Four things to remember when selecting a new supplier

Introduction

Selecting suppliers for outsourcing functions, buying services, etc is becoming increasingly common. This means that supplier selection is now a key organisational capability.

However many organisations struggle with supplier product/service selection. Therefore based on my (both good and bad) experiences I have drafted an approach (based on four lenses) to help organisations assess and measure a supplier’s capability as part of any procurement selection process.

The four lenses are (a) functional fit (b) commercial fit (c) timeline fit and (d) company and cultural fit

Functional Fit

This is confirming whether the product or servicing being assessed ‘gives you want you need or want’.  For example if you are looking for an accountant then do they provide all the book keeping, invoicing and other services required. Alternatively if you are looking at payroll software then can the package calculate the salaries, pay the salaries, calculate PAYE and so on.

 A three step process can be followed to ensure you confirm the functional fit:

Step #1

Initially create a list of your requirements with each requirement weighted by importance. The essential requirements would have a higher weighting with the less critical requirements having a lower weighting.  

These requirements should cover core requirements (such as can the accountant generate invoices), peripheral support functions (such as what support is in place if queries are raised with the above invoices) as well as any future needs.

Step #2

Secondly assess the product/service against your list of weighted requirements. This assessment can be done in a number of ways.

• Firstly you can ask them a series of questions (using a request for information document). It is essential that the supplier responds in writing (so there is no confusion over what is being said).
• Secondly you can ask for service or product demonstrations although these can be staged and do not provide any real benefit. Therefore I would suggest that you request a proof-of-concept to test and review any specific scenarios that are important to confirm the functional fit. You could also speak to other users of the product/service. The supplier will provide a list of their other clients but they tend to be clients who are happy with the service. Therefore it would be good to find a full list of their clients and try to speak to the ‘unhappy’ ones.

Step #3

Finally once you have completed the above two steps then you can evaluate the service or product against your list of weighted requirements to determine which is the best fit

 Commercial Fit

Basically this is ensuring that everything that is agreed within the entire procurement process is clearly documented in some form of legal agreement or document which both parties sign up to. This should avoid any misunderstandings later on.

This area is notoriously challenging and tricky. Therefore I would recommend bringing in some expert help. However the following bullet points should provide some useful guidance: 

The service or product being offered needs to be documented in detail with both parties agreeing it. This is normally documented in a Product or Service Definition Document. It is important that any bespoke or non-standard arrangements are also included.

Related to this, a set of measures need to be defined to measure supplier performance. 

•  These levels of service are usually documented in a Service Level Agreement (SLA) which will determine timings for processes, who is responsible and any dependencies. A SLA is often supported by a set of Key Performance Indicators (KPIs) to measure the supplier’s performance against the SLA. (For example (and using the payroll example earlier) the SLA may say that “all payroll payments must be submitted by 10th business day“ with a supporting KPI saying that “100% of submissions must be made on time” and if this KPI is missed then it is flagged as missed)

Linked to this, it is not uncommon to have a specific clause(s) to manage continued poor performance by the supplier. For example if certain KPIs are constantly being missed then a clause could be included which gives the supplier a defined period of time to address these issues but  if these problems are not resolved  in this time period then the customer has the right to financial refunds or even to terminate the contract.

To mitigate against contractual disputes then a dispute remediation process should be included.  This process should all aspects of the contract such as a breach of confidentiality, invoice dispute, and so on. It could state that if a contract dispute arises then (a) both parties would aim to address the issue within a certain period of time but (b) if this is not possible then they pass the dispute to a pre-agreed third party for arbitration.

 A change request process is required. This is to allow both parties to try and make changes to any part of the contract. This process will need to cover how change requests are raised, reviewed, authorised, costed, implemented and then ultimately closed.

Payment terms need to be clearly documented – please see below:

• This would cover a rate card of the charges of all services/products offered (including any tiering, minimum fees, discounts and so on). 
• It should also cover invoice frequency and how quickly these invoices should be paid. 
•  This section should also include the processes or methodology for any price increases. For example an annual price increase based on the UK RPI index or something similar.
•  Therefore it is important to stress test the rate card against your current and predicted business volumes to ensure you fully understand the impact.

It is also a good idea to include some sort of indemnity text around direct or indirect (or consequential) loss. 

•  Direct losses are where one party’s actions has directly caused a financial loss to the other party. For example due to an error by the supplier, you are being sued by a third party for £10 million and you expect the supplier to fund the £10 milion. Although it is not uncommon for both parties to put a liability cap in place. For example each party is limited to £5 million per calendar year.
•  Indirect loss are where the supplier’s negligence has caused you an indirect loss. For example a web-site provider crashes your website for two hours which mean you lost potentially £50,000 to £100,000 of new business as a result of this issue.  The challenge here is that indirect costs are can be very vague and the range of scenarios is almost infinite. Therefore it is not uncommon for each party to exclude indirect losses from contracts.

 A termination clause needs to be entered to allow both parties to exit the contract. Termination for poor performance was discussed above but there is often a need to terminate for more pleasant reasons. For example you want to change suppliers or the supplier is exiting the business and needs to roll off its clients. It is important that any lead-time for terminate is sufficient long to allow you to find and implement a new arrangement. Therefore termination lead-times could be for several years.

 A confidentiality agreement needs to be in place. This is normally two way – i.e. you cannot tell about us and we cannot tell about you.

It is normally good to have some sort of legal wording about protection of intellectual property and who owns it. For example if your supplier develops something bespoke for you (say some software) then who owns it? Does the supplier own it and license it back to you which means if you exit the arrangement then you will lose access to the software? Or, even though the supplier has written the software, you own the software and it keep it if the arrangement ends.

The final area is exclusivity. This means does either party want to limit the other party from undertaking a similar arrangement with different organisation. For example if you are distributing a firms products then it would make your easier if you had exclusive distribution rights to sell their products. However if you are the supplier then this may not be acceptable because you are putting all your ‘eggs in one basket’ with a single distributor and if they fail to deliver then you will get no sales. Therefore if exclusivity is on the table then you need to really understand what it means, whether you want to change your pricing model and also whether you would to limit exclusivity to a pre-defined period of time.

When negotiating commercial terms, it is important to ensure that both parties obtain benefit from the arrangement (i.e. a win / win). If all goodwill is extinguished during the selection phase – if costs are cut to the bone, or too much work has been agreed for the cost – then there could be problems when the contract is running live.

Timeline Fit

This area covers understanding how quickly (or slowly) the new product or service can be delivered. For example is a just a case of ‘flipping a switch’ and the new service/product can be delivered immediately; or is a long implementation project required, taking several months/years, requiring data migrations, phase implementations, etc.

 Therefore it is important to understand the implementation plan. This will cover what tasks are required, their dependencies and any critical dates.  It is always a good idea to include some sort of financial penalties if the supplier missing dates.

 It is also important to understand who performs the tasks because it may be necessary to involve other third parties in the process. For example if you are implementing a new payroll service then it may be necessary to involve the bank and tax office as well as you and the new supplier.

 Likewise it is important to understand what the implementation costs are. The supplier may want to charge for implementation costs especially if the implementation timeline is lengthy. However you will no doubt have some implementation costs such as external project managers, legal specialist, etc. Therefore these costs will need to be fully understood

Company and Cultural Fit

This area covers ensuring that you are happy with the organisation or firm who is providing the proposed vendor and service

 The set of variables looks at the company itself and covers the following points:

• Where is the supplier based? and does this location cause problems? For example the company is several time zones away then this could restrict easy communication. Also is the firm based in a country where your country has trade restrictions? In the 1980s it would be impossible for a US firm to arrange a defence contract with somebody in the Eastern Block.
• It is important to understand who owns the company and what their plans are. For example if the firm is owned by the employees (or small set of them) then one could guess that they would be focused on the long term. However if the firm is owned by outside investors then their focus could be on earning a quick buck so they can sell it.
•  It is also important to understand the company’s history and their future (say five years) plans. A solid history with consistent results is promising. However if a firm struggles to provide a plausible long term plan then that could be troubling and needs to be investigated
•  It is also important to understand the long term plans for the product or service you are contracting for. If the product is key to their company’s future and they have big plans for it then this is good. If not then you need to ask some detailed questions about the future of the product.
•  Also does the offering have existing functionality that you will not require now but could be useful in the future? And what future enhancements is the supplier planning? For example if you purchasing some software then it is the provider looking to offer a cloud version?

 It is also important to understand the organisation’s client base; viz:

•  How clients do they have?
• How many users of the proposed product / service do they have? If the number of users is low then this could be a warning sign that the product is not that good?
• Do they have any clients that are similar to you (say your competitors)? If so they who are they and how similar to you are they?
• If possible then ask for a list of all their clients so you can contact them to see how good/bad the supplier is? Also ask if there is a user group because they may provide some useful input.
•  What is the size of their other clients and how do you fit into this? For example if the supplier has lots of big clients and you are small then you may struggled to get your ideas taken forward. However if you are their biggest clients then (a) you should press for good commercial terms and also (b) press to ensure you have a large influence on the supplier 

It is important you have a good cultural fit with the supplier. This area involves answering the key question “are you happy to work with supplier for the length of the contract?” For a short contract (say two years) this may not be a problem but for a long term contract (say a seven year outsourcing deal) then if you have issues with the supplier then working with them for.

 This cultural area is possibly the most important area and often overlooked. However assessing this area is a challenging and is often down to ‘gut feel’ but the following pointers may held

•   If you are a small firm with light processes and controls then working with a large process heavy firm will be hard and a massive cultural shock. Likewise if you are large firm then working with a smaller firm could be a challenge. 
• Are they are any language differences? If so then this could cause problems with communication
•  Likewise is the supplier a distance and / or in a different time zones? Per above this could cause problems with effective communications.

Summary

In reality, if one is performing a supplier selection, it is unlikely that a single supplier will have the best score for each of the four areas. For example Firm A may be good on Functional Fit and Commercial Fit but poor on Timeline and Culture Fit whereas Firm A could be good of Function Fit, Commercial Fit and Cultural Fit but very poor on Timeline. 

 While it is possible to weight each area to create a quantitative score for selecting a supplier, a qualitative or subjective assessment is often required.

 Therefore selecting a vendor, service provider, etc is not an easy task and even the most experienced professionals make mistakes but I hope that this article provides some guidance.