Do Penalties for Poor Quality Make Sense for your Suppliers?

Supplier ManagementShould you charge penalties to suppliers when there is a quality issue?

And, if so, how to do it?

I discussed this topic with David Collins, one of my partners at China Manufacturing Consultants, and we agreed that the answer is variable.

1. One-shot deals

For a one-time project, there is a high probability that the supplier simply walks away from the deal if you charge high penalties.

I have even seen regular suppliers (including some who had agreed to getting paid 60 days after shipment) who felt they had the power to say no to penalties. The truth of the matter is, when a buyer relies on one manufacturer for regular shipments, that manufacturer knows he has power. Multiple-sourcing does not always make sense, so many importers are “hooked” by a single-source supplier.

2. What to do with regular suppliers?

When dealing with a regular supplier, the buyer’s focus should be on helping the factory solve its problems and implement corrective actions. As much as possible, both sides should work as partners.

For example, car plants often send quality engineers to a supplier’s factory that is experiencing difficulties, as a preventative effort to avoid shutting down the production line (it would be a disaster, since down time costs a car plant close to 40,000 USD a minute).

Naturally this is easier for large buyers. A small buyer will never have much weight, but still they can have an engineer go to the manufacturing plant and guide/oversee corrective actions. This is the right thing to do — the buyer takes his responsibility.

My point is, an antagonistic relationship never helps. A “penalty” or a “fine” sounds like the punishment of a child who doesn’t behave properly, and it does nothing to improve the relationship with a supplier.

3. In which cases do penalties make sense?

We can think of a few cases:

  1. The supplier’s company is large enough to easily “stomach” the penalty. (Some factories had to close because of one quality issue that triggered a huge fine.)
  2. Your company gets a penalty from one of your customers, and you charge it back to the supplier at the origin of that problem. Obviously it needs to be well documented.
  3. You signed a contract beforehand that addresses this situation.

Still, we think penalties are seldom a good solution. Buyers should not wait until a supplier makes a mistake. They should “own their supply chain” by selecting suitable suppliers and training them, down to the second- and third-tier suppliers if possible (at least for critical components).

Do you agree?

How 4PLs Can Help Reduce Costs Across a Supply Chain

Recently I had an interesting conversation with the founder of a 4PL agency. They help some large companies reduce their costs along a supply chain.

But first, what is a 4PL (4th party logistics services provider)?

You probably heard of “3PL”. These are carriers managing other carriers. Most importers work with a freight forwarder, which is a 3PL.

A “4PL” is a company that links the different parties in the supply chain, and sometimes also provides financing.

I found this nice graph on this page:


How do some 4PLs reduce the cost of a product?

Let’s take an example with 3 tiers of suppliers:

  • The end customer (think big companies like BMW or HP)
  • The first-tier supplier
  • The second-tier supplier
  • The raw material supplier

Here is a way it can work out:

  • The end customer knows (roughly) what quantity they will buy over the next year, and engages a 4PL.
  • The 4PL buys the raw material in large quantity and lock in a low price. This is possible since the quantity for the next year is known.
  • The second-tier supplier gets a batch of raw material and buys it from the 4PL. It processes that batch and then sells it back to the 4PL.
  • The 4PL arranges inspection at the second-tier supplier’s site (if it makes sense)
  • If the second-tier supplier has a high scrap issue, or is inefficient in its use of resources, it is his problem. The 4PL only buys the “good” products.
  • The same thing happens with the first-tier supplier.

Note that the 4PL can also arrange financing for the suppliers. Since they want to maintain their relationship with the end customer, and since the demand projections are relatively stable, the 4PL does not take large risks.

It seems to be used mostly in the electronics and the auto industries for components that are purchased in very high quantities. I have to say, I am not very familiar with this model.

QC Inspections: Why some Points are NOT Checked on All Samples

Quality Control TipsWhen it comes to random inspections (usually conducted based on AQL tables), the inspector has to check a certain number of pieces. For example, if there are 5,000 pieces in the whole batch, he/she has to check 200 pieces (in normal severity, level II).

If the inspection was properly prepared, the inspector has certain checkpoints to follow. However, does it mean that these points have to be checked on all samples (in my earlier example, on 200 pieces)?

This is usually not realistic.

Let’s take an extreme example: an inspection of Android phone. Doing a full function check on 1 piece could take an entire man-day. So it is not realistic to check all functions (as per the instruction manual) on all samples, in this case.

Very often there are checkpoints that take more than a few seconds per piece. If the inspector checks all these points on the whole sample size, it can easily get the workload from 1 man-day up to 5 man-days. This is quite common.

To drive my point home, here are a couple of examples:

  • Checking the size of the export carton — it usually makes sense to measure one carton, and to have a quick look at the others (“are they roughly the same size?”).
  • Abusing a product for 5 minutes to see if it breaks or gets deformed easily — do this on 200 samples, and just this one test will take 1,000 minutes, or 17 hours.

So, in my mind, the logic should be as follows:

1. What we can check very fast (in the case of your product: visual defects, fitness test between lid and body…) is checked on the whole sample size.

2. What we can’t check very fast is divided in two categories:

2.a What is very important to the buyer (“critical to quality”), doesn’t take a very long time to check, and/or might vary substantially from one sample to the next due to the production process: can be checked on the whole sample size but it might increase the workload substantially.

2.b Other checkpoints: to be checked on a smaller sample size.

A few more remarks:

  • In the 2.a case, any problem is classified as a defect, just the way a visual defect is counted. It makes sense since all inspection samples were checked for this point (and the statistics from ISO 2859-1 were respected).
  • In the 2.b case, let’s say a point is checked on 5 pieces and one problem is found on 1 of the 5 samples. The inspector can simply consider this problem as critical, which means the checkpoint is failed. And then the buyer (or the quality manager) decides whether it is critical or not.
  • This is a bit crude but that’s the way most inspection firms have been doing for a long time. The alternative would be to inspect all points on all samples, but usually that’s out of the client’s budget.

How a Mobile App can Help Quality Control Inspectors

Quality Control TipsOver the past 10 years, most buying offices have pushed their inspectors to switch from paperwork to a laptop, and to prepare their reports on Microsoft Excel or Word. It means many details (including photos) can be reported. But it is an inefficient process.

Switching from laptop to an app on a tablet is the next step. We have worked on a nice infographic to explain the benefits it provides. Here it is:


More details at

Managing your Product’s Life Cycle

New Product IntroductionEvery product has a life cycle. Think of a car: it comes out on the market and attracts attention, then gets more common on the roads, then needs a redesign, and after some time most models’ production gets stopped.

When it comes to most consumer goods bought from China, new designs are often copied very fast — sometimes with the active help from the manufacturer!

That lifecycle is broken down into a number of different stages, as shown in the model below:


I broke down the different phases.

1. Product Lifecycle Part 1

1.1 Design and Introduction

This stage mainly concerns the development of a new product, from the time it was initially conceptualized to the point it is introduced on the market and starts to sell. The company that first had the innovative idea often has a period of monopoly until competitors start to copy and/or improve the product (unless a patent is involved and respected).

1.2 Characteristics

  • Financial drain (this can be seen on the Profit per Unit line on the graph above)
  • No sales profit, all losses
  • Low sales volume
  • High development effort

2. Product Lifecycle Part 2

2.1 Growth and Competitive Turbulence

If the new product is successful (many are not), sales will start to grow and new competitors will enter the market, slowly eroding the market share of the innovative firm.

The first competitors to market the same product might be piggy-backing on the development efforts of the innovator by using the same Chinese factory (and slightly tweaking the design to avoid legal risks)!

How to reduce the risk of having your Chinese supplier sell the same, or a very similar, product to other companies? Here are a few ideas:

  • Source components from Chinese suppliers and put them together in your own country.
  • Alternatively, work with a Western-owned factory in China to do the final assembly. They will be more sensitive to IP rights issues.
  • Work with a large Chinese manufacturer that has a history of developing new products with Western customers, and have them sign the right type of contract (work with a lawyer very familiar with China law — here is one reason why).
  • Develop a strong brand (read about the example of Samsonite here).

2.2 Characteristics

  • Cost of Goods Sold (COGS) reduced due to economies of scale
  • Sales volume increases significantly
  • Increased profitability
  • Staff expansion, bring skill in-house
  • Production planning

3. Product Lifecycle Part 3

3.1 Maturity

At this stage, the product has been standardized, is widely accepted on the market, and its distribution is well established.

3.2 Characteristics

  • COGS are very low
  • Sales volume peaks
  • Prices tend to drop due to the proliferation of competing products
  • Very profitable
  • Promotions, special pricing
  • Inventory control and analysis

4. Product Lifecycle Part 4

4.1. Decline and Withdrawal

As the product is becoming obsolete, eventually the product will be retired.

4.2     Characteristics

  • Sales decline
  • Prices drop further
  • Profits decline

5. Lifecycle Extension Strategies

As a product nears the end of its lifecycle, the company must decide what to do: withdraw the product altogether or extend the life cycle of the product through a number of strategies.

Product lifecycle extension strategies are marketing techniques designed to extend a product’s life cycle. If an organization decides to continue selling the product as it reaches saturation or enters the decline phase, there are a number of strategies that can be implemented:

  • Repackaging and new sizes: the appearance of the product can be crucial gaining a customer’s attention and developing interest
  • New formulas, different scents, flavors, colors
  • Additional features, additional product as a bundle bonus
  • Lower prices to maintain interest or liquidate surplus stock
  • New advertising campaigns
  • Altering the channel of distribution, such as online shops
  • Finding new markets – this may be locally, nationally or internationally.


6. Speed to Market

Part 1 is the stage where the innovating company is under the most pressure from a financial standpoint. The longer the period to develop a new product and get that product into the market, the greater the financial drain.

With this pressure on getting to market as quickly as possible, most SMEs will take the most expedient route. If that means not following any New Product Development procedure, then some organizations see that as a risk worth taking. The problem is, a lack of formal process usually results in project lateness because of poor communication, unclear expectations, redesign and redevelopment caused by mistakes caught too late, etc.