Penny wise and pound foolish: How not to treat strategic suppliers

Cargo ship.

Recently, I’ve spent time with a number of sourcing executives who all seem to be struggling with key suppliers in low-volume, high-mix manufacturing situations. Under pressure from the “business” to reduce cost, many are finding that collaboration is a dirty word internally, even though most realise it’s essential to long-term sourcing success.

“Penny wise and pound foolish”, goes the old saying. In this case, it means that saving a few pounds on materials today could easily come back tomorrow as a capacity shortage, market delay or nasty battle over intellectual property.

Supplier power is growing

A few big trends are now conspiring to make supplier abuse increasingly painful. One is the consolidation of suppliers. The top tactic for creating value, according to our Future of Supply Chain survey 2015 conducted with over 1,000 respondents, is consolidating volumes to increase negotiating power.

Procurement tactics graph.

As a sourcing tactic, this approach makes sense for both buyer and seller, especially in the near term. On a longer-term horizon, however, the macro effect includes stronger suppliers buying out their weaker rivals, often leaving the buyer with at best a handful of competent business partners to rely on going forward. This is a dynamic that has played out in businesses like disk drives, specialised automotive electronic components, flavours and fragrances, and specialised food packaging.

The risk of being on the wrong side of this trend shows up when things like floods (Thailand) or tsunamis (Japan) expose a link that is single threaded. It also bites in times of tight capacity. Volatile petrol prices, ocean freight rates and semiconductors going on “allocation” demonstrate how sensitive this balance can be, with power swinging suddenly away from the customer and back to the supplier.

Another trend supporting supplier power is the increasingly sophisticated technology underpinning today’s product platforms. This includes consumer electronics, aerospace, industrial equipment and even automotive platforms that need not only mechanical integration but also software and even data integration to work correctly.

AT&T, for example, flagged this trend early when it established a Domain Supplier programme to treat key technology suppliers differently from the masses. The focus of the programme was on integration, collaboration and faster time-to-market at a moment of vital competitive importance when the iPhone was changing mobile telephony forever.

AT&T's domain supplier programme approach info

A final trend likely to strengthen suppliers’ hands is the rise of centrally controlled or at least centre-led procurement. Data from our Future of Supply Chain survey 2015 finds the procurement function proportionally more centrally managed than even supply chain strategy, IT or human resources. The business benefit for buyers is lower costs based on greater volumes purchased.

However, for suppliers, this too can be a boon. Centrally-led procurement means proximity to the CEO, product bosses and even finance. It also means non-price considerations like risk mitigation, technology sharing and preferential access to key resources apply on a much more leveraged scale. In a typical example, one semiconductor maker I met with last week had a top-to-top meeting with its biggest foundry supplier. The discussion wasn’t about purchasing, so much as jointly planning for future business.

Trust is everything

Supplier power may sound ominous, but only when relationships are contentious. US automakers learned this the hard way through the 1990s, when tier suppliers who were stretched to the point of breaking started shifting long-term investment to Japanese OEMs. Extensive research by John Henke of Oakland University proves the negative margin impacts on American OEMs of this combative approach.

Perhaps more important is the surging complexity of co-dependent relationships built on proprietary technology, especially in sole sourcing situations. Raytheon, for instance, relied on building a deep, business-first relationship with General Dynamics to win a big contract with the US Navy for radar systems. Playing hardball in a case like this is a lose-lose proposition.

Supply chain is more than purchasing. Suppliers should be treated as partners whenever success with end customers depends on teamwork upstream. It’s perhaps ironic, but also telling, that strict contract terminology generally matters less as a supplier’s importance grows.

After all, if it ever reaches court it’s probably because the business failed and everyone lost money.

Except the lawyers.

Author Kevin O'Marah

Chief Content Officer, SCM World

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