3rd Party Management: Opportunity or Cost

Transcription

1 3rd Party Management: Opportunity or Cost A Research Report on the State of 3rd Party Management by Dr. Kevin McCormack Dr. Marcos Paulo Valadares de Oliveira Dr. Peter Trkman Simplify the Complexity of Managing 3rd Parties

2 Table of Contents Executive Summary Why Another Research Report? o Previous research o What did people do with this knowledge? What Did We Find? (Knowledge) o Actions matter o The difference between 3rd Party Management leaders v. followers What Should You Do About This? (Actions) o 3rd Party Management is an investment not a cost o Eliminate the disconnect between importance and actions What Results Should You Expect? (Results) o Improved performance and reputation o Improved response to disruptions Conclusion References 2012 Hiperos 2 P age

3 Executive Summary Disruptions resulting from using 3rd Parties have been in the headlines for most of the decade. In today s world, most companies are attempting to manage a global network of 3rd Parties, which increases sensitivity to a menu of internal and external factors. This network structure seems to have amplified the perception about the frequency and impact of disruptions. After a decade of research on the topic we are still faced with some surprising facts. In survey after survey: A large majority (often 80%) of business leaders believe 3rd party management is very important A large majority (50-60%) has experienced a significant disruption during the year When asked what they are doing about this, only a small minority (10-20%) is investing significant time and money in 3rd party management practices What can explain this disconnect of importance and action? It seems similar to physical exercise. Most people agree that exercise is good for your health, but only a minority routinely does it. In our recently completed global research we found that a few factors describe the difference between 3rd Party Management (3PM) leaders and followers: Leaders: 1. View 3rd Party Management as an investment not a cost 2. Have employees from different departments actively collaborating in the 3rd Party Management process 3. Have a proactive 3rd Party Management approach and were not often surprised by unexpected incidents These leaders also say that 3PM is helping to increase the value of their products and services, helping to improve their share price, and is very important to the future of their company. In addition, the leaders say that 3PM results in an advantage in delivery performance versus their competitors. One participant in this research stated: With our 3PM program we have earned our customers trust and that earns us market share. What are the leaders doing to get this value from 3PM and why aren t more companies doing this? One survey respondent wrote Our organization has not implemented any major 3rd Party Management practices; in fact some senior management refuses to consider or implement suggested risk management practices. In this research we found it is all in how you look at 3PM. Is it a cost or an opportunity? The leaders clearly look at 3PM as an opportunity, an investment. The followers look at it as a cost, or a problem, something to be eliminated. Our research clearly shows a statistically significant difference on this point between leaders and followers. One of the leaders interviewed put it well; Our board talks about 3PM every time they meet. It is clearly a competitive opportunity in 2012 Hiperos 3 P age

4 their minds. A follower that was interviewed put the cost view very well when he said; Our leaders don t want to hear about it. Our job is to make it go away. Spend the minimum and make sure nothing happens. This research report will present the results from an extensive global study and attempt to address these important questions. Why Another Research Project? Previous Research There has been a lot of work done on this subject. So, why do more research? What hasn t been answered? When digging around, we found that according to a 2008 Aberdeen research study, 58% of companies suffered direct financial losses as a result of 3rd party disruptions in one year. In survey after survey, 80% or more of the people contacted state that 3PM is very important and becoming more important to their business success each day. This led us to believe that most people get it. It s important, like exercise. This realization is actually not new. Already back in 2006, 56% of executives identified 3rd Party Management as a current priority, while additional 30% argued it would be a higher priority by Nevertheless, most of the previous research efforts still deal mainly with 3rd party risk identification and assessment, decision and implementation of management actions, and monitoring. They rarely study either the underlying organizational factors/orientation in the company or the potential value to the company and its customers, or even the possible increase in the stock price. Our conclusion is there is no shortage of knowledge on the subject, but a shortage of answers and actions. What did People Do with this Knowledge? What about actions? Knowledge without actions is useless. What are people doing about attacking this very important issue? In a recent study published by ChainLink Research (May 3, 2011) they found the answer: very little is being done. Figure 1 captures the actions in the context of investment dollars Hiperos 4 P age

5 Figure 1 Amount Spent on 3rd Party Management (Source: ChainLink Research) If one mid-level manager costs $100,000 per year in salary and benefits, then the majority (50%) has less than one-person equivalent focused on 3PM. Could this be the truth on such an important issue? If it is such an important subject, why aren t people investing more? What are the high investment people doing, and what return on investment are they seeing for their efforts? Armed with these puzzling questions, we set out to find the answer. What did We Find? Actions Matter A top-level examination of the data provides a conflicted picture on the state of 3PM. We asked about practices and attitudes concerning 3PM within the participants company. We wanted to know what the people thought was important to the success of 3PM. In one section of the research we asked about seven key factors strongly thought to relate to successful 3PM programs. We asked how important the action or belief was in successful 3PM programs, and how they were doing in regards to implementation. In all cases the difference between the importance score and the action score was large with a range of between 30 and 65 percentage points. This means that although people feel the 3PM actions are important, they are not being implemented to the level they feel is necessary for successful 3PM. Actions speak loader than words, and in this case the actions suggest reluctance to fully implementing 3PM. The disconnect between the importance of budget dollars being allocated for 3PM and the actual allocation of the dollars (83% v. 30%) coupled with top management s involvement with 2012 Hiperos 5 P age

6 3PM is strong could suggest that the involvement is in the form of lip service rather than concrete allocation of resources to 3PM. This seems to confirm the earlier research from ChainLink highlighting the low level of investments in 3PM. We also found something else a little surprising. In analyzing the data we found that there is no statistical connection between being aware of the importance of an aspect of 3PM and performance. Without the 3PM actions (such as budgeting resources for 3PM or cross functional collaboration) the companies received limited value from the belief that 3PM was important. This really makes sense since just understanding the importance of exercising will obviously not get you in better shape. The Difference between 3PM Leaders and Followers Using statistical analysis (cluster analysis) we identified two very different groups within the sample: 3PM leaders and followers (Figure 2). The leaders feel that 3PM is helping to increase the value of their products and services, helping to improve their share price, and is very important to the future of their company. In addition the leaders say that 3PM results in an advantage in delivery performance versus their competitors. Followers are not getting these results. Figure 2 Leaders vs. Followers 2012 Hiperos 6 P age

7 One participant in this research stated: With our 3PM program we have earned our customers trust and that get s us market share. What are the leaders doing to realize this value from 3PM? We found that 3PM Leaders: 1. View 3PM as an investment not a cost 2. Have employees from different departments actively collaborating in the 3PM process 3. Have a proactive 3rd Party Management approach and were not often surprised by unexpected incidents The followers are very often surprised by unexpected incidents and are reactive in their 3PM approaches. Surprises are expensive. A general rule is that an unplanned incident can cost 30%-50% more to address compared to an incident you planned for and were prepared for, even though you did not know when it might occur. Being proactive and investing in mitigation to reduce the impact of an anticipated incident can often return ten times the value invested. In one of our mini cases a defense contractor that we classified as one of the 3PM leaders had detected the possibility of performance degradation and compliance infractions at a key 3rd party. To be proactive, they invested in a second source provider as a mitigation strategy. Through continuous management of their 3rd Parties, they were able to rapidly switch providers before the company was impacted. Results? This saved millions in potential losses, but most of all, they communicated their successful 3PM to the investment market and got an increase in share price. They also feel that their 3PM program has given them an advantage on contracts and they have gained business because of it. A surprising finding in our research was that recent turbulent times did not change the attitude of many companies to look at 3PM as value generator. This can possibly be explained by the expectation confirmation theory used in consumer research. Here is an example: If you view 3PM as a cost, you expect it will take certain efforts to prevent the worst. You build a budget, take some actions and if nothing happens you would be satisfied (spend a little money, no damage) and will continue with the same approach, trying to reduce the cost until something happens. This leads to a kind of a vicious cycle. If you view 3PM as a cost, traditional management theory says to reduce costs until something pushes back. On the other hand, if you view 3PM as an investment then you make an investment decision, invest some resources and are satisfied when nothing happens, or when something happens, you respond better than the competitor. This reinforces the need to optimize the investment and invest more and encourages you to look for ways to focus on how 3PM can deliver more value to the company. This then leads to a kind of a virtuous circle. If you view 3PM as an investment, traditional management theory says to maintain or increase the investment until the return decreases. People tend to want to invest more in successful activities Hiperos 7 P age

8 It is all in how you look at 3PM. Is it a cost or an opportunity? The leaders clearly look at 3PM as an opportunity, an investment. The followers look at it as a cost, or a problem, something to be eliminated. Our research clearly shows a statistically significant difference on this point between leaders and followers. One of the leaders interviewed put it well; Our board talks about 3PM every time they meet. It is clearly a competitive opportunity in their minds. A follower that was interviewed put the cost view very well when he said; Our leaders don t want to hear about it. Our job is to make it go away. Spend the minimum and make sure nothing happens. What Should You Do About This? 3PM is an Investment, Not a Cost Based on this research, here are some suggestions to consider for receiving the most value from your 3PM investments. Go for value not for costs You get what you expect. The purpose of 3PM should not be to minimize the risks or the cost of 3PM, but to find the efficient level of performance and risk prevention that will lead to better customer assurance, higher reliability and flexibility, and optimum value. Change the language When talking about 3PM do not emphasize avoiding disasters. Don t focus on terrible things and disasters that may happen to the company. Rather, provide a glimpse of the opportunity. Talk about business value that 3PM can bring to the company and the customers. Trust and reliability, dependability, proactive investments. It is all about the words we use in the conversation. Top management support is needed, but not enough in itself Top management support has been the mantra for any kind of organizational improvement. Interestingly, our research identifies the correlation between management support and 3PM practices, but failed to identify any significant impact of management support on 3PM results. This clearly shows that the goal is not to obtain top management support. The goal is to obtain this support for the right activities. Most importantly, this support is for building an aware and proactive culture within the organization and to set the mindset of 3PM as a value generating investment Hiperos 8 P age

9 It is not only important what you think, but also what you do People may realize various aspects of 3PM are important, but that does not mean they will do anything about it, and of course will not get any results. Lip service makes you feel good, but gets you nowhere. Just building awareness on the importance of 3PM may not be enough; you need to build the necessity to do something about this. If 3PM is viewed as an investment, then there is an opportunity cost for doing something and that begs for action. Go for actions not formalities Methodologies on how to do 3PM with many detailed steps, formal procedures and reports are not a good replacement for a 3PM-oriented, action-oriented culture. Just implementing formal procedures could mean that people will take them with the just another program attitude. Yes, effective 3PM is systematic and data-driven in identification and assessment, but that in itself gets you nowhere. A culture of what are we doing to change things today is what 3PM is all about. Turbulent or not turbulent: this is not a question It may seem at first glance that 3PM is more needed in turbulent environments where market and technology change quickly. Our result, however, show otherwise: 3PM is no less beneficial in less-turbulent environments. While the results may be more incremental they are also easier to achieve. 3PM is good for everybody, no exceptions. Focus both on day-to-day and on strategic issues Disruption in production for a few days is a problem. Your 3rd party losing that technology-edge can be an even larger one in the long run. You must focus on both. Investments are made with short term and long-term perspectives. 3PM investments are no different. Eliminate the Disconnect Between Importance and Action Changing the mindset about 3PM is a difficult challenge. The quality revolution of the 1980 s began in the same way. The concept of quality as an investment was new then. It was looked at as a cost and that if you increased quality you had to charge more and you would lose customers or market share. The book Quality is Free by Crosby changed the way leaders thought about quality. Edward Deming was the voice demanding the change in mindset and he refused to go away. Today, high quality and low cost is common and accepted. The quality leaders proved it and took tremendous market share away from the followers. The Toyota Way is the exemplar now Hiperos 9 P age

10 This is what is needed for 3PM. 3PM is not only free, it offers a strategic advantage. Be the Edward Deming of 3PM in your organization and ask for action that matches importance. Change the way your organization looks at 3PM. It s an investment opportunity. What Results Should You Expect? Improved Performance and Reputation If you invest the time and effort you will get the results. There is no silver bullet or magic exercise machine that allows a minimum effort to get a maximum value. Yes, there are technologies and methodologies available that aid in achieving the results, the Bowflex exercise machine in the exercise analogy, but what you get out is dependent upon what you put in. How much do reliability, dependability and trust get you with your customers? What does being prepared do for your reputation? One of the research participants from a financial services company put it very well when she said; 3PM helps our customers trust our products and, in this business, trust is everything. 3PM leaders see improved delivery performance to their customers, they feel they have reduced costs with 3PM, that the satisfaction of customers has increased, and their stock price has been positively impacted. You can expect the same if you make the investments. They also feel they are not often surprised by disruptions. In order to show the value of not being surprised or being prepared, we have to examine some 3rd party disasters. Reputation damage is one of the greatest impacts of 3rd party disruption on a company. The study from 2003, by Hendricks and Singhal, summarizes the reputation impact of not investing in 3PM. 1. Lost revenue - that is a natural result of not having products to sell or customers to buy them 2. Stock price - when a disruption hits the news your reputation will suffer and if you are a publically traded company your stock will take a tumble, an average of 20% 3. Market capitalization and debt - your company will subsequently be worth less and that might lead to financial repercussions for interest rates and perhaps bankruptcy 4. Brand name - your brand name that your company is built on might lose its value. Customers stop trusting in your product or service. Once lost, it is very hard to recover Mattel discovering that lead paint had been used in the production of their toys illustrates a specific example of reputation damage. As you can see in Figure 3, Mattel experienced a stock price decline of over 20%, with a loss in market capitalization corresponding to nearly $2 Billion Hiperos 10 P age

11 Verbal Report To CPSC 18.5% Decline On a $10 Bil Market Cap Or 1.9 Bil loss "We heard in early July that we had a possible issue," said Mr. Walter, who added the company stopped production in the Chinese factory around July 7. After further investigation, Mattel approached the Consumer Product Safety Commission with a verbal report July 20. A written report was filed July 26. The product is being recalled under the "fast-track" recall program whereby Mattel has admitted to the contamination and the CPSC hasn't done additional testing. Figure 3. The Mattel Story Improved Response to Disruptions Even with 3PM leaders, disruptions will happen. When you detect them, what you have done to prepare for them and how you react is critical. A 3PM investment in this area will have a big impact. In our research since 2004, we have identified some typical patterns. We found that the leaders of 3rd Party Management are using predictive indicators, in advance of an incident, that tell them where and who has the highest probability of causing the loss, and what actions they are taking to reduce the likelihood or significantly reduce the impact. Knowing what to be prepared for matters. Figure 4 highlights the difference between reactive followers in 3PM and prepared, proactive leaders. The lower (red) curve represents a 3PM follower that relies on reaction as a strategy. They detect an incident fairly soon after it occurs and go into action. They are referred to as the John Wayne Heroes. Unfortunately, our research shows that the impact is already starting to 2012 Hiperos 11 P age

12 be felt and continues into a trough. Recovery is fairly slow and takes some time before performance is back to previous levels. Figure 4. Incident Loss 3PM Leaders v. Followers The upper (blue) line represents 3PM leaders that are proactive and prepared. They identify and prioritize the areas to closely monitor and implement a specific set of precursors that allow early, and in some cases, advance detection of an upcoming disruption. An example would be using a methodology to identify the 3rd Parties most at risk coupled with a 3rd Party s immature, and therefore, ineffective processes. The leaders would invest in resources for monitoring and developing this supplier. In our research, the lower (red) approach had a typical loss of $120 million per incident as compared to and the upper (blue) loss of $1.2 million, a decrease of $118.8 million dollars, not an insignificant sum. Conclusion In closing, viewing 3PM as an investment changes the game. There are lots of methodologies and technologies available to help make this investment successful, but buying the best exercise machine with the secret to perfect abs in 30 days is not the answer. Recognize that investments in 3PM are important for every organization in every environment, but taking investment actions is the key. Nike has sold a lot of shoes with their pitch line Just Do It. That goes for 3PM as well as exercise Hiperos 12 P age

13 References Hendricks, K, Singhal, V, The Effect of Supply Chain Disruptions on Long-term Shareholder Value, Profitability, and Share Price Volatility, June 2005 Aberdeen Group, The Supply Risk Management Benchmark Report, September 2005 Forrester Research, Successfully Managing Security And Risk In A Global Supply Chain, August 2007 Forrester Research, Patrick Connaughton, Risk Management in the Global Supply Chain, October 2007 HEC, Paris, Bruel O, Menuet O, Thaler P-F, European Sustainable Procurement Survey, 2007 Handfield, R. and McCormck, K., Supply Risk Management, Auerbach Publications, December, McCormack, K., Business Process Maturity: theory and application, Booksurge, November Handfield, R. Supply Market Intelligence: A Managerial Handbook for Building Sourcing Strategies, Auerbach Publications, 2006 McCormack, K., Supply Chain Networks and BPO: Advanced Strategies and Best Practices for Obtaining Superior Results, CRC Press, November Hiperos 13 P age