Strategic Contracts: Clearly Defined and Measurable Desired Outcomes

(Editor’s note: Inside Supply Management^® Weekly recently published “Implementing a Successful Supplier Sourcing Contract” that highlighted why strategic supplier relationships need to use every tool in the contracting tool kit. This article is the fourth in a series that explores each of the 10 elements that craft successful buyer-supplier contracts, as highlighted in the book, The Vested Outsourcing Manual.)

By Kate Vitasek

Vested’s Rule No. 3 for creating a Vested agreement directs the parties to clearly define and measure their desired outcomes. There are two contractual aspects when it comes to how an organization should do this. Element 4 deals with the actual performance metrics, and Element 5 pertains to how the parties will manage ongoing performance.

Recall the definition of a desired outcome — a desire is something a buying organization wants and does not have, and outcomes are typically boundary-spanning business accomplishments that can be achieved only by working in collaboration with a strategic supplier. A simple way to think about this: In a highly strategic win-win Vested agreement, the parties are buying the future, not just measuring activities or service level agreements (SLAs) for the supplier’s performance.

Creating Well-Defined Desired Outcomes

A well-structured Vested agreement focuses on the few critical metrics linked to the desired outcomes, which typically are five or fewer in number. Creating well-defined and measurable desired outcomes depends largely on clear thinking and accurate answers to two essential questions:

●What are the results needed from the relationship?

●How will the parties know when they get the needed results?

Under Rule 3, the parties collaborate to answer these questions, taking care to ensure the metrics they pick clearly define and measure success against their desired outcomes, versus simply relying on SLAs and operational measures.

A key part of implementing Element 4 is to further describe the outcomes and statement of objectives by aligning the parties — or the targeted level of performance for each of the objectives — on a performance statement. This can be done by using what University of Tennessee researchers call a “requirements roadmap,” which links strategic objectives and associated KPIs. The chart below is an example of a how one company used the requirements roadmap to develop metrics with a third-party logistics (3PL) provider of food-grade distribution services.

In the example, the first KPI is to reduce warehouse damage and the second is to improve performance on a regulatory audit for food-grade warehouse quality. Warehouse damage had historically been a big issue, resulting in a profit loss. The company and service previously had blamed each other, with the company claiming it was the 3PL’s fault, and the 3PL claiming poor packaging.

When taken together, the desired outcomes and associated KPIs represent a broad set of success factors, regardless of which party is accountable for discrete activities. The big shift in a Vested agreement is that the company and supplier are now jointly accountable — and commit to work together on root cause analyses in a no-blame culture.

Don’t Drive Blind

A general rule of thumb is to have 10-12 total KPIs that align with the desired outcomes. In so doing, parties will avoid a common pitfall — “driving blind disease,” resulting from not having a formal process that monitors the relationship performance. Companies commonly make this mistake by never aligning their metrics with the bigger picture purpose.

You might be wondering about day-to-day activity-level measures. Simply put, these lower-level metrics can be important, but they are operational in nature and best suited to be treated as “data” and not a measurement to live and die by.

Also, most buying organizations fail to realize that suppliers (who are responsible for the work) often are already measuring operations data at low levels to run their business. Changing the mindset so the buyer and supplier see operational metrics as operational data and use them for root-cause analysis can be a breath of fresh air in helping drive a more collaborative relationship.

When the parties take the time to institutionalize a no-blame root-cause analysis culture, it’s not uncommon to realize a supplier’s issues stem from input failures caused by the buyer. A case in point is the construction industry, where, according to research by Arizona State University’s Performance Based Studies Research Group, more than 90 percent of issues have a root-cause analysis with the buyer.

The next article in this series explores Element 5, which examines the importance of establishing a mutually agreed upon performance management framework and process.

Kate Vitasek is an international authority on the Vested business model for highly collaborative relationships. She is the author of six books on the Vested model and a faculty member at the University of Tennessee in Knoxville, Tennessee.