E-Business Commentary -- Starving Suppliers Not The Answer

Dec. 21, 2004
OEMs are playing a dangerous game with reverse auctions, mandatory price cuts.

I got a phone call the other day from the CEO of a small manufacturing company that makes parts for a large OEM in an automotive-type industry. This CEO asked not to be identified, so let's call him Bob and his company XYZ Manufacturing. Bob had read my recent article, Co$t Vs Quality, which reported on best and worst practices in cutting costs while maintaining quality. In an effort to cut costs in many industries today, manufacturers are telling their suppliers to cut prices by X% or be dropped from their supplier base. Other initiatives such as online reverse auctions were spawned by "innovative" e-business practices. But Bob doesn't see any of these initiatives as innovative. He sees them as dangerous and -- in the case of small manufacturing companies such as XYZ -- deadly. "These mandatory cuts certainly can't go on forever," Bob says, speaking with the uncertainty of a man beseeching the heavens for an end to drought. "If people can't make any money, they're going to quit. There's not much money in it now." XYZ's OEM customer has a program in place to reduce the number of suppliers it deals with by half. At the same time, it has told its existing suppliers to cut prices by 3.5% this year and by the same percentage next year. The annual price reductions demanded by his OEM customer will have to come "all off the margin," Bob says. And XYZ is not alone. "A lot of companies are caught between a rock and a hard spot," says Martin Piszczalski, president of Sextant Research, a research and consulting firm in Ann Arbor, Mich. "A majority of Tier 2 and Tier 3 suppliers [in the automotive industry] have 4% margins or less." Bob has fewer than 100 employees; the company he supplies to, which is his primary customer, has thousands. To lose that business would kill him, as it would many other small manufacturers in his region. Small suppliers have other laments, too, such as demands to hold more inventory. They are forced to hold sufficient inventory to handle the OEM's shifting needs. Otherwise, if a customer catches you short on an order, you could lose that business altogether. "All suppliers are sitting on the inventory," Bob says. "You have to do it to keep up with them." Holding all that inventory -- XYZ, for example, has more than 1,000 units on hand for its lead customer -- carries its own risk, not to mention cost. The big one, of course, is engineering and design changes. "If they make an engineering change, you have to throw those parts away and make new ones," Bob says. But by far the scariest thing going for most small manufacturers is the online reverse auction, whereby a company pits a set of "qualified" suppliers against one another over the Web, each placing successively lower bids until only one supplier remains. That company gets the contract at a bone-scrapingly low price. "It doesn't seem very sensible for a large company to be playing you against everybody else," Bob says, adding that he and other suppliers he knows are all unhappy about the auctions. "I've gone to a lot of auctions for machinery, and the whole idea is to get you carried away so that you pay way more than what the item is worth." By the same token, he says, the reverse auction -- what he calls "upside-down bidding" -- is designed to get bidders caught up -- or down, as it were -- in the rush. Unfortunately, the process may push prices so low that the company with the winning bid may not be able to make any money on the contract. The bottom line for suppliers is that not only are times tough, but their customers are getting tougher. "For suppliers," says Bob, "It's a struggle now to make money." Adds analyst Piszczalski, "There are going to be bankruptcies among Tier 2 and Tier 3 manufacturers because they are getting squeezed on price reductions by customers." XYZ, for one, hasn't participated in any online auctions. "We can't go lower and lower on costs," Bob says. "Someplace down the line, quality suffers."

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