Improving and maintaining supplier performance is an important topic for global purchasing professionals. There is a continuum of approaches and tools that can be used including use of penalties and or incentives. A recent Linked In discussion on the topic of supplier penalties resulted in global interest and comment and this is a summary of many of the observations,

1. How Should Suppliers be Penalized
for Late Deliveries or Poor Quality?
A recent Linked In Discussion generated
a massive amount of response by Global
Purchasing Professionals. The following
is a summary of the discussion.

2. Global Purchasing Professionals Agree:
“Late delivery and poor quality destroys brand
equity and customers satisfaction index in the
supply chain continuum.”
Steve Ighorimoto
Director of Logistics-East & Central Region at NBC(Coca-Cola Hellenic Nigeria)

3. Main Discussion categories
• Assumptions for Using Penalties
• Can They Be Used
• Should penalties be used
• Alternatives to Supplier Penalties
• Suppliers Point of View
• Framework for How to Use Penalties
• Specific Penalties or Incentives

4. Assumptions for Putting Penalties in Place
• Buyer and Seller relationship has adversarial element
• Buyer has given seller clear expectations
• Seller delivery and/or quality problems are the result of
their problems.
• The failure of the Seller to meet the Buyers expectations
has resulted in actual and measurable damage to the Buyer
• The Seller values the potential of ongoing relations with the
Buyer enough to consider payment of a penalty

5. Can Penalties Be Used
• Concept of penalty's beyond actual cost of item
purchased are legally difficult to enforce
• The extent of damages is limited to actual
damages
• If pre negotiated and agreed to then liquidated
damages may be enforced.
• What good will a penalty bring to you and your
customers if you will have to face consequences,
not providing at the exact time table

6. Should Penalites Be Used
• Late deliveries and Poor quality are the
symptoms and not the root cause
• Service has evolved over the last decade The
bottom line is that you are paying the bill, and
if the service or product you received is not
what you agreed, you need to negotiate the
invoice.

7. Should Penalty Clauses Be Used
Yes
• With Non Critical Suppliers
with many options
• Where there is No trust is
Buyer Supplier relationship
• Determination of problem
cause not important
• Certified Supplier
• If mutually agreed to as
incentives in a collaborative
relationship
No
• Critical Supplier with no option
• Supplier Relationship is important
• Problem Root cause is important
• Un Qualified Supplier
• On-boarding a new supplier is
expensive, and the cost to switch
is high too.
• Helping the supplier is a good
gesture and this can transform
into a bargaining chip when the
contract is due for renewal.

8. Alternatives to Penalty For
Consistently Poor Performing Supplier
• Introduce a system of vendor rating for fairness
and transparency.
• Exclude them from your approved list of suppliers
• Collaborative root cause analysis
• Timely planning reviews and call off strategies to
solve late delivery problems
• Continuous vendors evaluation stage as part of
the company procurement risk mitigation
process.

9. Alternatives to Penalty For
Consistently Poor Performing Supplier
• Going out there and meeting your suppliers on a
regular basis
• In addition to the initial qualification audit,
suppliers' capabilities should be verified within a
certain frequency (i.e. once in every 3 years or so)
by conducting "reinstatement audits
• Conduct product-specific "delivery capability
audits" to determine suppliers' readiness and
capability to commence volume production for
NPI products

10. Suppliers Point of View
• Anytime you have a penalty it should also include a
bonus clause for performance as well.
• I have no issues with accepting a order with penalties
but that order should also include performance
bonuses.
• Supplier is only as good as the suppliers rep on your
account. If your rep is hands on and follows your orders
through from start to finish poor quality and late
deliveries are virtually eliminated.

11. Suppliers Point of View
• It is vital that there is both Carrot as well as stick.
Suppliers should be rewarded for excellent
performance as well as penalized for poor
delivery
• Be wary of where you stand in your suppliers
eyes. A single supplier may be critical to your
supply chain but are you critical to their
turnover? Talk of penalties may just leave you
high and dry quicker than you think.

12. Suppliers Point of View
• Quality Issues can be down to the standard of
raw materials that the supplier is using
(probably to ensure they can supply at the low
cost you've already hammered them down to)
• If you know a supplier struggles to deliver on
time, try to discuss a more realistic lead time
to avoid delays.

13. How they Should be Used
• Differentiate between Critical and non critical
suppliers
• Trust levels with the supplier have to be the
highest, which will allow you to incorporate
the late delivery or so called penalty clauses
with mutual agreement.
• how to get the peanalties caused by the late
delivery or quality from the not certified

14. How Should They Be Used
• Add clauses pertaining to penalties for late
deliveries or poor quality in your RFQ
• Key is to make sure you're on the same page
about the expectation - ie delivery date,
quantity or quality
• Include in your SLA'S (Service Level
Agreements) penalty clauses dependent upon
criticality of goods service

15. Specific Actions with a Poor
Performing Supplier
• Delay Payment until Acceptance.
• Require a deposit from the supplier
• Develop alternative suppliers
• Switching suppliers next order to low
value/low margin items.
• Closed loop process in which deficiencies in
performance from the capability shown in the
original audit are reexamined through a new
audit

16. Specific Actions
• Set up a mechanism/system that improve your
suppliers' performance in which penalty is
portion of the procedure?
• Set up the process of quality and delivery
issues upfront and be confident that supplier
can financially handle the penalty

17. Performance Incentives and Penalties
• Contract with the supplier that each week delay
is a certain % of money deduct from the final
balance
• 50% in advance and 50% upon acceptance on
delivery. If everything is ok we issue the 50%
balance, if not we adjsut the parts or we reject
them and we give less money to the supplier. Of
course the supplier wants proof, so you should
make a report and able to open a discussion with
the supplier.

18. Performance Incentives and Penalties
• Have supplier make all future shipments to
you at his expense over night next day
delivery
• Pass on any late fees you incur by your
customer
• 2% per week penalty to purchase orders
• Holding at least 50% of the total amount while
working on the root causes with OEMs

19. Performance Incentives and Penalties
• Payment deduction rules on purchase
agreement's, there should be % of payment
deduction agreed by supplier.
• Add a clause stating "for subsequent orders, in
case of quality or delivery issues vendor will pay
all expenses for buyer "man-in-plant" if quality or
delivery does not conform to original agreement.
Duration of man-in-plant is negotiable

20. Performance Incentives and Penalties
• Quality damages for production items:
– issue discovered at incoming inspection has a true
total cost of 10X the value of the part.
– A defect that is discovered in production test incurs a
penalty of 50X the value of the part
– A defect that manifests itself in the field should incur
penalty of 100x the cost of the item.
The exact multiplier can be debated but the idea is to encourage delivery
of good parts and recognizes that latent defects cost more.

21. Summary
• Improving and maintaining supplier performance is an
important topic for global purchasing professionals.
• There is a continuum of approach's to supplier
management ranging from adversarial penalty based to
collaborative based using formal continuous
improvement methods.
• There is general agreement regarding the importance
of qualifying suppliers, sharing expectations upfront,
monitoring supplier performance and having a process
to address issues