In a recent column, my colleague Eamon McKinney discussed the escalating loss of goodwill between Chinese suppliers and their U.S.-based original equipment manufacturer customers. He also pointed out that this has resulted in a loss of leverage that OEMs previously had over those Chinese suppliers due to lack of supply, with suppliers now having the ability to select from a variety of customers and to enforce price increases on available goods.
This led me to think about goodwill between OEMs and their U.S.-based suppliers, and whether the leverage between them has also shifted. It must also be pointed out that supplier goodwill is related to how customers have traditionally applied leverage in negotiations with suppliers. It is not something that can be righted overnight. While OEMs may now preach that they intend to work with suppliers more collaboratively going forward, the proof will be “in the pudding.”
I have previously written on how many OEMs have gone to excess in use of leverage over suppliers. For instance:
In Extending Payment Terms' Is Just Another Term for Pilfering, from 2016, I explained how many OEMs have unilaterally imposed extended payment terms on their suppliers, seemingly with an overall goal of not having to pay them until their own products are sold and paid for! As a result, what had once been OEMs paying their suppliers within 30 days—based on the time required to process “snail mail” invoices—became suppliers being paid over a financial quarter or two. With the implementation of electronic invoicing and payment, you should have expected payment terms to decrease
Bottom line, this change resulted in suppliers providing their OEM customers a “no interest loan” over the period of the delayed payments with the suppliers having to carry interest-bearing financing to maintain operations.
I’m pretty sure suppliers felt extremely leveraged by their OEM customers when they enacted their new payment terms.
A 2014 column, Supply Management Strategies to be Avoided, called out another practice that reduces goodwill between OEMs and their U.S.-based suppliers.
Suppliers are awarded business primarily based on having submitted the lowest piece-price quotes. Yet once that business is assigned, OEMs next tend to set annual price reduction goals for those same parts under the threat of either losing either current or future business.
You may ask, “What can be wrong with this?” Shouldn’t customers expect suppliers to reduce their internal costs through ongoing continuous improvement and then share a portion of that with their customers?
There are a couple of problems here. First, in a strategy to gain new business, many suppliers quote prices based on being able to recoup profit through ongoing cost-reduction activities.Others reduce cost by making capital investments, requiring the initial quoted price be maintained in order to support internal ROI targets. Pressure for annual price reductions increases the payback period for those investments, increasing supplier interest expense.
Many OEMs also have internal annual cost-reduction goals. The goals for these tend to be significantly less than those they set up for their suppliers. I have personally seen OEMs set their internal goals under 2%, while setting supplier goals at 5%.
Talk about a “do as I say, not as I do” proposition
The bottom line here is that OEMs don’t use reductions in material cost to lower the prices on their own products. The extra money goes directly to their bottom line. It is a fact that many suppliers reduce prices by reducing their own profitability. Instead of facilitating supplier “lean-ness,” in this case OEM leverage drives suppliers towards anorexia.
Sharing vs. Non-sharing
When business is booming, few OEMs reduce their supplier price reduction expectations. In other words, they don’t “share the wealth.” Instead, they keep whatever resulting financial windfalls to themselves. Some even demand price reductions from suppliers based on the increase in orders to them.
But in business downturns, these same OEMs often come to their supply base asking them to “share the pain.” This certainly is not a collaborative practice.
If, due to current business condition, suppliers now have enough leverage—and I think they do—they can start reducing the burden of past OEM leverage
One such action would be to demand a return to 30-day payment terms under the on the condition that if payment is not received within 30 days, all deliveries of to an offending OEM would be stopped. This will likely get the attention of OEM customers that operate under a just-in-time strategy since a lack of any supplier’s parts will likely cause factory shutdowns within their company.
Second, commit to continuous improvement and sharing any resulting savings with an OEM customer at a rate that will—at minimum—maintain profitability on each part. By doing this, you will still be offering customers potential annual price reductions, but by taking the lead assure they are based on reality, not fantasy. Target your own internal cost-reduction goals at the same level as that of your OEM customers
Third, don’t become too dependent on any one OEM customer. I have preached for years that suppliers should—at a max—not depend on any single customer for more than 20% of their revenues. Not doing so amplifies OEM leverage.
I was on site at one small supplier to a large OEM when, unexpectedly, a customer visited the supplier demanding an immediate price reduction of 15%, regardless of the contract that was in place, which defined pricing. After that meeting, I asked the supplier’s general manager how he had responded. He replied, “I had to accept it—they represent 80% of my annual revenues.” I then asked how he expected to rebound from this—his actual profitability was already in the single digits—and he replied that he had no idea.
The bottom line here is for suppliers to expand their customer base such that they are not as reliant on any one customer. This, in turn, will reduce OEM customer leverage.
Finally, realize the closer you are to the commodity end of the product spectrum, the more you expose yourself to customer leverage. In other words, it is easier to replace “commodity-like” suppliers, as there tend to be more available replacement suppliers. For instance, suppliers of simple stampings and machined parts are easier to replace than suppliers of deep-draw stampings and complicated, tight-tolerance machined parts requiring computerized three-axis machines.
For example, a supplier to the same OEM cited above—whose products were at the other end of the product spectrum when given the same 15% price reduction mandate—replied “No thanks,” and didn’t lose any current or future business.
You may think from the above that discussion I am anti-OEM. That’s not true. I am anti- many of the current strategies and practices OEMs use in the management of their suppliers. They are not collaborative and so should be considered short-term. Why? Because isn’t it reasonable to expect a supplier who has been leveraged in their relationship with an OEM to apply leverage to them when the leverage balance changes? And over the long term, this will negatively affect financial results.
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.