If anything, tariffs and the coronavirus pandemic have taught purchasing personnel that sourcing strategies need to include some sort of fallback plan. In other words, OEMs shouldn’t be putting all of their eggs in one basket. Unfortunately, too many of them have done just that by selecting and doing business with the one supplier who quotes the lowest piece-price. Often, this supplier is located in a low-wage overseas country, adding more variables and uncertainty to supply-chain management.
The stress this puts on worldwide supply chains is being recognized more and more. The question then becomes, “What is to be done going forward to provide some level of assurance to OEM customers that future supply chains will perform better under stress than they do now?”
There are two primary approaches to OEMs increasing the certainty of their supply chains, specifically having either a plan B or a contingency plan included in their overall sourcing strategy. Their differences will be discussed below.
Plan B’s
Plan B’s are back-up strategies where a customer has other pre-defined potential sources of what they buy and have had discussions with those suppliers to confirm they are capable of producing the needed parts or products. That may seem a good approach, but the challenges are in the details. What do I mean by this? As an example let’s consider the electronics industry.
Electronic product companies typically do not manufacture either the components used in their products or the actual products themselves. Instead, they deal with contract manufacturers located primarily overseas. The margin that contract manufacturers make on what they produce is usually between 2% and 3%, so there is not much wiggle room to account for manufacturing waste or errors. This means that to make a profit, such suppliers cannot rely on generic manufacturing processes. Rather, they develop unique processes for the manufacture of one (or a family of) specific products. To financially protect themselves, such suppliers usually require both long-term agreements and substantial—often several months or more—commitment to production schedules.
An important point is that plan B suppliers are not currently manufacturing products for their potential customers. Based on the above, it is not a good assumption that a backup plan supplier can—on short notice—provide sufficient quantities to support an OEM customer’s market demand. In other words, the fact that they are capable of producing your products can mean that they are already producing similar product for your competition, who can use up the bulk of that supplier’s capacity. In other words, to meet new customer needs, plan B suppliers will likely have to both develop specific manufacturing processes and invest in additional capacity.
Once a plan B supplier starts actually producing parts, most customers then require a review and confirmation a supplier’s process capability. This adds time to a plan B equation.
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Another factor is logistics. In the case of both tariffs and the present pandemic, OEMs are scurrying to arrange for the transport of product from new a supplier to their own point-of-use. You may observe that since no additional load is being added to the worldwide transportation web, that theoretically freight service providers should have the needed capacity to support rerouting of customer needs. Anyone who has been involved in logistics, however, will tell you that this is not the case. In fact, short- fuse rearrangement of freight routes can be a challenging task in the best of circumstances; i.e., you are not the only company that needs this. Large numbers of other customers also looking to do so increases the re-routing challenge magnitudes.
There are other issues that need to be considered; however, the above should give you a flavor for the types of things you’ll need to account for when your back-up strategy is based on having a plan B.
Contingency Plans
The main difference between a plan B and a contingency plan is that with the latter, you already have multiple sources supplying your company with the same product. This can, of course, add cost when tooling or fixtures are needed in the manufacture of the product, but most companies that employ a contingency plan strategy consider them a form of insurance. What are the benefits of having a contingency plan when a crisis dictates that a short-fuse sourcing change is necessary? That can be answered by examining the case of dual sourcing, which is their most common form.
Dual sourcing typically involves having both an overseas supplier and a domestic one. The overseas supplier is usually selected primarily on piece-price, while the more local supplier is selected on overall capability and being at least ball-park-competitive in pricing. One such factor in their selection is that they can react flexibly to increases in customer demand. As stated above, there may be extra costs involved in this type of strategy relative to the duplication of tooling, fixtures, etc. Higher piece-prices may result when there is a disparity in pricing. But due to the supplier’s more agile order fulfillment capability, that can be somewhat offset by reduced logistics costs and the ability of the customer to reduce internal overheads; i.e., vs. parts coming in from overseas.
What does an OEM customer garner from the investment needed for a contingency plan?
First, lean local suppliers don’t require a significant firm-schedule commitment as opposed to overseas suppliers. Consequently, local sources have a better chance of supporting short-fuse surges in demand.
Second, a dual-source arrangement sets up well-defined competition between the two suppliers—some of the ground rules of which are laid out below;
- As long as a supplier remains “ballpark competitive” piece-price wise, they will retain a minimum amount of overall requirements. I’ve seen ranges on "ballpark competitiveness” set as high as 5% to 10%. The minimum business suppliers who are within the defined “ballpark” is typically between 20% and 33%.
- The percentage of annual business each supplier receives is set based on their ongoing competitiveness. This creates quit an incentive for suppliers to work on cost reduction. When both suppliers are equally competitive, each gets a 50% of the business; however, when one of the parties becomes obtains a competitive advantage, they are rewarded with an increased level of business. The OEM will need to set their own sliding competitiveness scale for defining how their requirements are allocated.
- Capability to support short-fuse requirements is taken into account in the overall competitiveness equation, and it becomes easier to financially quantify due to having two sets of data points; i.e., what incremental sales one source can support and what would have been the financial loss if they hadn’t been supported.
There are also potential customer internal overhead cost reductions available when sourcing with a supplier with greater order fulfillment flexibility. For instance, a source—based on documenting their process capability—may not require as much customer receiving inspection. Local sources have an advantage by being able to deliver lower quantities through more frequent deliveries, lowering customer need to carry raw material and incur inventory management costs. Local sources are positioned to provide lower-cost on-site support when the need arises.
There are many additional customer internal costs that have the potential to be reduced by buying from a supplier with more order fulfillment flexibility.
On the other hand, I’ve seen a lot of OEM Total Cost Formulas based primarily on piece-price and logistics and, as you can see from above, this doesn’t actually represent a true picture of the costs of working with a supplier.
The main glitch that can interfere with a dual-sourcing strategy is when the minimum percentage of business is set too low or when suppliers aren’t really given a fair shot at increasing their percent of overall requirements outside of actual piece-price. Otherwise, I have seen having dual sources work as a contingency plan, and work well.
It is interesting to me that having a contingency plan based on dual sourcing is not a new concept. Old-timers will remember that even when sourcing overseas was not popular, it was a common strategy to source from two suppliers as a form of insurance should a crisis occur with one or the other. But then China started their manufacturing initiative and OEMs started chasing piece-price instead of valid total costs, and that idea mostly went away.
You might want to consider how your company strategizes to ensure supply chain performance, and whether that plan will be sufficient in the case of crisis.
Paul Ericksen is IndustryWeek’s supply chain advisor. He has 40 years of experience in industry, primarily in supply management at two large original equipment manufacturers.
