Sourcing Guy

Here’s an obvious truth that buyers often overlook in their drive to pressure suppliers to lower prices:

Over the long haul, you can’t make money in any industry unless your suppliers can make money, too.

The U.S. automotive industry has many examples of price myopia. For too many years they have used their volume leverage and power to focus on driving down Tier 1 supplier prices. Many suppliers in the domestic automotive supply chain who needed volume to amortize large investments conceded on price, resulting in margin erosion. At a certain point, those lost margins undermined new investment and created cutbacks in research and development. The result, companies were making products based on older designs using older technologies. That’s a combination that begs for competitors to move in with more efficient processes or better designed products. In some cases, the lost margins simply led to bankruptcy.

In contrast, automakers from Japan are taking a different approach. They focus on cost and cost transparency rather than price. These automakers make supplier development and joint problem solving a key priority. While still demanding cost and value improvement, the focus is on the elimination of cost using approaches such as specification change or waste elimination.

When companies view their suppliers as extensions of their own manufacturing capability, they can take a longer view of their relationships. One good example of continuous cost and value improvement can been seen in the pharmaceutical and biotech industries. Working from patented processes and technological breakthroughs, companies in these industries enter a 15-20 year relationship with suppliers and life cycle pricing models.

Executives will often argue that they have to serve shareholders over stakeholders, but that’s a short term view. Successful executives realize that over the medium to longer term, such a forced choice is inappropriate. It is in the interest of both manufacturers and suppliers to pursue value-added strategies in line with customer expectations and to align business strategies.

We enjoyed a supply managers’ market for over a decade where cost improvement and value improvement was a way of life. But record commodity prices, like $100 per barrel of oil, record wheat and soaring precious metal prices, has not only penetrated many of our supply chains, it has had a profound impact on the U.S. and global economies.
Supply managers are kidding themselves if they are not planning for cost increases in steel, aluminum, plastics, chemicals, freight, fuel, capital equipment and travel resulting from the dynamics of oil and energy markets. Many suppliers, working on already thin margins, will be aggressively pushing through price increases in 2008. Before they hit, here are three things to do to prepare for them.

1. Forecast your exposure. How much do you know about your suppliers’ cost structures? How much is actually tied up in commodity materials that are rising rapidly in price? If you can’t realistically do a full cost analysis, you can do a price analysis of your suppliers’ materials inputs. Knowing that could help create a negotiation environment where costs become transparent and the discussion turns to cost containment solutions for you and your supplier both.  For instance, there may be alternative designs or materials worth considering.

2. Condition against increases. Your expectation should be that over time your suppliers should be continuously improving — creating efficiencies that bring more value for your purchases, or lower your costs. Make it clear that price increases run against the grain of those principles. They should be hard to accept and suppliers should know that. Requesting an increase should be “difficult,” requiring the sales representative to work hard. Demand three months notice, in writing, of all increase requests and insist that they are accompanied by a detailed statement of the actions the supplier has taken to reduce or eliminate the need for an increase. A rigorous internal approval system will deter supply managers from recommending increases they might otherwise waive through because of time pressure or the desire for a quiet life.

 3. Preempt the increase. If you haven’t already, this is a good time to investigate other suppliers, prepare RFQs or RFPs and distribute them before you receive requests for higher prices. Find out what changes your suppliers have made. A new plant might have brought productivity improvements that would justify a price reduction. The same might be argued about higher volume sales covering the same overhead. Working ahead of your supplier could change the whole structure of the negotiation in your favor.

All these actions can prepare you for the inevitable.

Chrysler’s production hiccup this week is a great lesson in how and why. How NOT to treat a strategic supplier and why risk management is a worthwhile investment. They are both related, because let’s face it, if you leverage your suppliers for cost reductions to the point of bankruptcy, you’d darn well better be watching them verrrrry carefully for signs of distress, and be prepared when you leverage them right into bankruptcy court.

Do we really think that Toyota or Honda would let a critical supplier slip into bankruptcy without sending in a few troops to help sort things out? Not that they would be inclined to push a supplier into that position in the first place, but if the price of petroleum is creating a crisis with a supplier, either one of them would be working with their supplier to find solutions.

Supply chains are only as strong as their weakest links – that’s an easy truth. Finding where the weak links are and taking steps to mitigate risks before they turn into losses – that’s harder. You can’t plan during a crisis, you can only plan ahead of a crisis.

Here are some tips that I have presented and published before, but seem particularly relevant today.

One way to start is by creating a two dimensional grid. Across the top, identify the “disruptors”:

• Weather
• Disasters – natural or manmade
• Political instability
• War
• Terrorism
• Economic or Business changes

Working down, identify each link in your supply chain and all critical categories of supplies. Consider indirect spending categories as well as tracing sources for what your company might manufacture or distribute. A few examples to start a list:

• Outsourced components
• Raw materials – for your company and its suppliers
• Energy or fuel
• Transportation and logistics
• IT and communication

To really benefit from this kind of analysis you will need a comprehensive understanding of the supply chain for all critical ingredients and packaging materials your company requires. This means tracing your suppliers’ raw materials to their source with the assistance of your purchasing organization.

If your list is comprehensive and your information good you can simply consider each box in the grid to highlight your most vulnerable links. Using the grid systematically might unearth weaknesses in unexpected areas, as well.

Develop a Supply Chain Risk Management Plan

The best way to anticipate disruptions is to create a cross- functional team comprised of purchasing, manufacturing, research and development, marketing and quality personnel to create options for dealing with the vulnerabilities. If you realize that alternative materials or designs might have to be put in place, a testing program will likely be required to ensure that the integrity of the final product is not compromised. This team will have to buy the alternate supply sources and specifications you’ve designed.

This emergency action plan includes the following:

• Comprehensive documentation of the supply market including potential suppliers, their capacities and their capacity utilization
• An analysis of the supply chain down to the basic raw materials to understand vulnerabilities
• Critical review of specifications to understand how changes may be incorporated
• A detailed implementation plan

Interestingly, the thought process associated with building an emergency action plan may have some serendipitous beneficial consequences. By reviewing supplier relationships, you will gain in-depth knowledge of these companies, their capabilities and their relationship with their own suppliers. You will also acquire a more complete understanding of your specifications and how you can achieve the desired finished product.

Better supply chain risk management would have prevented a shutdown of Chrysler LLC factories this week caused by a dispute with Plastech Engineered Products, Inc.

It is unfortunate that many companies assess the vulnerability and risk in their supply chain after a catastrophic event occurs. The best practice in supply chain management is to have a detailed risk management plan, which would have anticipated scenarios such as a bankrupt supplier and set up contingency procedures.

For example, a set of duplicate tooling for critical plastic components might have been cheap insurance for Chrysler. It’s easy to see that in retrospect, but it’s also possible in many cases to assess risks in time to mitigate them. Tools are available to identify potential trouble spots by analyzing key supply chain risk factors. Those predictive models can spot troubled suppliers or other potential problems that can disrupt supplies.

Chrysler’s dilemma also points out the dangers when big companies use too much leverage to try to force down prices from their suppliers. It is unfortunate, but as the economy continues to worsen and prices for basic commodities soar, suppliers that have been leveraged by their customers are bound to fail.

Here are some early warning signals of suppliers who are in trouble.
• Constant price increases, early payment, accelerated payment terms or direct financing
• Consistently using your technical support
• Failure to support sales
• Failure to meet on time in full deliveries
• Requests for pre-payment
• Lack of investment
• Failure to appropriately cut costs during economic downturns
• Delinquent paying taxes
• Deteriorating accounts receivable and payable
• Employment of business turnaround specialists
• Introduction of many consultants – especially business turnaround specialists
• Lack of maintenance
• Negative variances from projections
• Payments on insider debt
• Use of third parties and factoring companies
• Loss of business or market share
• Recent rapid growth in sales volume
• Lack of focus by management or response to requests

Even before you spot those warning signs, here’s a few techniques for managing supplier relations and avoiding troubled suppliers.
• Conduct proper due diligence on the front end
• Periodically audit suppliers
• Create a program to effectively select and manage the supply base
• Conduct internal training for purchasing agents, accounts payable, quality control and plant managers so they can recognize potentially troubled suppliers
• Create a proactive Supply Chain Risk Management strategy

Congress and the President are getting ready to put a few hundred bucks into the pockets of most American families as a way to keep the economic pump primed. But how much difference will that make if manufacturers try to take advantage by passing along their higher costs across a broad spectrum of commodities?

Record commodity prices, such as $100-a-barrel oil, record wheat and soaring precious metal prices, have penetrated many of our supply chains. However, it’s pretty clear that consumers are not in any mood to simply absorb higher prices. Cost containment strategies by manufacturers are imperative to avoid a sharp reduction in consumer spending.

To avoid a spike in consumer costs, take action now:

Conduct cost analyses. Manufacturers should analyze supplier costs to understand the mix of material, labor, overhead and profit that are driving costs higher. An understanding of costs puts manufacturers in a better position to negotiate with suppliers seeking price increases.

Don’t accept price increases as “business as usual.” Manufacturers should make suppliers work hard for price increases by demanding three months notice, in writing, of all increase requests and insist that they are accompanied by a detailed statement of the actions the supplier has taken to reduce or eliminate the need for an increase.

Know your options. Investigate alternative materials, designs and suppliers now, before you face requests for higher prices. Manufacturers who don’t have options and market intelligence are at a disadvantage when they negotiate with suppliers.

They may only be bumping up against it now, but oil prices will soon hit and exceed $100 per barrel, and prices aren’t likely to drop substantially for the forseeable future. The reason for that is summed up in two countries: China and India.

Increased competition for the scarce oil from developing nations such as India and China are likely to keep the pressure on the price of oil for some time. Smart buyers who have watched the price go up have already created category strategies and relationships with their supply chain to manage the higher costs. Those who have not may be forced to look for strategic alternatives in energy and some raw materials in order to survive.

The $100 benchmark will significantly impact the Michigan, U.S. and global economies. The triple-digit price has a huge psychological impact that will affect consumers as well as every buyer throughout the supply chains that create consumer products. If they haven’t paid enough attention to the rising cost of fuel, the $100 mark is a loud wakeup call.

Buyers in every industry will be making cost containment an even higher priority than it has been, because oil provides more than just energy and fuel for shipping products. Industrial buyers will be encountering significantly higher costs for freight, plastics, chemicals, steel and travel.

ADR North America, based in Ann Arbor has been a leader in purchasing consultancy for more than twenty years.

ADR North America is part of a global group of consultants – ADR International — in Australia, North America, South Africa and the United Kingdom who have worked with over 200 clients in more than 50 countries. Among our clients are many of the world’s largest companies. Our consultants are recognized experts in the field and have authored hundreds of articles and commentaries in professional journals.

Our products and consultancy services have proven their ability to transform global company purchasing operations. We can start with innovative baseline assessments, move on to create and implement purchasing category strategies, and finish by developing staff skills to bring increasing value to a company. As appropriate, our consultants can deliver all or any part of a purchasing transformation. In short, ADR is purchasing knowledge, applied.

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