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Small Change 24221603

Suppliers Are Like Workers: They Both Come Up Short

Jan. 4, 2022
Note to OEMs: ‘Continuous improvement’ doesn’t mean continuously sticking it to the little guy.

My November 11 column, ‘We Are Not a Family’: Is It Any Wonder Workers Are Unhappy?”, discussed how many corporations have marginalized wages, whittling down the employee leg of the traditional “three-legged stool” of corporate stakeholders and channeling more profits to investors.

Since my columns typically focus on how OEMs can more effectively manage suppliers, let’s tie these ideas to the supply chain. The goal of most corporations—at least in theory—is to compete more effectively by becoming world-class-performing enterprises.

An important point that many corporations miss is that world-class status relies on having both internal and external world-class operations.

On the internal side, this requires world-class, incented employees. On the external side, this requires world-class, incented suppliers. Hence, it’s logical to think that both employees and suppliers should figure into the equation for overall corporate competitiveness.

Downgrading of Worth

The previous article laid out the case that over the last generation, corporate treatment of production employees has plummeted. I’ve observed that corporations also subject suppliers to this same downgrading of worth.

On the employee side, it has been well documented how wage workers have not shared in overall pay and benefits during corporate boom times. 

For example, John Deere recently settled a strike by providing what at first seemed to be a pretty good compensation package. A few days later—was the timing a coincidence?—Deere announced another fiscal year of record profits.

Review that corporation’s financial performance over the last 20 years, and count how many times Deere has achieved record profits. It is almost becoming an investor expectation. And if you look at the company strategy for managing its employees—a dual compensation package that differentiates between “new” and incumbent employees—it is clear that there has not been a true sharing of “the good times” with production employees.

On the supply side, suppliers gain new orders primarily by quoting the lowest piece-price among all bidders. This is a short-sighted strategy on the part of OEMs that leads to reduced financial results. But let’s put that point aside for the moment.

The result of the quoting process is typically that the winning supplier is selling to the OEM at what is considered a very competitive price. But then the OEM expects “continuous improvement” annual price reductions—often on the order of 5%--on that originally “competitive” price. Let’s look at what that usually means.

Read more of Paul Ericksen's supply chain management articles.

It is not unusual for an OEM to sell versions of a product for five to 10 years. This implies that the specs for many of the parts used in those products also remain in production for those same time frames. Let’s look at what this means from a supplier profitability perspective.

A 5%-annual OEM price reduction over five years would result in a corporation paying the supplier just over 77% of the original quoted price. After 10 years, the same expectation is that the price will be just under 60% of the original price.

Most of the time, after some negotiation, these 5% annual reductions do not fully occur. Yet the constant pressure from OEMs to reduce prices is real, and suppliers are the ones that take the hit.  

Have you ever seen an OEM reduce the retail price of their product by either 23% over five years or 40% over a 10-year life? I haven’t. So where does the money go? To corporate profitability, with the resulting raise in company stock price.

Going-Out-of-Business Sale

My column “Don’t Let Small Manufacturers Go the Way of the Small Farmer” lamented the significant reduction of family owned and operated farms. I posited that small- and medium-sized manufacturers, often family-owned, are positioned to fade away in a similar manner. And it is happening.   

The OEM focus on piece-price in sourcing—and piece-price reduction in supplier-retaining business—has driven out of business about half of SME enterprises. I base that reduction on the percentage drop in manufacturing’s contribution to this country’s gross domestic product over the last 30 years.  

Other SMEs have been sold to holding companies, either when private owners tire of the constant pressure of keeping their companies financially viable, or when the next generation decides not to put itself through what their parents have gone through.

Holding companies are known for buying SMEs, making extensive operational cuts—including cutting employee compensation and/or reducing staff—and treating their purchases as “cash cows.” Believe me when I say that it is not a nice experience for a purchasing manager to have to deal with a holding company. Compared to SMEs, holding companies tend to have more leverage and often parlay that into higher prices for lower levels of performance and support.

So, do we really want to continue down the path where SMEs either go out of business and sell out to holding companies? Or that we become even more dependent on overseas suppliers?

I surely don’t.

I think a basic tenet of this country is that if people are willing to work hard, they can pull themselves up by their bootstraps. There is less opportunity for getting a foot in the door at large corporations than at smaller supplier manufacturers. Not everyone is positioned to be a technology entrepreneur or corporate executive.

Let’s be clear. The way that corporations have managed their employees and suppliers over the last generation has not been to “remain competitive.” It has, for the most part, been to increase stock price. So in my mind, corporate complaints about needing to keep wages and material costs low to maintain their competitive edge is a red herring.

A tilted stool is not stable. Employees and suppliers are important stakeholders. OEMs cannot successfully compete in business if these two stakeholders are not loyal. OEM loyalty to their employees and suppliers is returned in kind.

Workers and suppliers have already started pushing back at their corporate employers /customers. OEMs need to re-evaluate their strategies and practices to remain relevant.

Paul Ericksen’s book is Better Business: Breaking Down the Walls of the Purchasing Silo. Ericksen has 40 years of experience in industry, primarily in supply management at two large original equipment manufacturers.

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