
13

% Billion

Market Forecast
100

% Billion

% Growth

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

Balancing supplier risk versus reward / 8

Supplier Six Sigma program


Another approach that can help reduce risk and drive significant
value from your strategic suppliers is implementing a supplier
Six Sigma program. Six Sigma is a methodology that uses facts
and statistics to measure, analyze, and improve processes,
and reduce variability in outcome. Using this methodology
can help reduce supplier costs, improve supplier quality, and
reduce supplier risks. One of the first things to consider is
identifying a few key strategic categories and existing strategic
suppliers. Since this program requires investment of time and
resources for both your company and the suppliers, one should
consider focusing on existing strategic suppliers that can help
you achieve the sizable benefits. In addition, assessing if the
existing suppliers have instituted a company-wide Six Sigma
program is another important step. This is because you want
to try and partner with suppliers that already have the Six
Sigma knowledge, experience, and tools. By using suppliers
that already have a Six Sigma program in place, you have the
potential to gain additional benefits including shorter time to
implement and higher probability of success. The following
are some additional key considerations when implementing a
supplier Six Sigma program:
Think big, start small, scale fast
Obtain management buy-in for the program
Use experienced supplier Six Sigma resources
(e.g., Master Black Belt), either internal or external
consultants, to help plan and implement your program
Develop a stakeholder assessment and communications
plan both internally and externally (suppliers)
Partner with your suppliers to help identify what criteria
and which Six Sigma projects to consider
Document and agree upon key milestones for
project reviews

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

9 / risk versus reward

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

Conclusion
Today, a constantly fluctuating demand
and supply market demands that
companies have an agile and flexible
supply chain, and one that derives more
value from suppliers while allowing
for proactive risk management. Those
companies that unlock the value in their
supply chain can save money, improve
quality, reduce risk, gain revenue,
and gain efficiencies. Companies
that can deliver significant benefits
across the organization can be a critical
competitive advantage.

2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All
rights reserved. Printed in the U.S.A. The KPMG name, logo and cutting through complexity are registered trademarks
or trademarks of KPMG International. 23095NSS

Contact us
For more information, please contact one of
the KPMG LLP professionals listed below:
Samir Khushalani, Principal
Business Effectiveness
T: 713-319-3570
E: skhushalani@kpmg.com
Byron Tatsumi, Director
Business Effectiveness
T: 415-963-7678
E: btatsumi@kpmg.com

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or
entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as
of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate
professional advice after a thorough examination of the particular situation.
2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. Printed in the U.S.A.
The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. 23095NSS