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'Extending Payment Terms' Is Just Another Term for Pilfering

Aug. 19, 2016
Don’t assume that OEMs have the power to call all of the shots. Suppliers have more leverage than they know.

A couple of weeks ago I read in IndustryWeek about an original equipment manufacturer (OEM)—one of the largest corporations in the world and one whom everyone will have heard of—that was changing its supplier payment terms from 30-days to as many as 120-days. This news didn’t come from the OEM itself but from one of its large Tier 1 suppliers. The CEO of that Tier 1 basically said “no go” and that he expected all customers to live up to their contractual agreements which, in this case, specified 30-day payments. Good luck with that!

This whole topic may seem a bit out-of-touch to those not involved in supply chains. After all, when everyday people put off paying for things they’ve purchased, it is considered debt which they incur finance charges on, i.e., pay interest. OEMs who delay supplier payments generally don’t pay interest—they just pay late. And they don’t allow suppliers to add pricing surcharges to compensate for the delayed compensation, either. How can this be?

Why do OEMs do this and why do they think they can get away with it? They do it because it gives them—in essence—a no-interest loan, thus improving their cash-on-hand. The spectrum of OEM motivations for taking such an action extend all the way from companies who are in dire straits and looking for some bit of relief to chief financial officers looking for a “silver bullet” quick-hit way to improve financial metrics. The problem is (as was laid out in my last column) that there are really no such things as silver bullet strategies—at least ones that are sustainable. The raw truth of the matter is that the financial benefit the OEMs derive from delaying payments comes out of the margins of their suppliers who, themselves, now need to borrow more just to pay their financial obligations on time.

So, why do OEMs think they can get away with it? Probably because they feel they have all of the leverage in the relationship with their supply chain partners.

OEMs’ unilateral tweaking of supplier contracts is nothing new. In the late 1990s I was visiting one of our large plastic parts suppliers. This company had annual revenues in the hundreds of millions and was privately held by a single individual. I was in the office of the owner when he received a forwarded call from his secretary that he was obviously expecting. As I got up to exit his office so he could take the call he told me to stay—saying I might be interested in listening in. The secretary then put the call through and I soon learned that the caller was this company’s purchasing contact from one of Detroit’s Big Three automobile OEMs.

That time was a time of turmoil for that OEM. Their executive leadership had recently changed and the incumbent purchasing management team had been replaced en masse with a bunch of people new to the organization. One of the programs this new supply management cadre then unilaterally rolled out was a mandated 5% across-the-board supplier piece-price reduction, which in effect breached existing contracts. This meant that the man whose office I was in was facing a loss of several million dollars in revenue to this OEM, which probably represented most of the profit he would have gained from sales to them. I was aware of the OEM’s new program—news like this travels across the purchasing community pretty fast—and was interested in hearing my host’s response to it.

He started out by citing his current contract terms which, of course, included price. He then went on to say that he hadn’t agreed to revise the existing contract and so he regarded the reduction of the prices he would be paid as breaking the contract, meaning he now regarded the contract as null-and-void. Consequently, he went on, his company would no longer honor that contract and was cancelling all future parts shipments to this OEM’s factories, including today’s deliveries.

The OEM representative just about choked. He said, “You don’t understand—this is a corporate initiative that all suppliers have to go along with.” My host replied, “What I understand is this. If within the next ten minutes I don’t receive a fax from you confirming the current contract pricing there will be no future deliveries from my company to any of your factories, starting today. That includes the three trucks currently in transit. The drivers of these trucks are waiting for my OK prior to completing today’s deliveries.” The OEM contact responded that “if you do this your company will never sell another part to our corporation.” My host replied, “I understand. Ten minutes.”

The phone call ended and I asked how much of his company’s sales were to this particular customer. He replied, “just south of 20%.” He went on to say that he understood losing this business would represent a significant business loss that would take years to recover from but that since he didn’t have any other owners to answer to, he could do what he thought was right. He went on to  add—with a small smile on his face—that according to his process engineering folks that even after the OEM had pulled its customer-owned-tooling from his factories it would take them at least a couple of months to develop and bring-up-to-speed alternate sources for the parts his company currently supplied. And since those parts were used across several of the customer’s vehicle product lines, more than a couple of its factories would face significant downtime during that period since parts deliveries to them were “just-in-time,” i.e., the OEM held no stocks of pre-built raw material.

Unlike my host, his OEM customer did have outside ownership—stockholders—who probably wouldn’t have been happy if several of their factories had to temporarily shut down due to lack of purchased parts. Sure enough, right at the 10-minute mark a fax came through to his office confirming the OEM’s intent to maintain the pricing of the current contract. My host then made three calls—one to each delivery truck driver—approving delivery.

I had always known that the owner of our plastics supplier was honest and tough. I’m sure he didn’t include me on the call to convince me of that. Rather, I think he was just giving me visibility to the-other-side-of-the-coin. In other words, suppliers also hold leverage over their customers, i.e., it really is a collaborative relationship regardless of what people and/or companies like to portray. He requested that I never retell this story and I haven’t until now—which has been done here without details or specifics so that both his identity and that of his company are protected. Further, l have never heard this story told from another source. This implies that my host didn’t take the action he did so he could boast about it later. Rather, he did it because it was the ethical thing to do. And in the end, his company’s business with this particular OEM didn’t decrease because of the stand he took. Go figure.

I relate this story because I believe suppliers have more leverage than they understand, i.e., it shouldn’t be assumed that OEMs have the power to call all of the shots. It’s true that many suppliers have more exposure than they should have with certain OEM customers—20% is a good rule-of-thumb for maximum reliance on any individual customer’s business. Suppliers with excessive exposure may feel they have to “dance to their OEM customer’s tune” when unilateral actions are imposed on them. Other suppliers who don’t have this type of reliance, however, should probably re-think whether they need to agree to unilaterally-imposed revisions to existing contracts.

I must really be out-of-touch. In the old days when I was involved in running businesses if improved financial results were needed managers were expected to do a better job of managing—not look to improve financial outcomes at the expense of other companies they referred to as partners. In other words, to figure out ways to increase the-size-of-the-pie so all parties involved in the business have the opportunity to benefit.

Extending payment terms is a phrase that doesn’t really capture what is happening here—this action needs to be called out for what it is. I’ve found that the old adage “if it looks like a duck, waddles like a duck and quacks like a duck—it probably is a duck” usually holds true. Well, extending payment terms—besides breaking existing contracts—sure “looks, waddles and quacks” like pilfering. I’m surprised suppliers continue to put up with it.

My next article will focus on what to look for—and avoid—in hiring managers.

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