Wednesday, February 15, 2012


In procurement there are two ways that you can pay for something that is performed or produced for you.You can pay a fixed price for the final accepted product or service performed or you can pay for the processes and services performed in producing the product or final service. The difference between the two approaches is risk. If you pay a fixed price for accepted products or services performed, the risk of yield in performance is with the Supplier. If you pay for individual processes or services performed in the manufacture or performance of the service, you bear the risk of yield in performance.

Few products or services are performed totally error free. Some errors may be corrected. Some errors can require the work to be scrapped. Yield is measured as a percent of the total output. Yield can be measured at the end of each process step where you measure the total number of items that started the process versus the number of items that successfully completed the process. Yield can also be measured based upon the number of units that started the process in comparison with the number of completed acceptable products at the end of all processes.

For example, if you were using a third party semiconductor foundry to produce a chip, you could pay them only for acceptable finished chip. You could also pay for all the processes they performed that are required to produce the chip. If you are paying for processes, what you are doing is paying the supplier whether the outcome of the process is good or bad so in those cases it’s important to get commitments from the supplier about the yield of each process will be or what the final yield will be to ensure that they have the quality management processes, procedures, controls and measurements to perform each of those tasks so they have a high percentage of yield to keep your cost of production down.

Why would a buyer ever want to consider entering into an agreement based upon paying for process costs and yields? The simple answer is if you are contracting to have the supplier produce something that they have never produced before they may not have a good idea of the types of yields that they can expect and may need to include contingencies. Yields can vary greatly based upon the design of the product, the complexity of the product and the processes used. Yields will also vary based upon the materials used, the volume of production and the learning curve of individuals that are involved in the production. In the production of a new product you could agree to pay based upon process costs simply because you have no history of what the yields will be so you use that to start production, determine what the yields are so you can fix the price based upon actual yields versus projected yields. You may also take that approach to take any contingencies that would have been build into a fixed price for expected yields out of the cost. If you did that, you would be assuming some, if not all, of the risk if there are production problems that cause the yields to be less.

As with any other risk, the risk of production yields is not a good risk to accept if you don’t have the ability to control the risk. One way to manage or control the risk is to establish minimum standards that must be met. With minimum standards you create a sharing of the risk. You assume the risk and cost as long as the production falls within the standards. The supplier assumes the risk and cost for defective items in excess of the agreed standard. The second way of managing the risk is control.If you are going to be assuming the risk and cost of quality yields, you need to make sure that everything related to the production is agreed, documented and cannot be changed without your approval as changes can change the yields.

The other main difference between the two is quantity. If you purchase on a fixed price basis you order your needed quantity only and the supplier needs to determine what quantity they need to start to achieve the ordered quality. If they achieve higher than expected yields you have no obligation to purchase those and they become supplier’s inventory that they can use to fulfill any future orders. When you purchase based upon processes, you and the supplier will determine the quantity you need to start to meet you desired quantity of completed products without defects. You pay for the quantities that are run through each of the processes. If the processes yield less than your desired quantity, unless you have a sharing of the risk you still will pay but may get less than the desired quantity. If the yield is higher than expected you get that extra quantity delivered.

While I have talked about yields from a production perspective, the concept of yields can be applied in a number of non-production areas. For example you could hire a marketing company for a program to generate sales leads by a targeted mailing to potential customers. They perform a number of tasks to do that. The “yield” for that activity would be the number of confirmed sales leads that get generated against the total they marketed to. That would show how effective their performance of those tasks was. When you pay a fixed price for their services, you are taking the risk on yields. You could pay them based upon the actual number of yields they generate where they are taking the risk on yields. You could also have an incentive based structure where you share in the risk of yields where you pay some of their production costs, and make them earn the rest based upon the yield of the activity – the number of confirmed sales leads they generate.