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3 Reasons Why and How to Measure Vendor Performance

4 min read
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It’s a scenario we see all too often. After signing a contract, an organization falls into complacency and fails to monitor or manage its vendors' performance. As a result, the organization is exposed to new and changing risks.

Vendor management involves supervision and management. This means regularly observing the vendor's performance, addressing issues, conducting formal risk reviews, and recalibrating performance targets when necessary. Failure to manage vendor performance opens the door to regulatory non-compliance, financial loss, and reputational damage. This is especially true for critical and high-risk vendor relationships. 

While not managing vendor performance invites unnecessary risk, let's explore 3 other compelling reasons for managing vendor performance.

3 Reasons to Manage Vendor Performance

Here are three great reasons for managing your vendors' performance

  1.  Enables early detection of emerging risks before an incident occurs. Vendor risk is constantly changing. A vendor's performance is often reflective of internal and external risks. Whether you’re dealing with a vendor's management changes, declining quality, or ineffective security controls, active performance management will help you identify small issues before they become bigger problems.
  2. Confirms that the vendor is fulfilling the terms of the contract and delivering value in the relationship. Performance management is most effective when it’s measured against the contract. Ensuring vendors meet specific contractual agreements and that performance is within established thresholds is a best practice. Remember that your vendors are supposed to deliver value in the relationship. When vendor performance isn’t monitored and managed, there’s no clear way to establish that the benefits of the relationship are being realized. Additionally, proactive performance management produces real data to help your organization decide whether to renew, re-negotiate, or terminate a vendor's contract.
  3. Enhances vendor comparison data. No two vendors are the same, even if they offer identical products and services. Vendor performance data can benefit organizations desiring to consolidate their vendor lists or drive more volume to a single vendor to get better pricing. Faced with a choice between two vendors with similar products or services, pricing and delivery, the higher-performing vendor ultimately delivers more value to the organization.

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How To Manage Vendor Performance

Vendor performance management doesn’t need to be complicated to be effective. Those new to vendor performance management are often relieved to find that it’s more of a science than an art. In other words, the more practical and tangible your requirements and expectations are, the easier it is to determine whether they’re being met. Clear expectations combined with regular reviews and constant communication sums up vendor performance management in a nutshell. But, let's examine these concepts a bit more.

Clearly define and document expectations. To manage your vendor's performance, you must identify the standard to which the vendor is held accountable. Ideally, these standards can be expressed as specific targets that can be measured objectively. These measurements or metrics often include:

  • Service level agreements (SLAs) as these define the expected level of service. SLAs represent the most essential and non-negotiable requirements for the product or service and are formalized in your contract. Examples include regulatory compliance, breach notification, or system uptime. Depending on the situation, the vendor may have financial penalties or other repercussions, such as contract termination, if they fail to meet the SLA. Alternatively, a vendor may receive a bonus or other benefit for exceeding the SLA for some products and services.
  • Key Performance Indicators (KPIs) that measure performance. Vendors and clients set these metrics to gauge how well the vendor is doing and if they’re meeting expectations. KPIs often measure different dimensions of performance, such as customer satisfaction, quality, errors or rework, inventory management, efficiency, etc. KPIs are often used to confirm that SLAs are being met.

Note: To measure performance and confirm that SLAs are being met, you must have reliable and repeatable data sources to substantiate the vendor's performance. 

As soon as your service level agreements have been established and the vendor's KPIs identified, you can create a performance scorecard or other report to officially record the vendor's performance.

Establish a formal performance management routine. Performance management must be a proactive and consistent activity. The higher the risk of the relationship, the more frequently you need to review performance. The performance of critical and high-risk vendors needs to be reviewed more often, as any decline can have serious implications for your organization. Recommended intervals for vendor management are:

  • Critical and high risk: Once every quarter, at a minimum. Review more frequently if there are issues, regulatory changes, ownership changes, etc.
  • Moderate Risk: Every six months to a year. Your organization can determine the frequency based on the product or service and the risks present in the relationship.
  • Low Risk: As needed or before contract renewal.

When a vendor performs poorly, best practices suggest observing and formally reviewing performance more frequently until the issues are resolved.

Ensure that you communicate, collaborate, and be honest with your vendors. Communication is key to ensuring a mutually beneficial relationship between you and your vendor.  Practice providing honest feedback or concerns as they arise – don't wait until the formal performance review. Be prepared to listen to your vendor when they're discussing issues or ideas. It's always wise to consider your organization's role in your vendor's performance. After all, it’s hard to meet unattainable targets or fulfill expectations that aren't clear. Your relationship with your vendor should be a two-way street, with both parties working towards a common goal.

Monitoring and managing vendor performance is a best practice and a regulatory requirement for many organizations. It can also assist your organization in identifying and managing vendor issues, ensuring service levels are met, and verifying that your vendor relationships are achieving their anticipated value.

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