What follows is a redaction of my book titled What CFOs Need to Know About Supply Chain Transactions and How Their Risks Should be Managed.1
Too many CFOs are not sufficiently informed about the thousands of daily supply chain transactions they sign under contract and errors too often arise. Anyone who wishes to avoid this dilemma should start asking the right questions -- not the wrong ones. But it happens too often. As Peter F. Drucker has noted:
“The most serious mistakes are not being made because of wrong answers. The true dangerous thing is asking the wrong question.”
Wrong questions lead to oversights like these:
- CFOs too often view many of these transactions incorrectly as “routine” and this prompts senior management to overlook the risks.
- The sheer number of the daily supply chain transactions creates a huge risk from mistakes and missed opportunities which, in turn, exposes the company to claims and lawsuits.
- Poorly defined responsibilities inevitably lead to busted budgets and failed objectives.
Start by taking another look at the CFO role within the organization. The Business Dictionary defines the “CFO” role this way:2
“Senior-most executive responsible for financial control and planning of a firm or project. He or she oversees all accounting functions including (1) credit control, (2) preparing budgets and financial statements, (3) coordinating financing and fund raising, (4) monitoring expenditure and liquidity, (5) managing investment and taxation issues, (6) reporting financial performance to the board, and (7) providing timely financial data to the CEO. Also called chief finance officer, comptroller, controller, or finance controller.”
“The universal heart of the role is financial management with particular emphasis on data integrity and the financial risks facing an organization. However, in a world of increasing uncertainty and volatility -- including the risk of global disruptions of all kinds -- organizations are demanding more than mere “accounting and reporting” from their CFOs. CFOs are expected to fully and actively participate in identifying and managing risk. This is especially true for those organizations that see the CFO as the likely successor to the CEO and the de facto “second in command.”
Clearly, unless CFOs understand what purchasing is doing and how, they cannot responsibly prepare budgets and financial statements; monitor expenditure and liquidity; manage investment and taxation issues; report on financial performance; and provide timely and accurate financial data.
Don’t rely totally on the supplier scorecard even though, as a CFO or future CFO, you may be tempted to believe that you can depend on your organization’s supplier or contractor scorecard to accurately measure the performance of the contract when approving or reviewing a particular transaction.
The dirty little secret about supplier scorecards is that they are unreliable and highly subjective. Of course, supplier scorecards need to be kept, but let’s not fall into the trap of the “illusion of knowledge.” Supply chain management experts readily acknowledge the limitations of supplier scorecards including these three pitfalls:
- The perennial questions are always what do you choose to measure and how is it measured? Notably there is no real consistency regarding scorecard methodology within industries.
- Different companies in the same business use scorecards differently. Even some locations within the same company sometimes do it differently.
- Very telling is that individuals may have very different opinions about the same supplier or contractor.
At the end of the day, commercial transactions consist of words which, by their nature, have an inherent unmeasurable ambiguity. Chasing numerical metrics also suggests that only what is quantifiable is valuable and worthy of management. However, so many important aspects of success are in fact not readily measurable and not quantifiable.
Don’t “worship” the scorecard numbers!
Place very little confidence in numeric values assigned to different scorecard categories. Why? Putting a number next to a metric is essentially a very subjective exercise. For example, if you are rating attributes such as “quality of service” or “on-time performance” on a scale of 1 to 4, this is essentially a completely subjective exercise. Yet it creates the illusion of objectivity. Moreover, it creates an ambiguous picture like these:
- Is a 4 rating twice as good as a 2 rating?
- What is the difference between a supplier or contractor ranked 3rd compared to one ranked 4th?
- How useful is scorecard information and how does it drive improvement? This is unclear at best.
Certainly scorecards -- whether rank, weighted, or cost based -- have their place for collecting information and grading or ranking suppliers or contractors. But let’s not pretend that assigning weights and weightings is anything more than plucking numbers out of the air based upon opinion and subjectivity.
Drawing conclusions based upon the total cost of doing business with a supplier or contractor ignores the fact that transactions and projects -- despite similarities -- often have very different risks and risk profiles which can affect costs or pricing. Depending upon the individual experience, different supply chain managers within your organization could conceivably rank the same supplier or contractor as “best” and “worst.”
Remember too that supply chain managers who have selected a particular supplier or contractor have a vested interest in seeing that supplier or contractor succeed. In other words, their professional ambitions may influence their view of performance. After all, efficient supply chain managers wouldn’t select poor performing suppliers or contractors.
Don’t forget that supply chain managers may ignore their own shortcomings in terms of how a particular transaction turns out. For example, let’s say that there were “excessive” change orders. Is that the fault of the supplier or contactor? Or consider poor scope of supply or scope of work documents? Anything like this could create yet another opportunity for the supplier or contractor to add additional bias to the so-called “objective” scorecard.
Why this love affair with scorecards?
We love our “scores” and see “numbers” as objective but can we really “score” judgment, leadership, wisdom, charisma, coachability, coaching skills, teaching skills, or the ability to make good hiring decisions? When evaluating people, performance, or even commercial transactions, be wary of placing too much trust in scores.
We tend to embrace a powerful notion that “if you can’t measure it, you can’t manage it.” Not true. While this notion of “measurability” has a superficial appeal, it can lead to chasing meaningless “metrics.” Guard against it.
Given that commercial transactions are so very word specific and case sensitive, collecting scorecard information is often a waste of time, particularly if a clear understanding of the supplier’s or contractor’s business does not exist. Worse, scorecards prepared under time pressure or influenced by performance evaluations can result in poor decisions.
I’m not suggesting that we do away with scorecards, but we need to recognize their limitations and the need to continually question and improve the process by which suppliers or contractors are measured. Most important to remember is each transaction requires a high level of due diligence and scorecards are no panacea.
Reviewers recommend this resource1
Paul Humbert’s book has been acclaimed by CFOs and academics alike. One reviewer stated when following advice from the book, “It is a great resource for all existing or aspiring CFOs or COOs, who want to improve their capabilities regarding contracts and contract management to avoid, manage, or mitigate financial risks.”
The legal opinions in this article are the author’s own, not WorldCC’s, and this is not legal advice.
- What CFO's Need to Know About Supply Chain Transactions, First Edition
ABOUT THE AUTHOR
- Paul Humbert, Esq. is President and Managing Director of The Humbert Group, LLC. The Humbert Group, LLC provides consulting services to global clients with particular emphasis on complex negotiations, strategic alliances, process improvement, risk management techniques, project management assistance, and training and executive coaching, as well as post-execution contract management, including claims and dispute resolution. Paul holds degrees in both business and law and has extensive experience in these matters.
Paul is the coauthor of three books dealing with supply chain and contract-management optimization, namely, Contract and Risk Management for Supply Management Professionals, Model Contract Terms and Conditions with Annotations and Case Summaries, and Playbook for Managing Supply Chain Transactions. Paul has also authored How to Analyze and Negotiate Warranties for Goods and Services. These books have been well received by both the business and academic community.
Content reflects views and opinions of the author and do not necessarily reflect the views and opinions of World Commerce & Contracting.