Vendor Management: Change the Performance Scale

How to use vendor performance reviews
to build strategic third-party partnerships

How are you managing the performance of your third parties?

Are they meeting your expectations? Are they providing good service? Do they have a service level agreement, and who is monitoring that SLA?

Evaluating Vendor Performance: Beyond the Basics

A lot of organizations use a keep vs. fire or A vs. F system of evaluating their third parties. They will go through and rate their vendors: grade them A – F, or score them 1 – 5, and come out of that saying they’re either going to keep the vendor or terminate the contract.

This system works, and we absolutely want to be rating our vendors, but I would encourage us to think through how exactly we are measuring them, and whether it is possible to get a better, clearer picture of our vendor performance by changing the performance scale.

Step 1 – Improve Vendor Relationships

First, ask yourself what type of vendors you want to do business with. Do you want to do business with strategic business partners, or companies that are just going to cash your check and think of you as a nameless customer that they don’t really have a relationship with?

I would encourage you to be very interested in what your vendors are doing. Educate them about your organization. Ask them to come out and present to your senior management team. Above all, work with them in such a way that they see you as a strategic business partner. This will help your vendors understand where to put their resource dollars and alert them of your changing needs so they can develop and improve their product to serve you more effectively. But if your performance scale does not communicate that to the vendor, then you are missing an opportunity to improve relationships and have a better return on investment.

Step 2 – Calculate Return on Investment (ROI)

Second, one of the key things you need to do is calculate a return on investment. To do this, you must understand what exactly the vendor provides to your organization and how that ties back into your strategic business plan. Once you have that information, calculating an ROI is relatively simple.

Vendor ROI Examples

1.  Efficiency ROI: For example, perhaps you sign a contract with a vendor to make you more efficient — but how do you calculate and measure efficiency? You take savings from your reduced hours, subtract the cost of using that third party, and get your return on investment.
2. Growth ROI: If you are purchasing a third-party product or service to help you grow, what kind of growth are you projecting? What’s the cost of that? Then you can calculate the ROI.
3. Customer Satisfaction ROI: Or you might contract with a vendor for products or services that will increase your goodwill with your customers. The question here is, do you expect to gain additional customers by creating greater customer loyalty? You take the estimated number of additional customers, multiply it by the average revenue generated per customer by time period, subtract your cost, and that gives you the ROI.
4. Risk Mitigation / Avoidance ROI: How do you have an ROI for an insurance policy? You take the cost of the potential event, divide it by the probability of the event, subtract the cost, and that’s going to get you your ROI. Admittedly, it is rather challenging to wrap your head around the probability of an event. For example, our office here in Washington sits in the blast zone of Mt. Rainer, an active volcano, and knowing the probability of it unleashing molten fiery death upon us is perhaps more of an art form than an exact equation.
5. Compliance ROI: Is there an ROI for compliance other than keeping regulators and examiners happy? Typically the ROI is… just do it.

Once you have a good ROI, tie it back to your original business plan and the vendor performance review cycle. SLAs are only good if they are actually monitored. Have a clear organizational structure such that vendors are owned by individuals, groups, or committees and no vendor is overlooked in the review process. Then, as you go through on an annual, bi-annual, or quarterly basis, recalculate that ROI.

Finally, don’t be shy about sharing your performance review with your vendor. This goes back to developing strategic business partnerships with your third parties. You might even consider making them a part of the process where appropriate. The review is a great place to not only sort out the performance of your vendors, but can also be a great way to uncover your actual needs and educate your vendors on how they can meet them. A clearer understanding of those needs and an improved method of evaluating your vendor performance can go a long way in developing strategic partnerships.