Everyone's Got to Eat

Jan. 9, 2015
The goal of every OEM’s procurement function should be lean, not anorexic, supply chain performance.

I took my first purchasing job in 1988 as a procurement engineer (translation: technical buyer) of hydraulic components. One of the responsibilities of that job was to negotiate pricing with newly designed and/or revised parts and components. Having a mechanical engineering degree and experience in design, reliability and quality I was ill-equipped to do this, so my employer sent me to one of those “two-day wonder” negotiating seminars. You know the type, the ones that tout things like “you don’t get what you deserve—you get what you negotiate.”

Anyway, after attending the training I felt I was ready-to-rock. Luckily for me one of my first negotiations was with the owner of a cylinder company who had been around the block at least a few times with “young bucks” like me. When we had finally arrived at what looked to be a fair agreement I pulled the “ask for one more thing” strategy and said, “We are going to need something more to finalize this deal.”

He sighed, looked me straight in the eyes, and said, “Paul, you know everyone’s got to eat.”

Well, my negotiating training hadn’t prepared me for such a fundamental truth and, after a moment of contemplation, I replied, “you’re right” and shook his hand on the deal. After that experience I came to the understanding that even after—perhaps especially after—my two days of negotiating training I was still ill-equipped to successfully conduct meaningful negotiations. That capability, by the way, came to me only through years of further learning and experience.

The reason I’ve related this personal story is that I received reader feedback from a previous blog (“Supply Management Strategies to be Avoided”) that I feel was on the same level of profundity of what that old-timer had said to me all those years ago. If you recall, in that blog entry I laid out the business reasons why annual “broad-brush” across-the-board OEM price-reduction goals don’t belong in Next Generation Supply Management practice. The reader feedback, which I show below in its entirety, addressed this specific thing:

WOW! Can I forward this article to my multinational OEM customer who just sent us the annual “Dear Valued Supplier” letter informing our small manufacturing business of mandatory 4% cost reductions for 2015? After ten years of Lean implementation that has resulted in a decade of no cost increases we have been served with yet another impossible demand instead of an invitation for cooperation. Now—gone is the margin and with it... gone is the Industrial Engineer; gone is the Apprenticeship Program; gone is the Preventative Maintenance Program; gone is the Capital Budget for equipment improvements; and gone is every indirect overhead non-variable cost input that doesn’t touch the customer’s product.

The only issue not mentioned by the author regarding these mandatory price cuts is the complete destruction of morale [it causes] in the supplier’s organization, particularly if they are a small company. Very often small suppliers will accept cost-cutting terms such as these much as a condemned man agrees to “dig his own grave”—hoping just to buy time and keep the doors open.

In the meantime, when the customer calls tomorrow and asks to expedite that big order for a very important client, I guarantee that we will be far less eager to answer the phone.... and the last thing we would do is voluntarily help them save money or improve any aspect of our product.

What this reader was really sayinggranted, in a more detailed, heart-rending mannerwas “everyone’s got to eat.” On the other hand, when I talk to my OEM purchasing manager colleagues about their annual “broad-brush” across-the-board price-reduction “mandates,” they reply to me along the lines of one of the following two positions:

• “You don’t understand—I get handed these goals by executive management!”

• “What’s wrong with them? They seem to get results.”

I’ll address each of these responses in turn.

You may remember that in an earlier blog I broached the issue about whether in your organization supply management “had a seat at the table,” or was it more a tactical function that was expected to deliver on the expectations set by other? Let me continue with this line of thought and relate it to this month’s topic.

If I were an OEM purchasing nanager today that was continually being handed 4% annual supplier cost reduction goals (as referenced in the reader feedback), I would ask the following two questions;

1. How are these price-reduction targets set? Are they based on supplier operational data showing available waste? Are they required for the ongoing survival of your company? Or (most likely) are they pulled from the air by some chief financial officer wanting to increase stock price? If so, they should be challenged, where appropriate.

2. Is the 4% price down goal being set for suppliers the same as the internal cost down goals? In other words do you “walk the walk” or just “talk the talk?” After all, in extended enterprise supply management all operations—be they internal (OEM) or external (supplier) —are just another link in the order fulfillment chain. What should be good for one should be good for all, right? So, if your internal operations are not being given that same 4% goal, year-after-year, you should ask why not and demand an explanation.

If supply management isn’t allowed to pose these types of questions within your organization I think you understand that it is considered tactical by your executives. As I elaborated on in that same earlier blog, this is unfortunate because it will prevent your company from attaining (or maintaining) status as a world-class manufacturer. Why? Because your supply management organization is not positioned to deliver lean supply chain performance or the non-piece price economic benefits that are available from such a supply chain.

My answer to the second question is that while I agree that over the last couple of decades “broad-brush” across-the-board price-reduction expectations have been a sort of “gravy train” for many OEMs, my gut feeling is this “easy ride” is just about over. You might ask, “How can you know this?” Here’s how I answer that question.

I am an executive level supply management consultant and in that role I have exposure to many suppliers. What I’ve seen is that many have reached the same point as the company the reader providing feedback to my last blog works at. They have done about all that they can do to cut costs—even cutting things that are necessary for their longer term viability—and there isn’t any more to cut. Many have reached the point where they are “mad as hell and are not going to take it anymore,” to quote the line from the movie “Network.”

And suppliers understand they have been working with their OEM customers like “the condemned man digging his own grave” (as the reader wrote), “hoping to buy time.” But all they bought was more of the same. Realizing this, I see suppliers positioning themselves to push back. How? In many ways.

First, as the reader response cited, suppliers are less likely to take on additional cost to support un-forecast customer demand. This is something the OEMs have come to expect at “no charge.” Some of my OEM clients tell me this type of support has already started going away.

Second, other support “freebies” are now resulting in charges, such as design engineering support. Previously suppliers had tried to include this in their pricing overhead. Now, due to the annual OEM price downs, services like this will now need to be charged for. Again, some of my OEM clients are telling me they feel like they are being “nickel and dimed.”

Third, and perhaps more ominously, suppliers are starting to identify those OEM customers that don’t care whether or not they “get to eat” or not and position themselves so they can “walk.” You may say, “So what? There is always someone who will take on this business.” I’d ask you to consider two things in this regard. First, many suppliers have learned how to play the OEM pricing game and the old “buying the business” pricing approach will only likely be used by suppliers in desperate straits, i.e., ones you really shouldn’t be working with. In other words, suppliers are less likely to quote low-ball prices to get their foot in the door with customers who ask them to “dig their own graves.” Second, the cost of changing suppliers is not trivial, at least for non-commodity parts, and the threat of shutting down a supplier’s business is often a hollow one.

And the final reason I think the “gravy train” might be leaving the station is that among my steady clients are two Standard & Poor’s 100 companies that have retained me on long-term assignments. They don’t listen to everything I have to say, nor do they initiate every strategy I recommend, but they are starting to make changes from the traditional supply management strategies that have carried them over the last couple of decades.

What are my clients picking up on? They see that the “zero sum game” that is represented by strategies such as OEM “broad-brush” across-the-board annual price reductions is not the way forward. They understand that at least for some supplier categories the only way to get sustainable cost/price reduction is to “increase the size of the pie” so that both sides see the relationship as beneficial. But probably more importantly they see that these traditional strategies have not produced lean supply chain performance that they need to differentiate themselves from their competitors.

Going back to the reader’s feedback, ten years of working under their OEM customer’s program has not led them to leanness; instead, it has left them anorexic. The goal of every OEM’s procurement function should be lean, not anorexic, supply chain performance. I think some of us have forgotten that.

I started out by telling a story about an owner of one of my suppliers telling me that “everybody’s got to eat.” To my credit, I listened to and learned from him. I hope many of you are also listening. Suppliers are less likely than they have been in the past to “dig their own graves,” which I’m afraid may be a shock to many OEMs.

At the end of my previous blog I promised to cover “giving credit where credit is due” in my next one. Now, I will promise that I’ll get to that in my next one. That is, unless I get a reader response as profound as the one cited here.

About the Author

Paul Ericksen Blog

Paul's blog "Next Generation Supply Chain," has moved. You'll find his latest ideas and commentary on IndustryWeek's IdeaXchange. 

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Paul D. Ericksen has 38 years of experience in industry, primarily in supply management at two large original equipment manufacturers. At the second he was chief procurement officer. After this, Ericksen headed up a multi-year supply chain flexibility initiative funded by the U.S. Department of Defense. He presently is an executive level consultant in both manufacturing and supply chain, counting Fortune 100 companies among his clientele. His articles on supply management issues have been published in APICS, Industrial Engineering, Purchasing Today, Target and other periodicals.

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