Supplier Relationships Key to Honda's Healthy Profit Margins

May 24, 2012
By Patricia E. Moody, [email protected] Why does Honda consistently deliver higher profit margins than Toyota? Dave Nelson, a former senior vice president of purchasing and corporate affairs at American Honda Motor Co. and co-author of "Powered ...

By Patricia E. Moody, [email protected]

Why does Honda consistently deliver higher profit margins than Toyota?

Dave Nelson, a former senior vice president of purchasing and corporate affairs at American Honda Motor Co. and co-author of "Powered by Honda: Developing Excellence in the Global Enterprise," cites two reasons.

"One is the Honda philosophy that empowers all their employees, as mentioned in the IndustryWeek May cover story celebrating Honda's 30th anniversary," Nelson says.

"The other reason is the inclusive relationships with their strategic suppliers, in which these suppliers are literally considered extensions of Honda."

At Honda, purchasing is a strategic function. During the last three years of Nelson's tenure as head of purchasing, the VPs of finance, HR, corporate communications, government relations and legal reported to him for a total combined spend of $8 billion.

More than 85% of the Honda vehicles sold in North America are produced in North America, according to Nelson. To meet the demand for vehicles in the United States, Canada and Mexico, Honda has built up a North American network of more than 600 direct suppliers.

In addition to the Accords, Civics, CRVs, hybrids and Acura models that Honda already produces in North America, the automaker soon will be manufacturing the Acura NSX "supercar" at an as-yet unspecified location in Ohio and the subcompact Fit at a new plant under construction in Celaya, Mexico.

"So the whole range of vehicle products will be built in North America," Nelson says.

Today, direct purchases alone in North America -- including the new plant in Celaya, Mexico, plus two factories located about 150 miles east -- add up to approximately $16 billion, with total costs of $20 billion.

That's $16 billion divvied among 600 suppliers.

While that might seem like an inordinately small number for a large corporation, Nelson asserts that it is a key to Honda's profitability.

"In-house costs are about 25% of the cost of a vehicle, while outside purchased costs represent 75%, which means that both the Honda associates and Honda suppliers are what make this automotive company so competitive," Nelson says. "Honda's strategic suppliers provide more than 90% of the cost of the parts that Honda buys."

What Does it Take to be a Honda Supplier?

Nelson, who was the first American to serve on the board of directors for American Honda Motor Co., offers this list of requirements for Honda's strategic suppliers. He admits it's just a partial list.

1. Have an open-book arrangement with Honda, in which Honda purchasing has access to all of your financials.

"This means that Honda purchasing has access to all the records of the supplier, including what they pay for their raw materials, how much they pay their workers, what their profits are and basically a total open book to all the company's records," Nelson says. "The supplier agrees to sell the parts to Honda at those cost standards."

This open-book concept was shocking when first introduced to suppliers that were producing for the Big Three in Detroit. Eventually, though, as information technology has enabled more accurate costing approaches, open book has lost much of its fear factor.

"The Honda buyers often know more accurately what the supplier's parts costs are than the suppliers do," Nelson explains. "If the Honda buyer makes a mistake, and after the supplier starts making the parts he feels the price Honda set is too low, the supplier advises Honda. Honda immediately sends a BP engineer to the supplier, and if that engineer cannot arrange the manufacturing process to make the parts for what the Honda buyer set, Honda will change the price to the correct level."

According to Nelson, this is a rare occurrence.

"While I was VP, about 300 new models of vehicles, engines, transmissions and various assemblies were introduced, and not one time were the target costs that were set at the beginning of the product-development cycle ever exceeded, nor did we ever miss a production start (SOP) date. Honda purchasing, Honda engineers and the supplier's engineers work as a team to achieve the target costs and SOP date, often set three years before the start of production.

"Once the products are in production, ongoing continuous improvements made by suppliers that reduce cost are shared with the supplier, significantly improving their margins."

In fact, some execs say that Honda purchasing associates know their suppliers' costs better than the suppliers do.

2. Agree to welcome Honda's BP teams (lean supplier development teams) to help optimize manufacturing and business processes.

3. Agree to participate in Honda training as necessary. Corporate training programs include leadership; finance; how to create effective employee-suggestion systems; how to develop quality circles (in which a small team follows a formal protocol to improve the process, the tooling and the machine layout); and a variety of ways to make numerous improvements to the manufacturing and business processes.

4. Agree to a top-management business meeting once a year where 1) the goals and results of the previous year is reviewed; 2) the current year-to-date goals and results are reviewed; and 3) their next three years' goals are reviewed. About 50 elements are reviewed in a very formal setting.

5. Agree to develop new models from the earliest development stages together with Honda engineers, giving multiple suggestions on how to improve the parts functionally and improve costs compared with the previous models.

6. Commit to world-class performance in quality and delivery. To shut down a line for lack of parts costs Honda thousands of dollars per minute. In the book "Powered by Honda," outside estimates for line-down situations at the time of publication stood at $26,000 per minute.

7. Practice continuous improvement in all manufacturing and business processes.

In return for meeting these and other requirements, Honda commits to maintain a relationship and award new business as it becomes available.

"Almost 100% of the original suppliers selected in late 1980s are still Honda suppliers today," says Nelson.

Patricia E. Moody, along with Nelson and Dave Mayo, co-authored "Powered by Honda: Developing Excellence in the Global Enterprise."

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