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Troubled waters

An expert offers tips on dealing with business storms before they hit

In today's business environment, where every firm has to focus intensely on ways to achieve a cost structure acceptable to their customers, tremendous strains can emerge between suppliers and customers, even ones that have had a long history of shared successes. It takes a significant effort by suppliers and customers to ensure that such strains are avoided and that there is a common focus on creating value.

The message in the case study and comments to follow is an important one. If your firm is involved in a CoDestiny relationship, one that has yielded value through shared successes and one you want to have survive and thrive, you need to be proactive in planning for the possibility of storms in the future. Such storms can take on many shapes – new people, profitability problems placing pressures on key executives, a deliberate change in strategy, an acquisition, among many examples. It's not enough to do "good works" and to deliver value. You must anticipate the inevitable storms that will someday appear, and prepare for them with frequent discussions, information exchanges, scenario plans and, occasionally, tough messages. When the storm hits, previously calm waters can quickly become troubled. At that point, it will be too late to do anything other than be taken wherever those troubled waters take you. The case study that follows
describes one strong supplier-customer relationship in which the waters unexpectedly became troubled.

"We have been a loyal supplier [to a certain customer] for years. We have innovated and allowed this customer to develop new products and grow to become the dominant player in their industry. Even though we have a great working relationship with all of the engineers and product development teams, a new purchasing executive arrived, introduced a totally new culture to his department, and began to run Internet auctions. These procurements gave no recognition to the value we create and there was only a 10% weighting in the formula for the quality of product and service that this firm gets from a supplier. This firm gave us their Supplier of the Year Award three years prior to this time, and we think our contributions have increased since then. In these Internet auctions, we are being compared side-by-side to suppliers who don't belong in the same room." [Ingredient Supplier Sales Executive]

Between technology changes and globalization, powerful cost reduction tools are available to modern purchasing departments. By writing specifications and using modern outreach tools to identify possible suppliers, a buyer can receive bids from suppliers across the world and choose the lowest cost supplier, and even groom an unqualified candidate into a future low-cost supplier with modest effort. In cases of low switching costs, this can be repeated almost real-time whenever another purchase occasion arises. Some buyers have become even more creative by holding multiple rounds of bidding to drive costs lower.

To suppliers, it seems like a game with loaded dice. Moreover, from the supplier's perspective, the customer that ignores everything other than price often ends up worse off, failing to sustain leadership in product quality and innovation. The same executive made these points in describing the outcome of the auction run by this customer:

"So, we played along and put in our bid. What else could we do? We cut to the bone, reducing our margins and substituting cheaper materials where we could without reducing the quality we typically engineer into our products. We managed to get our bid to the point where we were confident that it would be the lowest, so our internal celebration began because we thought there was no way we could lose given our aggressive bid and the superior quality of our product. But then, we got a call saying we had lost to another supplier. We later learned that the winning supplier had put in a bid that was only about 1 ½% lower than our bid. We learned they got the exact same score in the 10% element for the quality of product, even though this supplier has a history of quality and delivery problems well known by everyone in the industry. At this point, we concluded this was no longer a customer that valued us, if they were willing to pass us over with a process like this. From our perspective, they were willing to make a horrible long-term decision, trading off all the contributions we had made to their success in order to gain a very small price concession up front." [Ingredient Supplier Sales Executive]

Unfortunately, case histories like this one emerge all too often. In this instance, we also had the opportunity to speak with executives in the organization making the purchase decisions described by this ingredient supplier sales executive. Like most stories, there were two sides to
this one.

"Our business was changing, and even though we were the industry leader, we had tremendous concerns about our competitive position. Most of our customers had been regulated in the past, and were able to get approvals for their pricing based upon their cost structure. Now, as they go through deregulation, they are fighting it out over price and that's impacting their choice of suppliers. Some of the things that were important to our customers in the past are now 'unnecessary bells and whistles.' So we have to do the same thing they are doing, and make the tough decisions to get our own cost structure to the point where we can win. There were a lot of things we had to change, often to the great disappointment of our own engineers who were used to being rewarded for upgrades rather than for cost savings. And in the case of the ingredient we buy from [the supplier in question], it's such a significant part of our cost structure that every percentage point of savings is huge in the overall scheme of things. And it was one of the areas where both our customers and we felt there were some of those 'unnecessary bells and whistles'." [Customer General Manager]

When we talked with the purchasing executive that had run the Internet auction in question, we got even more insight into this situation:

"I've heard a real earful about this situation, both from our own engineers and from [the supplier in question]. They did have a long history with us, but they somehow stopped listening to us. Maybe the history got in the way. We had a bidder meeting they attended and we were very clear about the direction we were heading, about why getting to a lower cost point was the focus of our procurement. We said over and over that our world had changed. Most of the bidders heard that message. I don't think [the supplier in question] heard it very well, maybe because it was a new message, not the one they've heard over the years and probably not the one they hear even today from their friends in engineering. Or maybe they just assumed we were posturing for the other bidders in the room, thinking the message wasn't oriented to them. And while they do have a great track record, we have confidence that we've put in a structure with which we can succeed with [the winning bidder]. They've committed to funding sufficient inventory with us so that we aren't worried about delivery, and they have the ability to produce the ingredient according to our specifications." [Customer Purchasing Executive]

How to avoid a similar dilemma
It is essential for key principals in a CoDestiny supplier-customer relationship to get together regularly and ask the following questions: In terms of your expectations and priorities, what has changed since we last met? Looking forward, what changes should we anticipate and address? What new nightmares are keeping you up at night?

In any significant supplier-customer relationship, there are going to be many "touch points" between the two organizations. That's almost always a good thing, as insights necessary to spark value contributions often emerge from unexpected connections across the two organizations. But there can sometimes be a downside to such unconnected exchanges of information. The second recommendation is therefore that the principals in the relationship must regularly say to each other, "This is what we're hearing from your organization and how we plan to react to it. Are we all on the same page?"

The "two sides to the story" that were so sharply illustrated in this case study are especially dramatic in supplier-customer relationships that involve products with long life cycles in which total cost of ownership calculation is complex. In such circumstances, the focus on purchase price or "first cost" is often the basis of tension and the root cause of differences between the supplier and the customer. That was an important part of the problem in the case study. The ingredient supplier's focus and confidence was based upon life cycle contributions they were making to this customer in both product quality and the contributions they were making through the relationship. The customer's focus, on the other hand, was driven by their belief that their own customer's cost calculation was skewed toward first cost and that their customers had relabeled other factors as "unnecessary bells and whistles."

This fact leads to the third key recommendation. Within significant supplier-customer relationships, best practice organizations implement processes to ensure that there is a common understanding of what creates value and what doesn't. This process involves formal meetings, information sharing and interaction about what should and shouldn't be included in the valuation calculation. The third recommendation is to always ensure that both organizations are on the same page in terms of the calculation through which value is assessed. Check regularly to see if metrics and weights given to processes have changed since the last discussion. Had such a process been employed between the two firms involved in the case study, that should have enabled them – and others in similar relationships – to have created a solid foundation for a sustained "win-win" relationship.

Listen for the bells and whistles
In the case study described here, we investigated the specific product elements that had been given the "unnecessary bells and whistles" categorization. We found that the end-customers in this market didn't see any advantages to these product elements. They didn't help those businesses gain more customers, realize higher prices or reduce costs in other areas. So these end-customers made a solid sharp-pencil determination that those product elements weren't ones that they should pay for. Moving back one stage in the customer chain, it appears that the customer that ran the Internet auction heard this message, and incorporated similar thinking into their own decision processes. But the ingredient supplier failed to hear that message, and continued to engineer its products to include those bells and whistles.

Either the bells and whistles had value from a total cost of ownership perspective, and the ingredients supplier should have marshaled information and arguments to convince their direct customer and the end customer of that fact. Or the bells and whistles were in fact unnecessary, without value in the total cost of ownership equation, and the ingredient supplier should have been as aggressive as their direct customer in trying to ensure that they didn't unnecessarily drive up costs.

A key lesson is that each participant in an important supplier-customer relationship, at every stage of the customer chain, should carefully examine the value contribution calculation being made by the other participants in the customer chain. When an inconsistency is observed, work through and create a fact-based resolution.

George F. Brown Jr., along with Atlee Valentine Pope, is author of CoDestiny: Overcome Your Growth Challenges by Helping Your Customers Overcome Theirs, Greenleaf Book Group Press, Austin, Texas. Visit www.CoDestinyBook.com.

This article originally appeared in the May/June 2011 issue of Industrial Supply magazine. Copyright 2011, Direct Business Media.

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