Some things never seem to change. One of those is that payment plan changes rolled out by OEMs end up being to their benefit and to the detriment of their suppliers For instance, OEMs frequently increase the time between when they receive supplier product to the time that they pay for them it. For instance, it is not unusual for OEMs to pay Net 90 or Net 120 days. Although I haven’t tried it, I’m pretty sure that when buying groceries such a proposal wouldn’t work. It is also not uncommon once an OEM adopts such a strategy to increase payment lag time every couple of years. What a deal.
I once wrote a column where I called such a practice larceny since it in effect both reduces the price OEMs paid for their goods—due to inflation which always exists, at least at some level—and increases supplier costs, since they have to finance their finished goods “inventory” over a longer period.
A couple of years ago, some OEMs started to use another approach, which, believe it or not, was even more chilling than simply extending payment terms. Specifically, it involved OEMs outsourcing supplier payments. Under this scenario, an OEM would pay a discounted price for the parts to a third party whose business plan was based on being able to pay suppliers than the price they had paid.
The third party was given a lot of flexibility in how they worked with the OEM’s suppliers. For instance, they had leeway to increase the time between OEM receipt of goods and supplier payment for them. The carrot they then presented to suppliers was they could get earlier payment for accepting lower pricing. Remember, the price reduction the third party needed to justify their participation included the both discount they accepted from their OEM customer and the profitability targets of their own company.
You may ask “how insidious was this?” You only had to look at the type of advertising language the third parties used in trying to convince OEMs to work with them. One such ad stated:
“Have your suppliers finance your operations.”
Now we hear that Lockheed, General Motors and Ford are offering a program that pays suppliers in the shorter term. But you only have to look at the details of the program to understand that it is more akin to the two previously described programs than a boon for suppliers.
Specifically, these OEMs use banks as their third-party payer of invoices. The banks then charge their fees—which include some level of profit—to suppliers. In the end, the bank makes money and the supplier receives a lower piece-price. And although I don’t know this but suspect that the OEM gets some sort of kickback from the bank for their business which, if so, would also be included in the bank’s fee.
Back in the old days, OEM payment terms were typically Net 30 days. This was during the paper age, and the 30 days took into account the processing time needed by the OEM to receive the material and process the expenditure. Suppliers, for the most part, recognized that this was a realistic-based delay in payment and accepted it.
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Today, receipts and payment are made electronically, so you’d think that even 30 days wouldn’t be needed for the receipt and payment transactions to occur. For instance, today a person can immediately transfer funds from savings account to either their debit card or checking accounts through the phone. Instead, rather than reducing the times, OEMs have for the most part increased them for no practical reason other than to increase their own company’s profitability at the expense of their suppliers. No supplier I’ve ever had contact with has accepted that there is a process-based need for OEMs doing this.
What is the result when this occurs? In the short term, an OEM may experience lower material costs. Over time, though, supplier price increases are necessary to remain viable and the OEM benefit no longer exists. But—this is an important but—the need for suppliers asking for price increases put the issue directly in the strength of OEM purchasing functions. In other words, much of the training of purchasing personnel is in delaying, reducing or even denying legitimate price increases, i.e. ones driven by customers. There ought to be a law.
A few things really irk me about the whole issue of payment terms, which I’ll outline below:
- There seems to be no analysis or even mention of OEM payment practices and their impact on suppliers in the business press. I think that if there was more awareness of this phenomenon there would be increased pressure for OEMs to change their practices. On the other hand, maybe I have rose-colored glasses on as I write this.
- To my knowledge, no academic has written case studies on the three payment scenarios outlined above detailing their workings, the positive financial impacts OEMs reap from them as well as the negative impacts suppliers incur. Included in this study should be a discussion of how suppliers react to such schemes and how effective the supplier is at regaining lost profitability—in effect, eliminating some or part of the OEMs initial financial windfall.
- OEM payment programs are unilateral, arbitrary and based on leverage—not collaboration. For instance I’ve never heard of a new OEM extending a payment term based on consideration of the impact on suppliers. Never. Second, although I don’t think this is well understood, the new payment terms are not applied evenly overall all suppliers. It all depends on who has the leverage.
For instance, a couple of years ago a Fortune 100 domestic aircraft manufacturer announced that they were increasing the length of its payment lag time from Net 100 to Net 120 days, as well as requiring suppliers to lower prices by 15%. If they didn’t go along with these two changes, the OEM threated to pull their business, even in the case existence of existing contracts.
One of this company’s suppliers was another large corporation. They owned the intellectual property for their designs, which they sold to the aircraft manufacturer essentially as a “black box” component. This company rejected out-of-hand their customer’s demands and were given a pass on them. SMEs, however, don’t have this much leverage and usually have to accept such customer dictates.
Writing this column has been cathartic for me. Why? I don’t like bullies and feel one way to defend oneself from them is to put a spotlight on their bullying.
In my mind, the three scenarios outlined about represent both a form of bullying and OEM supply chain practice at its worst. I’d really like to hear from readers on experiences they may have had with this and how they reacted. Based on the volume and nature of responses I receive, perhaps this issue would be another good focus for a wider reader survey.
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.
