“There can be a perception that suppliers are making more profits than the customers, and companies often try, especially if they’re larger and more dominant, to extract that.”
These factors can mean senior ranks get it wrong when it comes to procurement. Companies that squeeze their suppliers too far can suffer disruption in their own manufacturing cycle if a key supplier collapses.
Downard gives the example of Ajax Fasteners, which collapsed in 2006. “They were the main supplier for fasteners to all the car companies. Those companies pushed and pushed for cost decreases, and Ajax fell over. But the car companies weren’t buying a commodity. They were buying specifically-designed fasteners. So they were forced to prop up Ajax for several months as they tried to find other sources overseas.
“If you do rough, back-of-the-envelope calculations about how much they paid to prop up Ajax, compared to the savings they got over several years from pushing for cost decreases, it wasn’t a very good investment.”
Leaving money on the table
When negotiating a contract with a supplier, it’s often worth “leaving money on the table”, Downardsays.
“It’s an investment in the relationship, and you’ll get payback for that.”
But the supplier-squeeze problem is rarely something that happens just in the negotiating room. In most cases, those on the front lines of procurement want to have good relationships with their suppliers, Downer says.
“The people negotiating the deals, they might have every intent of coming up with a win-win situation,” Downard says.
“But they find that as soon as the corporate lawyers get involved and come up with standard contracts and boiler-plate clauses, it’s easy to lose that original intent. It’s all very well and good negotiating win-win. But one has to contract it, too.”
The problem is that long-term, beneficial relationships with suppliers are rarely accounted for. Companies usually measure the outputs of their relationships with suppliers, rather than the relationships themselves, which can lead to bottom-line assessments dominating over more long-term considerations of business co-dependence.
Some companies and consultancies have pioneered more inclusive ways of measuring supply-chain value. For example, ‘vested outsourcing‘ is a model of outsourcing where both the customer and the supplier are formally vested in each other’s success on predefined business goals. Another way of measuring such relationships is the supply chain collaboration index, which looks at how closely businesses work together on a range of issues including quality control.
While far from the norm, many big companies follow relationship-oriented models and have success to show for it. For example, Proctor & Gamble, Microsoft and McDonald’s follow the vested outsourcing model.
With a bit of thinking, it’s possible to avoid using up suppliers to fund a business model, Downard says.
“If people recognise that those short-term actions are detrimental to the long-term, they wouldn’t do it,” he says. “But quarter-by-quarter, short-term thinking, it’s pretty corrosive to the benefits of building relationships.”
This article first appeared on LeadingCompany.
