Supply Chain Initiative
tombstone

Rest in Peace, Piece Price

Why supply chain management is long overdue for an overhaul.

You may ask whether step-function change is really needed in supply chain management. A historical review of the supply management function from the Industrial Revolution to today might be the best way to provide the needed justification.

Ford’s River Rouge Plant

Many scholars look back upon this factory as the true birthplace of modern manufacturing, since it was a leader in applying new, innovative practices during the dawn of America’s Industrial Revolution. The facility was built starting in 1917, in time to provide products in support of the United States’ participation to World War I. It was fully functional as a car manufacturing plant circa the early 1920s. Operations there were based on three primary areas, namely production of raw materials such as steel and rubber; fabrication; and assembly.

How does this relate to the practice of supply management, you may ask?

Because of the operational focus described above, Ford purchased very few-value added parts, instead buying commodities such as iron ore and natural rubber (latex) that would be used in-house to produce what was needed for their primary product, i.e. automobiles. And, of course, in procuring the needed commodities Ford’s primary focus was on unit pricing, which made a lot of sense.

Due to its focus on in-house production, the purchased content in Rouge River products ended up being between 10% and 20% of their finished-product Cost Of Goods Sold (COGS), making the purchasing function more of a minor tactical part of the business infrastructure, rather than one of more strategic importance.

Just for fun, let’s compare Rouge River’s supply management practices to those in use today. Today, the averaged purchased content across the finished products of U.S.-based OEM finished product accounts for about 66% of COGS. And, in fact, it is not unusual for purchased material to make up over 80% of an OEM’s COGS.

The basis of this change was OEM outsourcing of their raw material production and in-house fabrication processes so they could focus on their “core operations.”

What this meant was that the OEM focus became more and more on assembly. While they continued to buy some commodities, the vast majority of their “spend” was on value-add products.

Yet even with this transformational shift, most OEM supply management departments retain a primary focus on piece-price when selecting sources, essentially mirroring the strategy from River Rouge 100 years ago, in the industrial pioneering days.

Think about that for a minute. How many other areas in manufacturing have NOT experienced significant process change over the last century? The answer is few, if any. Because of this—at least from my seat in the ballpark—with its primary focus on sourcing based on piece-price, the supply management function remains tactical and so isn’t part of most corporations’ strategic planning. Rather, it merely executes strategies developed by other non-supply-management functions.

The primary goal of all purchasing organizations should be Lean Supply Chain Performance: developing responsive supply chains with minimal waste so that an OEM customer can also reduce their own internal wastes, for instance those associated with receiving inspection.

I’m pretty sure most people who work in the OEM supply management function would agree with me that very few supply chains even approach that level of performance. Why? Again, because of the OEM focus on piece-price. The point here is that if the piece-price focus was sufficient for developing lean performing supply chains then why, after 100 years, do significant waste and other non-value-adding costs exist in most supply chains?

Tomatoes

Unless you are around my age (63) or buy your vegetables at a farmer’s market, you probably don’t know what a real tomato tastes like. In the 1950s and 1960s, most of the produce available at corner markets—as well as at the bigger grocery chains—was still produced on local family farms. And the taste of tomatoes, then, was almost heavenly. Really.

Today, when compared to the taste of those tomatoes from family farms, tomatoes are tasteless. Why? Because for the most part family farms are no longer financially viable and have been replaced by corporate farming, meaning that big industrial farms are the primary source of produce available in most grocery stores. In other words, profit has now replaced the pride of product that existed with family farms. The result is that rather than taste, tomato varieties are produced with an emphasis on color, shelf life, transportability and, of course, piece-price.

I am married to a farm girl and even in the 1970s, her father had to work 50 to 60 hours a week in construction to be able to continue farming on the 600-acre farm his great-grandfather had homesteaded back in the late 1840s. Today, most farms of that size are considered “hobby farms” and barely produce enough revenue to cover costs. In addition to losing product quality, I believe that with the disappearance of family farms our society has lost an important underpinning to the culture of our society.

I also believe there exists a true analogy between family farms to small- and medium-sized supplier/manufacturers. Such companies were commonly started by families and/or partnerships that offered opportunity through long hours and a total dedication to the customer. In my experience, such firms provide their customers with all sorts of value-added services akin to the flavor that family farmed tomatoes provided.

What do I mean by this? When I was a technical buyer in the 1980s my factory allowed no purchased product to go into production without a print review including purchasing, engineering, manufacturing and partner suppliers. It was through this that we were able to ensure that the part’s specifications were matched up with cost-effective manufacturability. Many times, these reviews led to altered design and/or tolerances such that both production costs and piece-price cost could be lowered below what would have been required had the original design went into production “as is.”

Our suppliers were paid nothing for this service, either in compensation or out-of-pocket costs. We understood supplier capability not solely by their machine listing but also through their ideas on how to improve our initial designs to take cost out and improve safety and function.

Today I see a lot of OEMs sending their prints out for quotes without supplier review—with no effective channel for getting processing feedback on the design itself—and selecting sources solely based on piece-price. This is only one example of the type of value-add services that are available by collaborating with small- and medium-sized suppliers.

So it comes down to the dilemma we had with tomatoes. Do we want the cheapest price regardless of the taste of the product, or do we want a better product that is likely priced in the same ballpark or even lower than the initial lowest piece-price option? I, for one, want a better-tasting tomato. Similarly, when I managed supply management organizations I took the time and effort to collaborate with strategic suppliers because I knew, that by doing so, I would end up with a better overall deal. To complete the analogy, OEMs and our society have a lot to lose if we lose the small- and medium-sized supplier manufacturer in the same way we did the family farm.

Going forward, IndustryWeek will champion the need for reasonable, win-win changes in supply management focus and processes. These changes will allow small- and medium-sized supplier/ manufacturers to put their best foot forward and show OEMs that they offer a better value proposition above and beyond piece-price.

Paul Ericksen, IndustryWeek’s supply management advisor, will be a featured speaker at the Manufacturing Technology Conference in Pittsburgh. On April 2, he will lead a session in the Supply Chain track called “It Takes Two to Tango: How to Keep Both Suppliers and Customers Satisfied.” On April 3, Ericksen will conduct the workshop “Build-to-Demand: The Lean End Game.”

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