Every so often I read an article that I find especially meaningful. The December 6 article It’s Time to Pay Attention to Pricing Power is one of them. There are some IndustryWeek contributors that exemplify what it means to be fact-based. Michael Collins is one of them. After reading the column cited above, I need to include its author—Stephan Liozu—in that same category.
Of course, one of the reasons I like what Mr. Liozu writes is that it aligns with some of the points I make regarding practices that are essential to OEMs maximizing financial benefits from their purchasing functions. These same practices are part of what is needed to be considered a world-class manufacturer.
One of the issues I harp on in my columns is that OEMs rely too much on piece-price in selecting sources. I support this position by—among other things—citing the value of supplier capability to respond flexibly to variations in demand for their OEM customer’s products. The more a supplier can respond flexibility, the more OEMs can increase their customer fill rates and take advantage of incremental sales. This results in increased OEM revenue—and income—that should but seldom is considered in sourcing decisions, at least from what I’ve seen.
Liozu’s article points out an important consideration when selecting suppliers. Namely, a supplier’s ability to support—and contribute to—ongoing product development. Support from suppliers can improve overall product value and allow more time for products to establish themselves. This, of course, also leads to revenue and profits, since consumers are open to paying top dollar for high-value products.
I’ve seen the value of this consideration firsthand. One of my former employers had a goal each year of generating 33% of revenues from new and/or significantly upgraded products. As a result of this, our products were recognized as providing the most value in our competitive sector.
In order to effectively manage the product development that supported our product’s value leadership, we had to have close and ongoing collaboration with our suppliers. In fact, as a result of applying collaborative processes in managing our supply chain, suppliers would suggest product modifications and features that might increase our product’s value equation. And quite often we agreed and added them to our upgrade plans.
My recent experience with overseas suppliers is limited, but back in the day I found it very difficult to work with them in a collaborative way. What I mean by this is that the extent of the working relationship they wanted with us was a spec, a production schedule and a three-month firm order commitment period. Due to the time involved in their order fulfillment, they could not deliver lean performance, even if their internal factory was lean. Another way of putting this is they had extended “true” lead times.
Some will say that with the electronic communication available today, collaboration with overseas suppliers is no longer a problem. In other words, distance no longer matters. I would contest this. As an example, I can name an aircraft manufacturer that tried to work with their foreign suppliers exclusively through electronic means. This approach came back to bite them severely on a major—and highly visible—product development program. They found out the hard way that while the suppliers they had selected could produce prototype parts to spec, many of those suppliers didn’t have the wherewithal necessary to manufacture production parts in the quantities needed to support their customer’s production schedules.
You don’t learn about things like that through communication apps. It takes ongoing, on-site experience to understand supplier overall capability—at least it did for me.
The result of their electronic-based supplier management efforts was a several-year delay in the introduction of the OEM’s product—which resulted in significant levels of lost revenue/profits. By the way, it also resulted in the purchasing executives responsible for this approach needing to look for new employment.
The author also makes the point that when an OEM delivers marketplace value differentiation, the higher prices they command further support their ability to develop the new models and features that will help them maintain their product’s competitive value advantage.
This same principle also applies to suppliers. OEMs that constantly pound their suppliers for price reductions do not recognize other facets of a supplier’s value equation, such as the ability to support ongoing product development. Why? Because this continual pressure put on suppliers to reduce prices tends to drive them towards anorexia rather than lean-ness.
Consequently, this can put OEMs that source based primarily on price in a “race-for-the-bottom” relative to competing in the markets they serve.
The following is a very powerful quote from Liozu’s article: “A company cannot cut its way to prosperity.”
If you haven’t read this article, I highly recommend that you do so.
Supply Management Basics
On the other hand, I was more than a little disappointed in the opinions expressed in the article More Supply Chain than You Can Imagine. It was based on feedback from Material Handling & Logistics’ Editorial Advisory Board, which is made up of what are considered leaders in the supply management profession.
The issue I have is with what they consider the areas with the highest potential for improvements in managing supplier logistics; i.e. electronic-based applications that can reduce costs in transportation, warehousing and material management.
My position is that excessive costs in these three areas occur when OEMs work with suppliers that cannot deliver lean supply chain performance; i.e., order fulfillment with a minimum of waste. These costs can be all but eliminated when sourcing is based on creating lean supply chain performance, which is what all supply management function should be trying to develop.
The Editorial Board did note the need for increasing speed through the supply chain all the way to the customer, including distribution. To increase speed, however, there needs to be a focus on “true” lead time reduction in all facets of order fulfillment, from the supply chain through the OEM to the customer. Not pre-built and pre-positioned inventory.
Companies like Toyota, Honda, Subaru, etc. understand this and source in their primary markets. This means that for their U.S. factories, they source mostly with U.S.-based suppliers. In doing so, they minimize transportation, warehousing and material-handling costs and, by the way, can support their targeted customer fill rates with about half of the prebuilt finished product of domestic automobile manufacturers. Why? Because the domestic automakers have tended to source based primarily on the piece-price of overseas suppliers. Doing so adds significant costs related to having to rely on dealership inventory to support demand.
I’ve yet to hear of an OEM who places much weight on the need for lean within the purchasing function. This is a mistake.
Lean-ness does not imply simply being lean within your own factory walls. A company is not lean unless its complete spectrum of order fulfillment processes produce lean supply chain performance. This, of course, implies that OEM factories and their distribution process should be considered components of that supply chain.
It really bothers me when people with influence in the supply management profession seem not to consider points like those above in their opinion on sourcing decisions.
Paul Ericksen is IndustryWeek’s supply chain advisor. He has 38 years of experience in industry, primarily in supply management at two large original equipment manufacturers.