Question

13.8End-of-Chapter Case: Pay To Play? Motivating Megadiamond's Suppliers The supplier-quality meeting ended at 3:10 PM and Tim Rock was bummed. The meeting ended without having accomplished one of Tim Rock's major goals. Tim Rock, senior purchasing manager at MegaDiamond, had hoped his idea to offer advantageous payment terms to certified suppliers would be approved. Unfortunately, Mega's CFO, Jack Hardplace, had rejected the plan dismissively, saying, "We just can't do that. We can't offer some suppliers special payment terms for doing what they should be doing in the first place." As Tim entered his office, he muttered, "Who does Jack think we are? Mega is no Fortune 500 player. We don't buy in big volumes. And we're definitely not Honda. We don't have an engineering team to send out to teach suppliers how to improve their own operations. Why in the world would our suppliers want to cooperate more fully in Mega's new supplier quality improvement program? Without some sort of monetary inducement, we're powerless." Mega's Quality Track Record Technological uniqueness had paved the way for Mega's entry into the market. Tim knew, however, that Mega's reputation for producing and delivering high-quality inserts was vitally important to future growth. The tight-knit oil and gas drilling industry was a lot like a small town—bad news traveled quickly. Because customers talked to one another, defective product could kill a company's reputation overnight. By contrast, positive word-of-mouth could help Mega's recognition as a preferred supplier of PDC inserts go viral. Because a reputation for poor quality meant a quick exit from the market, Tim had always viewed quality as critical. However, the quest for quality became formalized in 2004 when Superbdrill, Mega's largest customers obtained ISO 9000 certification. Superbdrill had pressured its major suppliers, including Mega, to get ISO certified. Mega complied, obtaining the ISO certification in the same year. Tim was proud of the fact that by 2009, Mega had established industry-leading standards of excellence in quality, on-time delivery, and pricing. Mega was hitting on all cylinders. The result: DrillMaster, a major Mega customer, named Mega as its "Number 1" vendor for 2011. As part of the commendation, Mega was elevated to "Level 1" vendor status, which meant DrillMaster would no longer conduct receiving inspection on incoming parts. The entire management team at Mega was thrilled to have met the standards necessary to be named a "dock-to-stock" supplier. This triumph validated Mega's quest for excellence. It also motivated Tim to extend "dock-to-stock" certification backward to Mega's suppliers. Motivating Supplier Quality Tim Rock had joined Mega in 2002—shortly before the initial ISO certification. He quickly realized that much of Mega's success rested on its reputation for producing extremely high-quality PDC inserts. The coolest designs only mattered if the quality was equally good. Tim had also recognized that purchasing had a significant opportunity to impact Mega's competitiveness through the acquisition of low-cost, high-quality materials. Mega purchased from approximately 400 suppliers, which were classified into three levels. Level 1 suppliers provided materials that were used directly as components of PDC inserts. Each PDC insert consisted of two principal components: A tungsten carbide base A polycrystalline diamond cutting surface Because of the composition of the inserts, Tim referred to these two parts as "bread and butter products." In effect, the tungsten base was the bread and the PDC the butter. Given the simple nature of a PDC insert, only 12 suppliers classified as Level 1 suppliers. However, these 12 suppliers represented over 50% of all purchase dollars. Level 2 suppliers provided inputs used in the production process. Mega actively sourced from 100 Level 2 suppliers, spending about 30% of the purchasing budget with these suppliers. Level 3 suppliers provided routine inputs that supported both operations and administration. The remaining 300 suppliers were all Level 3 suppliers. Tim dedicated most of his time and effort to improving relationships with Level 1 suppliers. In fact, to support Mega's quality emphasis, Tim completed the training needed to certify as an ISO auditor in 2009. Tim used this training to help suppliers improve their quality processes. For example, in a visit to Tungsten Specialist Incorporated (TSI), Mega's leading supplier of tungsten carbide substrates, Tim noted that TSI was not matching the specification sheet they received from Mega with the final materials certification. This finding helped explain why Mega occasionally received lots that did not meet required specs. More importantly, it raised serious questions about the quality practices at TSI. Because the quality of the tungsten carbide substrate was critical to the performance of the finished PDC insert, Tim had initiated a study of tungsten carbide suppliers. Mega had been purchasing tungsten carbide substrates from three suppliers; however, 99% of its tungsten carbide substrates were sourced from TSI. After surveying both existing suppliers as well as other buyers of substrates, Tim decided that TSI was the best source of substrates and that it would be more appropriate to "tighten up" the relationship rather than start over with a new supplier. The decision to "tighten" the relationship with TSI provided an excellent opportunity to begin to extend supplier certification backward to Mega's Level 1 suppliers. He was worried, however, that simply recognizing suppliers as certified would not motivate them to want to become a "Mega Certified Supplier." After all, despite Mega's world-class performance, a plaque from MegaDiamond hanging in a supplier's lobby wouldn't be viewed as a "world-class" endorsement. And, although Mega was growing fast, it couldn't buy in the kind of blowout volumes that would excite suppliers. To motivate the exceptional quality performance he desired to see from Mega's suppliers, Tim felt he needed to put some kind of "bottom-line" incentive on the table. Tim had identified three primary challenges to providing such a "bottom-line" motivation. Mega's small size had historically prevented it from being a dominant customer for most of its suppliers. In the case of TSI, Mega already purchased 99% of its substrates from TSI. Mega couldn't promise increased volumes as a reward for certification. Senior management needed to approve any—and all—ideas like offering special payment terms to certified suppliers. As Tim sat at his desk, he wondered aloud, "What can we offer to Level 1 suppliers to get their attention and motivate them to improve their quality practices?" Questions What do you think of Tim's plan? What are the pros and cons of a pay-for-performance certification program? If you think Tim should proceed, what can he do to get the CFO and other top management to support a financial reward for certified suppliers? If you don't like the pay-for-performance concept, how do you suggest Tim proceed to get suppliers to buy in to certification?

Answer 1

1) Tim should think of a plan to pay exra incentives to the suppliers who will maintain minimum quality standards as per Mega. The suppliers who meet or exceed the quality standards as set by Mega should be paid over and above their regular invoiced prices. Time to time payment in cash or kind will kindle the suppliers towards reaching for better quality standards.

2)

a) Pros of the model

- High source of motivation

- Directly linked to productivity

b) Cons of the model

- Hard to remove once implemented

- Huge costs involved

3) In order to proceed with the model, Tim should make the top level management understand that pay for performance method is really necessary for them. It is directly linked to the supplier productivity and quality. If the qualiy of the supplier products increase then the overall quality of their products will improve. This will in turn help them stay at the top of the business.