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Managing Procurement Risks

Procurement strategies should not just take into consideration schedules, procedures, and resources, but also risks. If it is the first time a product is being purchased by your company, then there are unknown factors that revolve around quality, workmanship, capability in meeting delivery schedules, personnel in the particular supply chain, and long-term reliability of the product. As in the case of all risk management efforts, there are best-practices that help identify and avoid problems in advance of a catastrophic mishap.

If a component or an assembly is being purchased for the first time, and it is not part of an existing family of parts already in the Approved Manufacturer's List (AVL), then there are a few actions that can be taken to help guarantee the product will not only perform as expected, but will also be on hand when needed. Let me address the performance consideration in this blog, as it is integral to the overall top-level product integrity.

When the purchase involves an assembly or module where several key specifications must be accurate and consistent, then of course the specifications must be clearly detailed and documented in a specification control drawing (SCD). If your company has designed the prototype or has outsourced the design or production of the prototype with commitments for follow-on volume, then it becomes absolutely imperative that you employ a purchasing strategy called “first-article approvals.”

The company that is building the product for you must demonstrate that it can meet your functional and mechanical requirements as defined in the SCD and at the target price you have stipulated. Now, this is a very important consideration. On your volume purchase order, which you have made contingent upon first-article approvals, you clearly state that your company is not obligated to pay for, or take the balance of, the purchase order quantity unless the first articles are approved and signed off by your engineering department and the outsource house can meet your delivery requirements. In addition, you must also stipulate that the balance of the order must be 100 percent compliant with the approved first articles or your company is not obligated to purchase the non-compliant goods.

In some cases, where there are risks based upon the potential suppliers' volume capacities, it may be advisable to have two suppliers identified and qualified with the first-article stipulations on the purchase agreements. In that event, you will want to consider dividing the overall volume based upon assessed capabilities between the two suppliers. This can be more costly upfront if tooling or nonrecurring engineering (NRE) fees are attached to the agreements, but in the end it may be worth it if the part or assembly is critical for your product's viability.

I have had many occasions to employ the first-article practice. The upside is the absolute guarantee that the design is viable, the cost is doable, and the supplier/manufacturer is capable. Of course, if the supplier cannot design or manufacture the product as originally tendered, that will become obvious at the first-article approval evaluation efforts. The downside is… well, there is no downside. First-article approval practice is designed to help the company move forward with innovation while leveraging the dollars invested, such that the risks are mainly on the supplier.

The purchase agreement is written to cover any incidental cost that may result from a failure to deliver for any reason. The liability is time lost if the supplier, after an agreed development time allowance, cannot produce an acceptable product. But your company's engineering department can help guarantee a win-win if they spend the upfront time to do a thorough evaluation of the potential supplier's capabilities and technology know-how. If your engineers say the supplier has the experience, the equipment, and the people to do the job, they are probably correct, and so the risk is further reduced by a solid pre-evaluation.

The first-article approval process is the best strategy for guaranteeing a supplier's capability, in product development and technological worthiness, to become part of your company's product offering.

1 comment on “Managing Procurement Risks

  1. SP
    October 23, 2012

    Nice article. Wondering if suppliers would really be ready to sign an agreement where they are liable to pay something for not meeting the delivery schedule. Personally I am in favor of that something like this comes in place.

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