A Performance Measurement Framework for Supplier Relationships

A Performance Measurement Framework for Supplier Relationships Dr Mihalis Giannakis Warwick Business School, Coventry, UK Abstract This paper develops an analytical framework for assessing the performance of supplier relationships (SRs) based on gap analysis. The majority of performance measurement models incorporate hard quantitative measures that are not appropriate for the soft and elusive features of business relationships. As they are usually designed by the customer organisation, they are imposed on suppliers, do not take into account the relationship as a unit of analysis and therefore they carry a bias in their interpretation.

INTRODUCTION In the broad business and management, economics and accounting literatures it is widely accepted that a prerequisite for a successful implementation of the corporate, business and operations strategies of an organisation and for any improvement initiative is the use of a reliable performance measurement system. Being such a fundamental issue of management of organisations, performance measurement has been one of the main concerns for managers and academics. The Operations Management literature on performance management suggests that performance should be always measured against benchmarks (Slack et al. 2001). These could be either:

 Historical Standards - Measure against previous performance  Target Performance Standards - They reflect some level which is regarded as appropriate or reasonable  Competitor Performance Standards - Compare performance against competitors  Absolute Performance Standards - It takes performance on theoretical limits.

Traditionally many of the performance measurement systems were designed within the academic discipline of accounting since the main strategies of organisations for many decades was price competition and cost reduction (at least in the western world) (Hayes et al. 1988). These models have been criticised as being one-dimensional and simplistic (Johnston and Kaplan 1987), having an effect in motivating managers to behave opportunistically (Emmanuel et al. 1990), and being short-term oriented and backward looking (Van Looy 1999). Kaplan and Norton (1993) for example state: “While today’s financial results are the results of yesterday’s performance they are poor indicators of tomorrow’s success” In that direction Kaplan and Norton (1992) provided a balanced scorecard (BSC) framework that integrates operational, financial and customer satisfaction perspectives to measure the performance of organisations. Based on the BSC several other integrated frameworks were developed; one of the most notable is the European Foundation for Quality Management Quality Award (EFQM) which also takes a balanced approach to measuring performance by looking at various types of performance as well as financial performance. The major strength of these frameworks is the integration of all the possible factors that could influence performance. Despite their usefulness and success however, these frameworks do not take into account the ‘externalisation’ of the operations management discipline as their focus is the organisation itself. In the operations management literature historically performance measurement focused on assessment of internal processes such as machine utilisation, machine reliability, employees productivity, inventory turnover etc. As every academic discipline in the business & management studies, Operations Management has experienced major changes over the last 50 years, reflecting the changes in the economic and business environment. Driven by the rapid changes in Information Technology that enabled more effective communication between business and the competitive globalised environment that brought about the emergence of new forms of inter-organisational relationships (Giannakis et al. 2004), operations management became Inter-Organisations Operations Management with a focus on issues that cross the organisational boundaries and performance measurement systems were transformed accordingly to reflect these changes1. In the early 1990s performance measurement models started emphasising the link between internal (operations) and external (operations) performance (Slack 1991), in terms of general operational dimensions as cost, speed, quality, dependability and flexibility which customers could value. The ‘customer perspective’ in performance measurement for example which is reflected in the marketing and relationship marketing literatures (see for example (Parasuraman et al. 1988) has been adopted in the operations management and service management literatures (Schonberger and Knod 1994), with the realisation that the service provided to customers can be used to improve operations performance. New performance systems have been developed with an emphasis on the ‘soft’ dimensions of operations management such as effective supplier relationship management. An underlying (implicit) assumption in this paper is that effective relationship management is an enabler of effective operations performance. By developing a framework for the assessment of supplier relationships its aim is to provide some direction and launch a research agenda in improving operations and supply chain performance. The paper is organised in four sections. The first section discusses various models that have been used in measuring supply chain performance that originate from the operations management, service marketing, and strategic management literatures, to identify those dimensions that are considered pertinent to the measurement of relationships’ performance in this study. In the second section a framework for the conceptualisation of the nature of SRs is developed, utilising several dimensions and levels of analysis and in the third section the proposed framework is presented. Finally the fourth section the implications to operations practice as well as future direction for research is discussed. SUPPLY CHAIN PERFORMANCE MEASUREMENT

1 The natural evolution of this shift in focus has been the emergence of the new Supply Chain Management discipline. The transformation of the Operations Management discipline into Supply Chain Management is reflected in the number of papers presented in the Operations Management conferences across the globe, in which the number of articles that refer to supply chain phenomena has increased dramatically over the last 20 years. In the literature there is a profusion of studies that discuss performance management systems and metrics across several areas of supply chain management (SCM) (Beamon 1999). One of the most commonly used performance management systems design to assist companies to improve their supply chain operations is the Supply Chain Operations Reference-model (SCOR) model introduced by the Supply Chain Council. It is a process reference model that defines and assesses performance objectives across four supply chain management processes (plan, source, make, and deliver), matching them against best practices across several industries2. The SCOR model has become a standard performance and improvement system for several industries worldwide. As the balanced performance measurement frameworks for Operations Management, despite the fact that it reflects a wide array of processes and activities of SCM phenomena it does not focus on one of the fundamental objectives of SCM; the harmonisation of contrasting interests and objectives of different actors in a supply network with the objective to improve the supplier relationships (Giannakis and Croom 2004). SRs have attracted considerable attention in the (SCM) field over the past few years. To some extent, this is the corollary of the emergence of new forms of organisational structures that was accelerated by the latest technological, political and demographic changes in the global marketplaces. It is widely acknowledged today that business performance improvements (both financial and non-financial) that result from close buyer-supplier relationships are significant and indisputable. The automotive industry in particular is full of anecdotal and documented evidence of such success stories that evangelise closer more co-operative relationships between suppliers and buyers, emanating from the immense success of the Japanese car manufacturers in the ’80s (see for example Helper 1991; Helper and Sako 1995; Dyer and Chu 1997). Most of these studies however do not directly examine the performance of the relationship per se, but the effects or the outcomes of their effectiveness. Although the closeness of the relationship and the effectiveness or efficiency of operations are clearly related (see for example Zaheer et al. 1998; Kumar 1999), outstanding organisational performance (operational or financial) is not necessarily an outcome of a close relationship. In the press and academia there are many examples of close strategic partnerships that did not yield the desired outcomes for organisations (Bleeke and Ernst 1993; Ramsay 1990; Ramsay 1996). As an outcome, there is an increasing recognition of the importance of measuring the performance of this type of business relationships3 (and their impact on organisational performance) because of the increased dependency between parties (Babbar and Prasad 1998). The majority of research in measuring relationship performance, perceives supplier relationships as being composed by monolithical entities as firms. A thorough review of the literature in business relationships though (Hakansson and Shenota 1995; Ebers 1997)

2 http://www.supply-chain.org/html/100496.htm 3 The term business relationships has been used in the various literatures synonymously with the term Inter- organisational Relationships (IORs). In this paper IORs will refer only to relationships that cross the boundaries of an organisation in order to distinguish them from other forms of business relationships that developed within an organisation. In that sense our term business relationships describe both Intra and IORs, although it is acknowledged that many authors use the term IORs to describe intra-organisational relationships as well. can reveal that business relationships are extremely intricate constructs that are developed through systems (or networks) that are not always the same as entire firms. It is in fact groups of individual managers, or departments that interact and form these relationships. The performance of SRs is a contentious issue that is very much under-researched in the management literature. Performance is often difficult to measure because of the dynamic (and sometimes chaotic) behaviour of SRs, their elusiveness and the inherent complexity in their nature and outcomes. In situations where pre-set targets are met, outcomes can easily identified and assessed using any of the benchmarking measurement systems prevalent in the performance management literature (e.g. the balanced score-card). However in most real life cases outcomes are difficult to define and thus to monitor. For example, the level of trust between actors in SRs (as discussed earlier) may be considered as an outcome (as well as a structural variable) of a relationship, and is so elusive that is very difficult to identify and monitor. Harland (1996) posits that most performance measurement systems incorporate hard quantitative measures that are not appropriate for the soft and elusive features of relationships. Lamming (1993) also contends that these measurement systems are usually designed by a single organisation and thus do not take into account the relationship as a unit of analysis. Finally, given that these models are usually designed for a customer organisation, they are imposed on suppliers and therefore may carry a bias in their interpretation. Without a clear method for defining the performance criteria of a particular relationship, a potentially beneficial relationship for an organisation could be neglected. In the strategic management and marketing literatures, relationship performance has been assessed for example by measuring the degree to which objectives have been achieved, and using managers' perceptions of the relationship effectiveness (Heide and John 1992). Bucklin and Sengupta (1993) define relationship performance as the “extent to which both firms are committed to the relationship and find it to be productive and worthwhile”. Other scholars have measured the performance of a SR using quantitative measurements, in terms of the gains or benefits a company achieves in comparison to the costs invested, using financial and non financial measures (including operating performance, learning outcomes, expenditure and goal attainments) (Clifford 2000). As the paper deals with the performance measurement of SRs, it is faced with two conceptual challenges. Firstly, a framework that conceptualises the nature of SRs needs to be adopted or developed. Secondly, the variables which characterise the SRs need to be defined in such a way for it to be operationally feasible to assess. CONCEPTUAL FRAMEWORK Nature of SRs Given the lack of a unifying theoretical framework that addresses issues regarding the synthesis of SRs and synergistic collaboration between partners, a framework that classifies the nature of SRs according to two typologies is developed: one based on their level of analysis and one based on their genesis and development. Its underlying principle is that it views SRs as evolving processes of collaboration, rather than abstract entities created by collaborating parties or any form of governance structure. Levels of analysis of SRs: The first typology considers the level of complexity of SRs processes. Inspired by the interaction approach of the Industrial Marketing and Purchasing group that acknowledges SRs as intricate constructs developed through systems that are not always the same as firms, SRs are considered as developing between the individuals involved in the exchange (inter-personal level), between business units from the same or the partnering organisations (inter-departmental) and between entire organisations (inter-firm). It is reasonable then to assume that a SR is an extension of inter-personal and inter-departmental business relationships. Despite the fact that most SRs involve three or more members for the sourcing, making and delivery processes, as well as the use of the product or service that is exchanged, most of the studies in the SCM literature examined the dyadic relationships between two adjacent organisations (Croom et al. 2000). It is contended furthermore in this paper that the triadic level is more accurate in analysing SRs in cases where the direct consumers/users of the product/service exchanged are internal departments of organisations. Development of SRs: The second typology considers three distinctive phases of SRs’ genesis, establishment and development. SRs are conceptualised in terms of three dimensions which inform their structural and procedural characteristics, namely the pre- contractual, institutional and operational dimensions.  Pre-contractual dimension: The pre-contractual dimension refers to the factors that lead organisations to engage in SRs and factors that condition the selection of potential partners. In this paper the external factors which may initiate or deter the formation of such relations which are proposed by Oliver (1990) are adopted. These factors involve the necessity of an organization to acquire resources another organization which does not possess, the asymmetry between organizations that implies the potential of an organization to exert its power over other organizations, the reciprocity between organizations which refers to the aim to have mutual advantage or the aim to share mutual risk, the drive for efficiency which refers to the objective of improving organizational performance, the drive for stability which refers to the desire to minimize the effects of environmental uncertainty and the drive for legitimacy, to conform to the prevailing norms and values imposed by the institutional environments in which the organization is embedded. Institutional dimension: The institutional dimension refers to the establishment of the SRs and the distribution of rights amongst the partners. Institutional characteristics therefore can be seen as determining the setting up of an appropriate governance structure for the SR. The governance structure of a SR encompasses contractual and non- contractual binding agreements between the partners in the SR. Contractual commitments involve legal issues such as selection of the legal form governing the SR (e.g. partnership or strategic alliance), the appropriate type of contract and contractual safeguards to determine the extent to which partners will be bound to the agreement. It also involves the delegation of roles and responsibilities of the parties, such as formal or informal definitions of the decision rights between the involved parties. Non contractual agreements may consist of agreements in spirit of fellowship to devote managerial expertise, or to provide unconditional help to the partners. The choice of the most appropriate governance structure is regarded as an important dimension in structuring SRs as it prefigures the setting up of operating procedures of the SR (such as the monitoring) and may help to resolve potential disagreements among the partners.  Operational dimension: The characteristics of the operational dimension of SRs (i.e. the interaction processes) refers to the actual exchange of resources between the partners. This defines how organisations co-ordinate their activities and how they interact within the arrangements agreed through the institutional characteristics. The way that this interaction amongst the partners takes place can be understood by looking at the frequency of transactions, the frequency of communication, the number of operations shared between the partners, the level of personal contact, and the number of people involved in the SR. More importantly however the examination of the way that managers conduct certain activities in their everyday life can provide a more accurate realisation of the degree of coordination amongst the trading partners. Variables that characterise SRs SRs can be characterised and assessed in terms of four ‘high rank’ (structural) variables that have been extensively used in several theoretical models of SRs and are considered as fundamental elements of any business relationship: their contribution to the development of trust between the trading partners, the level of power they possess in decision making, their involvement to the SRs, and their contribution to the development of commitment to the SRs. As these four ‘high rank’ structural variables are complex constructs that are difficult to assess, they are broken down into lower, measurable variables that are easier to identify and assess (Table 1). Each of the structural variables can be considered in this sense to be dependent on and determined by a set of second rank variables.

Trust Calculative: Actors would act in a trustworthy fashion only because it is in their self-interest to do so Cognitive: Arises on the grounds of common cognitions amongst the involved parties Normative: Characterised by a mutual understanding of expectations and responsibilities of the involved parties based on industry or societal norms (comply with organisational culture, honesty and openness) Trustworthiness: Characterised by keeping promises and having confidence in partner Power Authority: Responsibility for taking decisions and issuing orders Control: Arises from access to critical resources that give contextual pertinence to those that hold them Influence: Indirect dimension of power arising from centrality in a network of actors and not Involvement Complexity: Refers to the level of intricacy of a SR (number and level of individuals involved) Scope: Refers to the amount of resources devoted and the capabilities that are transferred between the partners Intensity of Interaction: Refers to the quantity of information exchanged between the parties, the personal contact and spatial proximity between the actors, and the early input of suppliers in a customer’s projects Commitment Effort: Refers to the propensity of the partners to continue their business relationship Loyalty: Refers to both repeat interactions and attachment to the trading partner Length of SR: Primarily refers to the length of a contract agreed Table 1 – Second rank variables

These second rank variables can be assessed by analysing the way that the managers that participate in the SR handle/implement/manage certain factors that determine the nature of the SRs and conduct certain activities (with regard to the management of SRs). The proposed conceptual framework for the nature of SRs is presented in Figure 1. Its rationale is that to assess the performance of SRs, the levels of trust, power, involvement, and commitment that they exhibit need to be identified. These variables are determined by the activities they conduct in the SR, which are accordingly influenced by the adjusting and initiating variables of a SR.

Pre-contractual Phase Institutional & Operational Phases Structural Variables Role in SRs Trust Initiating Variables Adjusting variables Calculative trust Cognitive trust Normative trust

Necessity Power Elements & Authority Asymmetry processes of Control interaction Institutional Influence Reciprocity Pre-Contractual Activities Activities Collaborating Parties Operational Involvement Efficiency Activities Environment Complexity Scope Stability Atmosphere Intensity of Interaction

Legitimacy Commitment Effort Loyalty Length of SR

Figure 1 The nature of Supplier Relationships

RELATIONSHIP PERFORMANCE INSTRUMENT In the discussion of the relationship performance literature it was revealed that the perceptions of managers of the relationship with their trading partners and of the relationships that the (department) organisation they work in and the supplier/customer organisation (department) can be used to define as the unit of analysis to assess the performance of the business relationship. Based on this principle the proposed model for measuring business relationships takes two general assumptions.

 In order to capture the multiplicity of the social networks in which the relationships are embedded it takes a social network theory assumption that organisational relationships are the intricate mesh and extensions of individuals' relationships (Scott 2000) and  The managers' perceptions of the nature of the relationship and the performance against the factors that determine it carry the same weight.

Similar to the Gap model the performance of the SR is measured in terms of the disparities between a party's perception of:

 The nature of the relationship, and its partners' perception of the nature of the relationship in terms of the importance of the factors that constitute it.  The nature of the relationship and their perception of their actual performance in the relationship.  The nature of the relationship and their perception of their partners' performance in the relationship.  Their partners' performance in the relationship and their perception of their own performance in the relationship.  Their partners' performance in the relationship and the partners' perception of that party's performance in the relationship.  Their performance in the relationship and partners' perception of their own performance in the relationship.  Their performance in the relationship and the their partners' perception of that party's performance in the relationship.  Its partners' performance in the relationship and the partners' perception of their performance in the relationship.

An organisation's perception of the relationship with another organisation is defined as the combination of the individual managers' perceptions of the factors that could affect the relationship. The performance of the relationship will high when the gaps are small. The model is presented in Figure 2 and is referred to here as the RelPerf model.

Customer's Supplier's perception Gap 1 of nature of perception of relationship nature of relationship 5

G p Supplier's perception Customer's perception

a Gap 8

G of customer's

of supplier's performance to the performance to the 2 relationship relationship 7

Customer's Supplier's perception of perception of their their performance to the performance to the relationship Gap 9 relationship

Figure 2. Framework for measuring performance of relationships (PerfReL)

Explanation of the gaps in the Framework Gap 1: This gap measures the difference in the perceptions of the nature of the relationships that the two actors have, in terms of the importance of the factors that constitute it. This mismatch indicates the disparity in the expectations that the two parties have from the relationship they are engaged in. For an effective relationship this gap should be assessed at the initial stages of the development of the relationship to form the basis of the nature of the relationship. Gap 2: Mismatch between customer's perception of nature of relationship and their perception of their actual performance in the relationship. Gap 3: Mismatch between supplier's perception of nature of relationship and their perception of their actual performance in the relationship. They could be used by the organisations (internally) to assess their performance against their expectations and use more (or less) resources/effort in certain areas where there is a mismatch. Gap 4: Mismatch between customer's perception of the nature of the relationship and their perception of supplier's performance in the relationship. Gap 5: Mismatch between supplier's perception of nature of relationship and their perception of customer's performance in the relationship. These gaps indicate whether the parties meet their expectations from the relationship. This gap represents imbalances that may create friction in the relationship. For example if the customer organisation believes that the supplier's involvement in their operations is important and that the supplier is not actually involved in their operations as much as they expect. Gap 6: Mismatch between customer's perception of supplier's performance in the relationship and customer's perception of their performance in the relationship. Gap 7: Mismatch between supplier's perception of customer's performance in the relationship and supplier's perception of their performance in the relationship. The existence of these gaps can create frustration in the eyes of each of the actors as they represent how much effort and resources the actors believe they commit in the relationship and how well they manage it. For example, if the supplier thinks that they are very much committed to the relationship but the customer thinks that supplier's commitment is poor, then this could create imbalances and dissatisfaction. Gap 8: Mismatch between supplier's perception of customer's performance in the relationship and the customer's perception of supplier's performance in the relationship. This is one of the most important gaps in the perceptions as if the customer believes that the supplier does not trust them and the supplier feels that the customer trusts them. Lack of communication, distance in the relationship an indication that the relationship is not good. The existence of this gap represents the level of dissatisfaction from the relationship of one or both parties, as their performance is not recognised as being satisfactory by their partner. If the supplier believes for example that they trust the customer and that the customer does not trust them that gives power to the supplier which can create imbalances in the relationship. Gap 9: Mismatch between supplier's perception of their performance in the relationship and customer's perception of their performance in the relationship. This gap is the subject of most of the misunderstandings in a business relationship and its existence substantiates the necessity of a joint performance measurement system that will incorporate soft and hard performance measures. Gap 10: Mismatch between supplier's perception of their performance in the relationship and the customer's perception of supplier's performance in the relationship. Gap 11: Mismatch between the supplier's perception of customer's performance in the relationship and the customer's perception of their performance in the relationship. If the customer believes that trust is important to the relationship and the supplier does not trust them this can lead to opportunistic behaviour of the customer. If for example if the customer believes that the supplier is not trusting them and they feel that they do trust them in other words if they feel that they put a lot more effort, resources this could create imbalances in the relationship. Process for utilising the model The use of qualitative as well as quantitative data can be appropriate for the assessment of a SR using the proposed model, in order to provide richness in terms of the cognitions of various managers involved in buyer-supplier relationships with regard to mechanisms and sociological factors that construct their relationships as well as to identify any causal relationships for the success or not of a SR. From the qualitative data collected (interviews with managers participating to the SR, focus groups, historical analysis), narratives can be developed to be examined for patterns in the answers, in terms of the way managers carry out certain activities pertaining to the management of SRs. Following the interviews, a draft questionnaire can be developed and delivered to key managers who asking them to rate:

 on a scale from 1-totally unimportant to 7-extremely important the perception of the importance of all the variables included in the conceptual framework (initiating and operational) to the relationship with the other two parties,  on a scale from 1-very poor performance to 7-excellent performance their perception of the actual performance of their firm/department against these factors, and their perception of the other two parties' performance to the relationship against these factors and  a scale from 1- extremely easy to 7-extremely difficult their perception of the difficulty to manage/implement these factors in the relationships.

Conclusions In this paper the literatures in operations and supply chain performance and the performance of business relationships were considered to highlight the increasing need to understand and measure the performance of business relationships and to select the most appropriate performance measurement tool for supplier relationships in this study. A framework for assessing the performance of SRs is proposed, using gap analysis and individual managers perceptions of the nature and their performance as the unit of analysis. It is argued that the aim of any improvement strategy for the performance of SR should be to minimise the gaps in these perceptions and pursuit the role that the parties play in the relationship and identify those factors that have greater importance to the relationship. Appropriate strategies should be then selected to minimise the gaps in the perceptions of the individuals against these factors. The contribution of the research to the performance measurement literature is related to the fact that many research studies focus their analysis of the nature and performance of SRs from the point of view of the vendor rather than the supplier. The proposed framework takes a different perspective by taking into account the perspective of the supplier as well as the internal customers. Including the interested parties’ perspectives on the nature and performance of the SR, a more holistic view into the possible problems (as well as causes of these problems) can be achieved. Despite the potential usefulness in assessing the performance of SRs, the RelPerf model has certain limitations. The soft dimensions of the management of SRs are widely regarded as critical in relationship management. As the crux of SRs are the harmonisation of the strategic intents of the partnering organisations, the perceptions of both parties of the nature and performance of their business relationship can provide a powerful source for determining the condition of the SR, utilising soft as well as hard measures. From the experience of assessing the performance of the SRs over a period of 14 months however, a number of questions and issues regarding the administration and implementation of the tool have emerged. Research participants: A fundamental issue on the composition and importance of perceptions of the individuals that shall participate in the surveys and interviews may emerge. Individuals that may yield significant influence on the perceptions of the nature and performance of the SR may be left out and as such the calculated performance may not be absolutely accurate. Furthermore, the perceptions of the managers are considered to bear the same ‘weight’ on the nature of the SR, irrespective of their organisational rank. A more detailed process for the calculation of gaps that takes into account these concerns would yield more accurate results. Scientific objectivity and diagnostics: The main weakness of the reliability of the model is the fact that for the assessment of the disparities between the trading partners it utilises the perceptions of the participating managers. The perception of an individual however is not considered as a hard (objective) measure for the assessment of SR performance. For that reason there is no ‘scientific’ accuracy of the results of the analysis. Under different conditions for example the perceptions of the participating managers could have been different (either better or worse than reported). In that respect doubts are raised on the value of the model as a diagnostic and prescriptive tool. For example the measures of the gaps in mangers’ perceptions are provided only as a guide for the general reliability of the results. Further research is needed on how to interpret the results for a particular gap in a SR. It is for this reason that no on-the ground actions should be taken based solely on the gap analysis. Ground-based surveys should be conducted prior to taking a specific management decision. An additional weakness arises from the employment of unweighted measures of the factors that may influence a SR and of the activities that purchasing managers conduct for the calculation of the 11 gaps of the model, as it fails to gauge the priorities of each SR across the four management areas of product & process management, contract management and SD. The extent of the gaps calculated with this method should only be considered as a rough approximation and therefore can be misleading of the actual extent of gaps. 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