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Managing value in a rebounding economy

If the 16 straight months of growth in the Institute of Supply Management’s manufacturing index wasn’t evidence enough that we are in a rebounding economy in the US, the news from Detroit is a 17 per cent jump in monthly vehicle sales over last year and third quarter profits topping $2 billion for both General Motors and Ford.

Certainly within the automotive industry, and likely elsewhere, growing demand is putting great upward pressures on prices. However, one of the lessons learned from the last downturn should have been the realisation that there are forms of value other than low cost that suppliers can bring to the table.

We are already seeing some signs that US companies have refocused their procurement approaches on price, and arbitrary year-on-year percentage price reductions. While there is merit in conditioning suppliers with a cost-saving message, their profit margins are not an infinite source of savings for buyers.

Most suppliers will have survived the recession by cutting their overhead and profit margins razor thin. New orders have the potential to be very profitable, based on the lower overhead. On the other hand, insisting on price reductions when margins are already thin can push a good supplier out of business – or to a rival customer.

Many management teams view suppliers as a source of incremental profit rather than an extension of manufacturing capability. The reality is that suppliers’ margins are not infinite and you must have healthy suppliers to innovate and invest to bring your company competitive advantage. Therefore, as buyers move to the new economy, value extraction will become as or more important than price reduction.

Consider how Apple worked closely with a core of suppliers to create the iPhone and iPad. The payoff from their collaboration is dominance in a rapidly emerging market. If Microsoft moved computers from mainframes to our desktops, Apple is leading the way putting them in our pockets. There is a lesson in that for every company.

The only way to get consistent value improvement from suppliers is to understand the cost structures in each category of spend. Most purchasers, when challenged to identify and execute cost improvement, will concentrate on their high dollar-volume items and implement leveraging to attack prices.

However, that’s not necessarily the best solution. The opportunity for long-term value improvement also depends on how easy it is to source the category, the level of supplier expertise and the potential for a supplier to generate innovations that will generate new revenue for you or open up new markets. 

If you identify your strategic suppliers, the route to continuous value is to build trusting relationships with them over the long term. In the first stage of open communication you may be able to identify efficiencies that generate new cost improvements – for instance, more flexible product or material specifications, sharing market information to set better production or delivery schedules or adapting spare factory space to store supplier materials and buying it on consignment. At the same time you may gain a more secure supply or reduce other risks.

In the second stage of collaboration the frank discussions may uncover issues within your organisation that suppliers are “covering” in their prices. An example is a design change too close to production.

Rather than imposing a penalty if that happens, some suppliers will anticipate it and build an allowance into the original price. In an open relationship the value comes from identifying and fixing the internal issue instead.

As trust builds you can expect first rights to process or product innovations from your strategic suppliers, collaboration on research and development or reductions in the complexity of design.

Finally, in the most integrated supply chains every company is contributing to the success of the entire network. Information flows easily up and down stream, streamlining processes, synchronising production and supporting new product development.

We can expect a trend toward competing, integrated supply chains with a focus on value management because there are strong rewards for the effort. That kind of collaboration doesn’t just contain costs, it can open or capture new markets.

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