Center for Management of Emerging Companies

Supplier Assessment Techniques

It is now commonplace for manufacturers relying on outside suppliers for parts and components to require all suppliers to regularly complete a comprehensive assessment questionnaire and go through other due diligence procedures.  This report discusses some of the techniques that manufacturers are using to review the quality controls and compliance procedures used by their key suppliers.

Vendor Selection Policies and Procedures

This week I'm presenting a comprehensive policy that sets for the steps that should be taken by companies and their personnel in selecting vendors and negotiating and consummating contracts for the purchase of goods and services from those vendors.  Care in this area is particularly important in trying economic times such as this.

Identifying and Evaluating Prospective Suppliers

Supply chain relationships are key elements of any company's business strategy.  This week I am featuring a report on how to identify and evaluate prospective suppliers.

Vendor/Supplier Due Diligence

The process of selecting a vendor, including conducting a comprehensive due diligence process, can be quite complex and time-consuming.  For significant projects and functional activities vendor selection may take anywhere from three to nine months and the costs associated with the process may be significant and should be included in the company’s analysis of the target return-on-investment for the project or activity.  Vendor/supplier due diligence is something that companies need to learn to do right.  For more about setting up procedures for vendor/supplier due diligence, read the attached report. 

Refurbished Services Agreement

Companies that have a significant volume of warranty obligations to their customers with respect to their products may outsource the necessary repair work to a third party manufacturer that will serve as an authorized service organization.  The relationship between the parties should be memorialized in a refurbished services agreement.  The agreement should describe in detail the exact services to be provided by the manufacturer which typically would include securing all products delivered for services and providing the repair services according to agreed specifications and using parts, tooling and packaging materials provided by the buyer. The manufacturer will provide trained labor and also contribute its own existing equipment for use in carrying out the repair services.  A fixed price for the services would be negotiated that would provide the manufacturer with a steady and predictable stream of revenue while also giving the other party the advantage of controlling the costs associated with comply with its warranty obligations to its customers.  The agreement should also cover standard issues such as delivery procedures, change orders, warranties, limits on liability, term and termination, payment terms, dispute resolution and confidentiality.  The content in this post has been adapted from material that will appear in Business Transactions Solutions (Fall 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

Extending Compliance Programs to Suppliers II

I’ve been discussing the need for companies to extend their compliance program obligations to their suppliers. One basic step that should always be taken is to include standard language in every contract with an outside party that creates a contractual duty on that party to comply with all applicable laws and regulations and spells out specific areas of concern (e.g., the Foreign Corrupt Practices Act in the case of foreign parties dealing with local government officials).  Beyond that, however, companies are beginning to create their own standards for supplier activity and integrating those into how they create and manage their supplier relationships.  For example, a company may promulgate a social and environmental responsibility policy for its suppliers.  This policy becomes a public statement of the values and business practices that the company seeks in its supplier group and a de facto checklist for the due diligence that company personnel are expected to do before entering into a relationship with a new supplier.  The requirements and expectations in such a policy can then be made a part of the formal contractual arrangement between the parties through the use of a supplier social and environmental responsibility agreement.

Company policies regarding social and environmental responsibility are often derived from industry-wide efforts to develop, and build a consensus for, standards for socially responsible business practices that would apply to all participants in a supply chain regardless of their size or where they are located.  An example of such an approach is the Electronic Industry Code of Conduct released in October 2004 following collaboration by some of the major manufacturers in the electronics industry.  This Code of Conduct becomes the basis for company-specific policies that include standards for labor, health and safety, environmental matters, and business ethics.  In addition, companies electing to comply with the Code of Conduct would be expected to establish and maintain an acceptable system of internal controls and procedures to ensure that they carry out their business activities in a manner that meets or exceeds the specific standards in each area.

While imposing compliance standards on partners in the supply chain seems to make a lot of sense, and may have actually become a mandate to fulfill specific legal obligations, a word of caution is in order for those companies adopting such an approach.  One obvious potential problem, especially with suppliers in remote foreign countries, is making sure that adequate resources are invested in actual monitor of supplier activities and enforcement of the standards set forth in policies and supplier agreements.  One of the reasons for including third parties within a compliance umbrella is the ability to represent to regulators, customers and investors that the company is indeed a good “corporate citizen” and deals only in goods and services that have been produced in accordance with the highest legal and ethical standards.  If it turns out that their vendors fail to follow those standards the company runs the risk that its own reputation will be tarnished, particularly if it can argued that the company did not adequately monitor a vendor’s activities.  It is important therefore for companies to use their contractual audit rights and take other reasonable steps to monitor their suppliers including regular visits to supplier facilities to observe the effectiveness of the supplier’s efforts to adhere to labor and environmental standards.  In fact, failure to do so might even be perceived as a breach of an unexpected duty to a third party such as a customer injured by products provided by the supplier or even employees of the supplier.  Potential problems of this type should be managed by including language in policies or supplier agreements that expressly deny that anything therein is intended to create duties to and rights in favor of third parties.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (Fall 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

Extending Compliance Programs to Suppliers I

An issue that is coming up more frequently in the context of vendor relationships is whether or not the purchaser should insist that its vendors and other parties involved in the supply chain process should be subject to specified elements of the purchaser’s own global compliance rules and procedures.  It is clear that with increased use of rapid communications technologies and sophisticated logistics tools, companies are becoming more dependent on the skills and actions of outside firms and persons who are not their employees.  As such, it is understandable that companies may be concerned about whether their domestic and foreign partners are adhering to ethical principles and obeying applicable laws.  However, before extending the scope of their compliance programs to their suppliers companies must carefully evaluate the legal consequences associated with that decision, including the possibility that they will be held responsible for liabilities arising from supplier legal problems, and also consider possible adverse impacts to their image and reputation.

Potential legal liability for the conduct of others, including firms in the supply chain, may be based on a variety of common law theories, court decisions and statute-based rules:

• Companies are increasingly vulnerable to expansion of common law principles of “respondeat superior” that could lead to liability for actions of suppliers who are deemed to have become “agents” of their customers by virtue of the duties that they undertake and the benefits derived by their customers.
• Liability for illegal actions of third parties may occur under the Foreign Corrupt Practices Act of 1977, which makes it unlawful for a company to make a payment to a third party while knowing that all or a portion of the payment will go directly or indirectly to a foreign official for the purpose of influencing the official in his decision-making capacity.
• The Sentencing Guidelines for Organizations (the "Guidelines") have attempted to create real incentives for corporations to establish and maintain an "effective compliance and ethics program" as a way to identify and respond appropriately to misconduct and mitigate sanctions for such misconduct that might be imposed by governmental agencies.  In its definition of what constitutes an effective compliance program the Guidelines call for (i) communicating company compliance standards and procedures to agents and providing training therein to agents about their roles and responsibilities; (ii) establishment of a publicized system that allows agents of the company to report misconduct anonymously or under protection of confidentiality; and (iii) encouragement by larger companies to their smaller business partners that such partners implement their own effective compliance and ethics programs.
• The Sarbanes-Oxley Act of 2002 effectively requires audit committees of public companies to establish procedures for confidential, anonymous submission of concerns of accounting-related misconduct that are broad enough to be known, and accessible, by non-employees.
• The voluntary Guidelines for Multinational Enterprises promulgated by the Organization for Economic Cooperation and Development includes a strong recommendation that companies actively encourage their business partners, including suppliers and contractors, to establish and adhere to principles of corporate conduct that are consistent with the Guidelines.

In addition to these specific legal considerations companies are also becoming increasingly sensitive to how the business practices of their partners, particularly foreign vendors, may reflect on how they are perceived by regulators, customers and investors.  For example, US companies have come under strong criticism when it is disclosed that they have used overseas suppliers that have used child and/or forced labor in their manufacturing activities on behalf of their US customers.  In light of how the business conduct and practices of third parties can expose companies to legal liability and/or have an adverse impact on their image and reputation it comes as no surprise that they are considering and implementing various strategies for making sure that the rules and principles in their corporate compliance programs are applicable to their business partners (i.e., suppliers and contractors performing various activities such as customer service and maintenance).  I’ll describe some of those strategies in my next post.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (Fall 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

Tips for Successful Joint Product Development with Customers

In my last post I began discussing the advantages and disadvantages that should be considered by manufacturers when they contemplate a joint development arrangement with one of their customers.  Assuming some sort of joint development project with a customer makes sense here are some simple suggestions for making sure that the project has the greatest likelihood of success:

1. The manufacturer should be prepared, and eager, to open up its day-to-day operational activities to the customer and provide the customer with an opportunity to carefully scrutinize and evaluate the way in which the manufacturer approaches each key issue in the development process.  For example, the manufacturer should show the customer each of the steps that are taken in order to ensure an adequate level of quality control during the manufacturing process in order to build trust with the customer and provide the customer with a chance to suggest improvements.
2. Both parties should come up with ways to assist the manufacturer in gaining a better understanding of the challenges that the customer faces when attempting to market and sell its finished products, including the products that are being jointly developed.  Representatives of the manufacturer might accompany the customer on visits to end users of the customer’s products.  In fact, this sort of due diligence is best done well before the specific goals and objectives of the joint development project have been established since the knowledge gained might lead to unexpected and highly innovative ideas about what might be done by the manufacturer.
3. The level of integration and collaboration between the parties (i.e., just how “joint” the development process will be) must be aligned with the risk, complexity and expense of the chosen project.  Challenging joint development projects that are focused on developing new products and technology, as opposed to creating features that amount to relatively minor enhancements and improvements to something that has already been conceived, must be supported by frequent interaction and communication with customer representatives including ongoing feedback that ensures that the manufacturer remains on the right track and that the customer will be satisfied with its investment.
4. A real serious attempt should be made to develop two-way communication between the manufacturer and the customer that encourages and facilities the continuous exchange of ideas between the parties even when there is no current project underway.  For example, if the manufacturer learns of an idea that it thinks might interest the customer the manufacturer should share the thoughts with the customer even if the communication has not been solicited.  While the customer may not be interested in the specific idea it may lead to something different that eventually becomes a solid concept for formal joint development planning.
5. Intellectual property rights that will be used in and/or created by the joint development project should be identified in advance and clear rules should be established for allocation ownership and usage rights for such intellectual property.  The manufacturer should be mindful of the risks associated with sharing its proprietary technologies that serve as the foundation for its core competencies.
6. Each side of the relationship—manufacturer and customer—should actively build and maintain a team of dedicated and enthusiastic scientists, engineers and marketers that remain committed to joint development activities for as long as the parties are willing and able to formally collaborate.  Many joint development agreements include an undertaking to establish a new project review committee with representatives from both sides that will be periodically to vet and approve new development projects and discuss the overall progress of the relationship.  Whenever a project is underway both parties should be required to appoint project managers, engineers and other skilled professionals who will be allowed to invest the necessary time and effort outside of their other responsibilities to ensure that the project is successful.  The team members from each side should regularly visit with their colleagues at the other party.  For example, representatives from the manufacturer should visit the customer to learn more about how products under development will be used and/or marketed by the customer.  In turn, customer representatives should go to the manufacturer’s facilities to conduct tests on new products while they are a “work-in-progress” so that the manufacturer can receive timely and thorough feedback on product quality and performance.

The content in this post has been adapted from material that will appear in Joint Ventures and Strategic Alliances (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

Working with Customers on Joint Development Projects

Manufacturers engaged in intense competition with other firms for customer business are well advised to look for ways to become true development partners with their prospects as opposed to simply being just one of several potential vendors.  Rather than approaching customers with a standardized sales pitch to buy generic products and services manufacturers should seriously consider opening with a serious and sincere proposal to collaborate directly with the customer to create new products and services that are unique and specifically suited to that customer’s requirements and sales and marketing objectives.  If there is interest the parties can move forward with a joint research and product development project that involves the contribution of ideas, feedback and financial and technical resources from the customer to support the manufacturer’s efforts to create new products and technologies in which both parties will have an ownership interest of some sort at the end of the initial collaboration. 

Working with customers on joint development projects can be advantageous for several reasons.  First, assuming that the customer is willing to contribute toward some of the costs of developing new products and technologies a manufacturer can use these types of relationships to maintain and even enhance core competencies in the research and development function without diverting budgeted funds from other functions or attempting to obtain new capital that might dilute ownership stakes and management control.  Second, the manufacturer will be given a valuable opportunity to learn about how the customer operates and the way in which customer views its relationships with vendors and the needs of its own customers.  This type of information has value beyond the specific customer relationship since it provides the manufacturer with greater insight into the overall business environment in which it is operating.  Third, while the manufacturer’s main challenge is demonstrating its expertise in product development to the customer the relationship should also be a platform for the manufacturer to showcase its skills in other operational areas such as logistics and marketing with an eye toward the possibility of an expanded alliance at some point in the future.  Finally, if the customer is willing and required to invest significant time and other resources in the development phase there is likely to be a much higher level of commitment from the customer to make the finished product commercially successful and this will hopefully translate into a stronger long-term revenue stream for the manufacturer.

There are, however, corresponding risks and disadvantages that also need to be considered by manufacturers before joining forces with a customer.  For example, smaller manufacturers need to safeguard their core technology and bargain for reasonable rights to use and exploit intellectual property that is created during the joint development relationship.  If care is not taken in this area a larger customer will simply appropriate whatever technical know-how is available from the manufacturer and let the relationship lapse.  The manufacturer should also be sure that the customer is able and willing to fulfill commitments made by the customer to support the development work.  If promised funding does not appear or the customer withdraws personnel and other resources during the project the chances of success diminish and the burden on the manufacturer will suddenly increase.  Another challenge for the manufacturer is making sure that its functional resources, including personnel and equipment, are strong enough to withstand the scrutiny that will come from attempting to work closely with a customer and give the customer open access to the day-to-day operational activities.  If the customer uncovers weaknesses in important areas, such as quality control, it may abandon the project and remove the manufacturer from its vendor list even for generic items.

In my next post I’ll try and provide some simple suggestions for increasing the chances of successfully completing joint development projects with customers.

The content in this post has been adapted from material that will appear in Joint Ventures and Strategic Alliances (2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

Achieving Success as a US Manufacturer

Bring It Home, an article that appeared in the September 2007 issue of Entrepreneur, included research data that indicates that domestic entrepreneurship in the manufacturing area is up even as total manufacturing employment in the US continues to decline.  The article provides a few tips on launching and maintaining a successful US manufacturing business even as foreign firms in China and elsewhere continue to use their low-cost labor advantages to erase the smokestacks that drove US economic growth in the late 19^th Century and through most of the 20^th Century.  Interestingly, while manufacturing skills are obviously important, the winners are likely to be those firms that are able to package and market some of the specific advantages of using an onshore production partner.

Since many schools are focusing on training service-oriented graduates, recruiting skilled production workers and manufacturing managers can be challenging; however, the flip side is that since there are fewer domestic firms looking for such employees the competition in the labor market is less intense.  The key is to focus in on schools that continue to offer manufacturing-related training programs.  As for managers, companies should explore bringing in experienced hands from larger firms that have decided to shut down US operations in deference to foreign competition.

With larger manufacturing firms shutting down, smaller new companies often find there is little or no domestic competition in their particular geographic area or industry sector. As such, these companies can offers themselves as a unique, local alternative to distant foreign manufacturers and focus on building personal relationships with the customer.

By being “local,” US manufacturers can quickly learn the specific requirements of their customers and position themselves as being the best solution for customized items and quickly implementing new designs.  The ability to provide quick turnaround, in relation to foreign manufacturers, is a tremendous value proposition for US companies that often can win the business at higher prices that customers are willing to pay for responsiveness.

Fledgling manufacturers would do well to focus on niche markets that the competition prefers to ignore.  For example, the best strategy may be to concentrate on small- to medium-sized customers that require customization and avoid markets where cost is the primary factor or larger customers that require high volumes that would exceed the relatively modest production capabilities of an emerging US manufacturer. 

US manufacturers can add value, and enhance their profit margins, by importing raw and semi-finished materials from low-cost foreign suppliers and then integrating them into the customized finished products that they sell for their US customers.  The customers will be willing to pay a premium for having someone else deal with the uncertainties of working with foreign vendors.

In order to convince US customers to “buy USA,” domestic manufacturers need to create and execute a solid marketing program that communicates the specific advantages of working with a local firm.  As noted above, building and maintaining strong relationships with key customers is essential and clearly distinguishes the domestic firm from a foreign competitor that is rarely seen in person.  Post-sale support and strong warranty service are also important “value adds” that can win a bid and seal a long-term business partnership.