When sending out a request for quote (RFQ), original equipment manufacturers have the option of soliciting bids either on individual parts or parts packages as a whole. This latter practice is often referred to as bundling, and its purpose is to incentivize suppliers to quote in the most competitive manner since they can sense a significant amount of business is at stake. This practice, in itself, is not procurement malpractice.
It becomes malpractice, however, when the OEM changes the quoting process after bids from all of the potential suppliers have already been received. What do I mean by this?
Even in bundled quotes, suppliers are expected to give detail pricing on the individual parts included in the bundle. Unfortunately, OEMs often use this to their advantage by de-bundling the parts, effectively treating these line items as quotes for single parts. This is called “cherry picking,” and should be considered malpractice.
When suppliers quote on a bundle of parts, they don’t simply add up each cost per part to arrive at a total. The quoted cost is lower because bundling helps suppliers lower their own costs through strategies such as leveraging material acquisition across multiple parts, combining several parts for processing, etc. This allows the supplier to quote more competitively than with separate bids for each part.
The end result is that if a supplier wins the bidding for individual parts but not the whole bundle, the supplier loses out on margins and OEMs reap lower composite costs. OEMs also gain a false sense of what the parts would cost if individually ordered.
A supplier CEO told me this story: He had RFQ of about a dozen bundled part numbers. For over half of the parts, his company offered a significant pricing advantage over the other bidders. For the remainder of the parts in the package, he was very competitive with the lowest price. The OEM gave the supplier only the parts with significant savings and gave the other parts in the package to other suppliers, even though the price in the bundled parts was off by maybe 1%.
Certainly, in his mind, the OEM had exhibited procurement malpractice.
Drop-in Price Reduction Mandates
Purchasing contracts usually address pricing over the duration of the agreement. Sometimes they detail firm prices. Sometimes they define expected annual supplier price reductions. And at other times they may define price adjustments that will occur with either rises or falls in uncontrollable supplier costs, such as in raw material.
This is all “OK,” since any supplier entering such a contract agreement understands what they are getting into.
Or do they?
Today it is seldom that you see simple, concise and straightforward contracts. OEMs typically have legal departments and it usually is lawyers—who know nothing about supply chain except a lot of “wiggle word terms”—that put together their employers standard purchasing terms contracts. The end result is that they are usually long and detailed.
I was once a chief purchasing officer for a company that was an outside purchased product (OPP) supplier to another corporation. Just after I came on board, I asked for a copy of the contract so I could become more familiar with the relationship our company had with an important customer.
I was given several bound volumes comprising over 10,000 words. It turned out that no-one on my purchasing staff or the in marketing department—which had signed the agreement—had read it.
Many OEMs use contracts as a basis for legalizing malpractice.
The CEO who I spoke with recently related a story about a personal experience one of his companies had relative to a contract. Halfway through a three-year contract, one of their important customers phoned to tell them that they would need an immediate 15% price reduction in order to keep their business. I suspect that the OEM asking for the price reduction could reference contract language that gave it the flexibility to act in this way.
This meeting was being conducted as a conference call between a couple of OEM procurement people and the CEO, who responded—in a professional way—that he wouldn’t be departing from current contract pricing terms.
OEMs that try pull this tactic usually believe (or at least project) that they have all of the leverage. In other words, they both have more lawyers—who know how to extend a case years, if not decades—than the average suppliers, and have replacement suppliers “in the wing” should they wish to break a contract. Many suppliers put in such a situation accept this premise and believe there is no other choice than to accept the new pricing terms.
So, the conference call ended. At least the OEM participants thought so. But they apparently hadn’t pushed the correct phone button to close out their end of the call. So the CEO of the supplier heard all of their subsequent discussion.
Basically, they asked each other, “What do we do now?” They discussed that they had no short- or medium-term resourcing plan since the supplier they had just been on the phone with had unique processing capabilities needed in the manufacture of the part. In the end, they had been putting up a “false front,” hoping to “bully” their source into submission.
Anyone with any morals would certainly consider this procurement malpractice.
I wonder if, at the end of the OEM’s fiscal year, the procurement people who failed to get this supplier to reduce their price got coal in their stockings rather than the bonus they had been hoping for (:=0)!