PSM 502:

Negotiation & Contracts in

Supply Chain Management
Contracts
Terminology

• Key Performance indicator (KPI)

• Specification
• Five rights
• Market dialogue
• SMART
• Standard
• Service level agreement (SLA)
• International Organization for
Standardization (IS)
• Information assurance
Introduction

• This chapter provides fundamentals of specifications and key

performance indicators that are included in contractual
agreement made with suppliers.
Five Rights

• Specification is the most important documents within a procurement contract. Any

ambiguity, misunderstanding, lack of clarity or confusion about the specification will
result in a failure against one or more of the Five Rights of purchasing:
• Quantity
• Quality
• Time
• Place
• Price
• the right quantity, the right quality, at the right time, from the right place, at the right
price
Five Rights

• The concept of the original Five Rights is a very basic, transactional approach to
purchasing, which could easily be extended into further ‘Rights’ to cover the source,
approach to ethics, and environmental and social impacts etc.
Drafting specification
Writing first draft of a specification

• Specification rarely start from a blank piece of paper

• The vast majority of goods and services purchased commercially already exist in the marketplace
which means that someone somewhere is already buying them and therefore specification
already exists.
• A good place to start is by assembling a number of comparable specifications from different
sources
• The ease or difficulty of obtaining sample specifications will vary from sector to sector and
category to category. The more competitive the sector in a given category, the less likely it is that
purchasing organizations will be willing to share. Public companies and third-sector charities are
more likely to share, but arguably, in many cases they are less likely to be at the forefront of
specification development.
Drafting specification
Writing first draft of a specification

• Suppliers will always be willing to assist in specification development, as this is one way in
which they can seek to influence the design to favour their own products.
• Purchasers need to be aware of intellectual property issues. A ‘non-disclosure agreement’
will certainly be requested by most of those willing to share specifications.
• A previously used specification must always be robustly challenged to see how well it fits
the proposed circumstances
• Specification must not be drafted in isolation form the rest of the contract documents
Drafting specification
Writing first draft of a specification

• Ten key aspects of specification design

 What you are trying to achieve
 Any preference for conformance or performance specification
 Varying perspectives of different stakeholders
 Relevance and avoiding the inclusion of anything not actually needed
 The limits and constraints of the scope of the procurement
 Performance standards to be achieved
 Improvements sought
 Ensuring that there is no ambiguity
 Compliance with regulations and standards
 The expected operating environment
Drafting specification
Advantages and disadvantages of starting
from a pre-written specification

Advantages Disadvantages
It should be easier to critique than it is to Time can be wasted discussing irrelevant
create. A blank page is never a good starting aspects. Good project management skills are
point for a discussion. needed to close out these areas quickly.

Most of the necessary elements will be Some elements relevant to your organization
covered, acting as a prompt to ensure they are may not be included and could be missed if the
considered and a conscious decision made to sample is totally relied on.
include or omit.

Using more than one sample provides ideas Trying to combine aspects from different
and options regarding different potential sample specifications can create inconsistency
solutions. and ambiguity, especially if different terminology
is used in different parts of the specification for
the same thing.
 Drafting specification
Advantages and disadvantages of starting
from a pre-written specification
Advantages Disadvantages

Using more than one sample specification is The sample specification(s) may require a
a good way of understanding the quality higher quality than your organization either
variations available. Remember: the 'gold needs or can afford.
standard' is rarely required and there is
always a trade-off between quality and price.

If you are able to obtain price brackets for the The sample specification(s) may be aimed at
various quality levels, a more intelligent a lower quality than your minimum threshold
conversation can be had about the and therefore be incapable of delivering your
specification in a full-business context (taking desired outcome.
into account budgets, cash flows, likely It can be difficult to understand why the
lifespan, etc.). sample specification is the way it is, and
therefore the degree to which its operating
environment matches your own environment.
Cross-reference to legislation, international Reference to legislation, international
standards or codes of practice act as standards or codes of practice may be
prompts to check what you need to comply outdated or obsolete.
with
 Drafting specification
Advantages and disadvantages of starting
from a pre-written specification
Advantages Disadvantages
The sample specification(s) may The difference in the length and format of the contracts can
suggest ways in which innovation either lead to the inclusion of things you do not need or may
can be promoted or captured suggest that items which are potentially value-adding are not
during the life of the contract. possible in your scenario. There is a risk that if the specification
is looked at in isolation (i.e. on the basis of an assumed form of
contract) then such opportunities may simply be disregarded.
The procurement role is not only to challenge the specification.
It should also raise the possibility that if such innovation would
add real value to the organization, then it should not be
automatically omitted from the contract, even if it will only be
acceptable under a different contractual approach. Instead, the
whole contractual approach should be reviewed in that light.

The sample may be drafted to align Changing the specification to align to a different form of
with a standard form of contract, contract may create inconsistencies.
ensuring consistency of format and
terminology.
Standardization vs increasing range of products
Standardization

Advantages of standardization:
✓ Clarity of specification
✓ Economics of scale
✓ Reliability
✓ Service enhancement
✓ Time saving in the procurement process
✓ Accuracy of quotations
✓ Wider supply market
✓ Narrower supply base
✓ Inventory savings
✓ Reduced risk
Standardization vs increasing range of products
Increasing range of products

Advantages of increasing the range of product:

 Breadth
 Innovation
 Product differentiation
 Cultural differences
 Economic factors
 Flexibility
Key Performance
indicators (KPIs)
KPI

• KPI- Key performance indicator

- what you are measuring
• Targets- the performance level to be achieved
• Consequence- what happens if the measures are not achieved and/or if they are
exceeded.
KPI
Purpose of KPI

• KPI is for the purchaser to understand what ‘right’ means in their own context
(five rights). The ‘right’ quality for a luxury band will be different to that for a
budget brand.
• The purpose of KPIs is to measure how well the contract is performing in
delivering those elements.
• KPI measurement is about improvement.
KPI
How many KPIs?

• ‘Measuring things simply because we can’- is not good concept for setting KPI
• IPA rules (Laura Tyson):
 Be important
 Potential improvement/potential problem
 Authority/ ability
• It should not be necessary to have more than five or six KPIs.
• The costs of capturing and analysing the KPI information must never exceed the potential
benefits from improvement or likely costs of potential problems occurring.
KPI
Types of KPIs

• Binary measures
• Yes/no, pass/fail
• Numerical measures
• Number of accurate order as a % of the total number of orders
• Qualitative or subjective measures
• poor, good, very good, excellent
KPI
Tolerance against specification
KPI
Setting targets

• SMART
 Specific
 Measurable
 Achievable
 Relevant
 Time bound
KPI
Setting targets
KPI
Setting targets
KPI
Setting targets
KPI
Setting targets
KPI
Setting targets
 Service level
agreement (SLA)
Service level agreement (SLA)
What is SLA?

• Service level agreement (SLA) is an agreement between the provider of a service and the
recipient of that service, setting out the quality standards of various aspects of the service,
actions to be taken if those standards are not achieved, the consequence if such actions do
not resolve the problem, and (where applicable) the consequences of such standards being
exceeded.
• SLA is a document outlining the expected minimum level of service between a service
provider and a client. It clarifies the scope of the service, responsibilities of each party and
how to escalate among other factors. A service level agreement is legally enforceable if it is
referred to in a contract
Service level agreement (SLA)
What is SLA?
Service level agreement (SLA)
What is SLA?
Service level agreement (SLA)
Reviewing KPS and SLAs
Service level agreement (SLA)
Typical KPI measures

Activity KPIs
Delivery  Delivery on time in full (OTIF)
 Delivery on time
 Average lead time
 Average time to fill emergency orders
 Consignment stock availability
Quality  Product/ service compliance
 Reliability/ durability
 Usability/ satisfaction Page 111
 Technical support
 Supplier response time
 Repair lead time
Health & safety  Endangering health and safety
Service level agreement (SLA)
Typical KPI measures

Activity KPIs
Resource efficiency across  Number of credit notes per month
administrative tasks  Invoice preparation
 Provision of quotations
 Documentation
 Management information

Resource efficiency in  Supplier innovation

terms of innovation, best  List of targeted value-added activities
practice and continuous  Value-added activities
improvement  Proactivity Page 111
 Responsiveness
 Responsiveness to change/flexibility
 Openness and cooperation
 Understanding of accountabilities and responsibilities
Service level agreement (SLA)
Typical KPI measures

Activity KPIs
Resource efficiency and service  Abandonment rate
levels of contact/call centres  Average speed to answer
 Time service factor
 First time resolution (or first time fix)

Cost management factors (e.g.  Savings (reduction in unit price)

cost savings, cost reductions)  Savings (total cost reduction)
 Cost avoidance
 Transaction cost reduction
Page 111
Any Question?
THANK YOU