I admit it. I’ve never really enjoyed fairy tales, even when being read to as a young child. Harry Potter? Never read a single one of the books or watched the related movies. I have always been more interested in hearing about real things done by real people. To this day history is my favorite leisure reading subject.
Along these same lines I’ve never laid much stock in people advocating Silver Bullet solutions. Over the years as I’ve observed and observed the impact of many such offerings successfully foisted on companies this position regarding them has been pretty much validated. In other words, they had incremental positive impact—at best. Sure, there are really good ideas out there that properly packaged might represent elegant solutions to just about every problem faced in business. And based on circumstances they may bear using. But even then—in my experience, anyway—their adoption requires significant amounts of extended heavy lifting. It may be a sad realization to some but there are really no magic elixirs out there that when applied will make everything better—just as there are really no unicorns.
I thought it might be illustrative to review a case study I was involved in with one such offering that at was being championed as a sourcing process alternative, i.e. a Silver Bullet. Anyone who has been involved in the due diligence of source evaluation knows that to be competent at it requires a special background and significant investment in time and effort. They also know that to short-cut either can expose an original equipment manufacturer (OEM) customer to what can be catastrophic financial impacts relative to loss of production, warranty expense and/or product related liability claims. In spite of this, about 20 years ago several commercial companies started marketing “on-line auctions” as an alternative to the traditional sourcing process. These companies offered to take over responsibility for supplier capability assessment and then host a real-time (Dutch) auction in which potential sources would vie for business, i.e., the action of a Dutch auction involves participating bidders undercutting each other’s price proposals until a lowest overall price is arrived at. The advertising by these firms virtually guaranteed OEMs lower purchased part pricing.
I got involved with online auctions in the late 1990s when I was a sourcing manager and my company had just brought in a person from the outside to replace my manager, who had just been promoted. My new boss wanted to make a splash coming into his new job and decided that on-line auctions were just the thing to use to demonstrate to his new employer what a great decision they had made in hiring him. Shortly after he came on-board he called me into his office and told me to conduct an on-line auction on our machined rounds and tubing spend. I questioned, “Why with these products?” and he answered that he had a lot of experience in that product area and felt it generally had great potential for reduced pricing. I pointed out to him that over the last two years we had provided extensive Supplier Development support to all machined rounds and tubing suppliers and that based on this perhaps it would be better to focus on another product grouping. He just smirked and said, “Make it so” (really, just like Captain Picard, those were his exact words!).
As this was the first on-line auction to ever have been conducted by my corporation I had some research to do regarding them. Here’s what I found out. The cost to the OEM is for the up-front set-up and conduct of a real-time Dutch auction. What the OEM is essentially paying for is the auctioneer’s promise to bring a set of capable supplier participants within the targeted commodity to the auction to compete against your incumbent sources. At the time our fee came to around $100K. The second cost is borne by the suppliers who end up winning business during the auction. It takes the form of a manufacturer’s representative fee on all business they win as a result of the auction. Again, at this time, the fee amounted to between 3% and 4% of the bid piece-price. So—no matter who wins—the online auction company gets an agency fee across the total spend! A pretty good gig if you ask me. I won’t go into all of the details of what was involved in putting together and reviewing and/or otherwise supporting quote packages for a group of potential suppliers (in our case, six) that we had never previously engaged with but I will tell you that it took up a lot of time and effort.
When I met the online auction team I experienced a bit of apprehension regarding their capability to adequately conduct supplier assessments. Although they did have what appeared to be a pretty good Supplier Assessment Tool around which to structure evaluations, the actual assessment team was staffed by three individuals who looked to be in their early to mid-twenties, i.e., pretty young to have accumulated the experience needed to understand how to assess supplier capability, in my thinking. In fact, in talking to one of them, I found he was a recent college grade and this was his first job. Hmm. Regardless, I was under strict orders to run a successful on-line auction so I held the course and allowed it go forward. Shame on me.
The actual online auction event ended up being a “goat rodeo,” to put it diplomatically. As I mentioned earlier in the article we had recently focused Supplier Development support on this commodity and as the real-time bids came in it soon became clear that the bids of the online auction company’s alternate sources weren’t going to get anywhere near our current pricing! In fact, they generally came was in at just under 10% above that pricing. I remember sitting there as one of our current suppliers asked whether this meant they could raise their prices since they obviously were too low! What a mess. As a consequence I got to put up with some serious face-to-face venting—as well as eat significant crow—from those current suppliers as I sat down with each of them post-auction in an attempt to restore the collaborative relationship we had previously worked under.
Afterwards, the company conducting the online auction told us that this had never happened before in auction conducted by their company. On the one hand I was pretty happy to hear this since it seemed to confirm the effectiveness of both our own in-house sourcing process and approach to supplier development. On the other hand it was a real downer to find out that the on-line auctioneer had no intention of refunding all or part of the up-front fee we had paid. After all (according to them) “they had out-of-pocket-costs they had to cover.” Another result was that my boss was furious, as he had been touting the auction event across the corporation and the results weren’t going to give him the kind of exposure he had been looking for. That same day he told me to organize another on-line auction, this time in a commodity group where Supplier Development support hadn’t been previously provided!
Wire Forms was selected as the product group for our next auction. I won’t get into the details of Wire Form processing other than to say that on more complicated parts their manufacture can involve at least as much art as science. In other words, it is difficult to predict up-front the actual processing that will be required to consistently manufacture such parts. We went through the same preparation process as we had before—again, a lot of work—and then conducted the real-time Dutch Auction. Three part packages were successfully bid on—about half of the parts that we had put up on auction—bringing two new suppliers into our commodity group, with New Supplier #1 getting one of those packages and New Supplier #2 getting the other two. The average savings on those three packages was a mid-single digit percentage. My boss was happy and trumpeted this/his success to anyone that would listen. In fact, in the weeks after the action he did a “dog and pony” show across the corporation showing how easy it was to reduce supplier prices, i.e. on-line auctions obviously represented a new Silver Bullet approach to sourcing. But now you get to hear the rest of the story.
Bottom line, implementation was a b*tch. Here’s what we experienced.
By contract, we had a 90-day window with suppliers when business was to be resourced. In other words, our current suppliers agreed up-front that if they lost business they would continue to maintain supply for a period of 90 days at current pricing. Shortly into the transition of the first package it became apparent that New Supplier #1 was having difficulty in actually producing the parts they had successfully bid on! This left us in a quandary since we needed to maintain continuity of supply. As a result I took a road trip to Incumbent Supplier #1 (the one who had lost the first part package) to request that they continue supplying us past the contractual 90 day window. They declined! After much cajoling (and personal groveling) they agreed to continue to supply us the parts in question until New Supplier 1 could get production approval on them—but at a 40% premium. Ouch! When I balked, they responded that in putting their business with us up for bid on the Dutch auction we had communicated to them that we no longer wanted the previous partner relationship that had existed between our two companies and that in the future they would only work with us on a commercial basis. In other words, the 40% higher price was a “take it or leave it” offer. I had no choice but to take it. In the end—even with an extended ramp-up period—New Supplier # 1 couldn’t get production approval on about 1/3 of the parts that were in the package they had successfully quoted on. So, with under a 10% savings on 66% of the package and an ongoing 40% increase on 33% of the package, we ended with higher overall pricing on that first package.
New Supplier 2 had some of the same production ramp-up issues as New Supplier 1. To make a long story short, we also ended up also having to pay a premium to Incumbent Supplier 2 to extend the ramp-up beyond the contractual 90 days. And even though New Supplier 2 was eventually successful in manufacturing and supplying a fairly high proportion of the two packages they had won, in the end the savings was more of a “mole hill than a mountain” due to those parts that they weren’t able to obtain production approval on. Across the three parts packages our overall spend went up.
So what was the result of this Silver Bullet event?
- No piece-price financial benefit.
- $200K in up-front fees.
- A significant additional procurement work load in support of both the quote and the production approval processes. This is time that could have been spent working on lowering costs and prices in traditional ways.
- Significant deterioration of relationship with two high performing incumbent suppliers.
- Two additional suppliers to manage within the commodity. Managing more suppliers takes more time and resources.
- Two new suppliers for our design folks to have to learn to work with. Again, adding new suppliers implies additional work-load.
- Below average quality and delivery performance from the two new suppliers.
- I could go on and on.
On the positive side, I guess I was right with my intuition about the lack-of-ability of the online auction company’s 20-something employees to conduct capable supplier assessments. On the negative side, the whole online auction sourcing experience created a chasm between me and my new boss that never mended. I worked for him for another year-and-a-half and it was not pleasant.
So, what did I learn? Source capability assessment is probably the most important purchasing function. To do it well requires significant experience and heavy lifting. In working with online auction companies OEMs essentially outsource this responsibility which, at least in my mind, poses the following question:
“If your company is willing to outsource the most critical supply management roles—why stop there? Why not outsource the whole function and see where that gets you?”
By the way, companies have actually tried outsourcing their purchasing function and for the most part it hasn’t worked out so well for them.
There are usually no easy paths for doing things the right way. Next time you hear someone promoting a Silver Bullet approach let them know that you’re willing to try it out just as soon as they can bring you incontrovertible evidence of the existence of unicorns.
My next article will be on OEM payment terms.