Beyond Squeezing Margins

Over the years I have been invited to speak at many supplier days. The best ones share the stories of the lean progress made by the hosts to encourage their suppliers to follow suit, to mutual advantage. However there is always some tension lurking in the background as both sides size up whether this is a genuine step towards win-win cooperation or merely the same old margin squeezing dressed up in a new guise. The truth usually turns out to be a bit of both.

However it is becoming apparent to me that simply squeezing supplier margins is reaching the end of the road. Without any fundamental changes to the way the shared process works, there is a limit to how much margin there is left to squeeze. More seriously, I am now seeing growing evidence that successive raids on margins are now beginning to have a seriously damaging and even perverse effect on supplier performance. Ignore this at your peril.

This was brought home when visiting a supplier making a basket of different components, which they deliver to a customer for assembly into a complete piece of equipment, made in a variety of different configurations. At the moment the market for this product is buoyant and suppliers are having a hard time keeping up. This is a well intentioned supplier, taking action to respond to pressure from its customers to reduce its prices. However these actions have not always had the intended consequences, for them and their customers.

First, they decided to upgrade their machining plant by buying a completely new set of machines. After a struggle to get all the machines installed and running they are still struggling to get this equipment to work more than 30% of the time! Instead of solving their capacity problems, it made them worse than ever. It turns out the machinery was just not capable of running with these products, to the required tolerances and at the planned volumes. Sure the supplier is making some progress in reducing changeover times and breakdowns, but not nearly enough. This is not just a maintenance problem. More worrying, they were not able to specify the design conditions for what Toyota calls basic stability when choosing the equipment in the first place. It turns out their customer is suffering from the same problem with its new equipment, even though they have been going lean for some years. This is a very expensive lesson for all concerned. Not surprisingly it is a common problem that people do not want to talk much about!

Second, this supplier centralised each of its processes in different “focused factories” across Europe. This was supposed to reduce production costs. But instead most of their products now travel through three or more of their plants before being marshalled for delivery to the customer in their central warehouse. Total lead time through this supplier has gone up and not down, and the probability of having the exact basket of parts ready when the customer wants them has fallen. As a result they are constantly chasing “missing parts”, and their overtime and excess freight bill is enormous.

Third, in order to manage this complex routing through their plants they bought an ERP scheduling system. This turned out to be a disaster. They are still struggling to win the un-winnable war between data that is constantly being undermined by the expediters, trying to end-run schedules based on forecasts that always differ from what the customer actually wants. Schedules to their suppliers jump up and down all the time and not surprisingly on time deliveries from them have fallen.

Fourth, like many they have sourced several key components to low cost sub-contractors in China. Quite apart from all the start up and logistics nightmares, prices in China are beginning to rise. Their sub-contractor is more interested in fulfilling booming domestic demand than their orders, which gyrate far more than planned. They will soon have to find another sub-contractor further inland in China or look for a supplier closer to them in say Romania or Turkey.

This is not an isolated case. Indeed by conventional wisdom they did all the right things. However they were undermined by a lack of real knowledge of the equipment needed to produce their products and by focusing on point economies rather than the cost of the product travelling through the entire supply chain. Every supply chain contains many such stories. Rather than walking away, there are several positive steps that should be on the agenda for the next supplier day.

First, establish an expert working group to pool and upgrade the collective knowledge about specifying right-sized equipment that is fully capable and available. This is a strategic foundation underpinning the shared enterprise.

Second, the customer should, like Toyota, begin to assume responsibility for organising inbound logistics, picking up products from suppliers using frequent milk-rounds. This is brings the heartbeat of the supply chain to the supplierís door.

Third, by creating level schedules for high volume products and separately scheduling capacity for low volume make-to-order products the customer can create the conditions where suppliers can follow suit. This inevitably leads to freeing up previously hidden capacity and achieving and sustaining record levels of output, while also freeing up the time of many of the planners and expediters to focus on improving the process.

Fourth, suppliers and customers should jointly map their value streams back to raw materials, as we described in Seeing the Whole, over time compressing them by regrouping as many value creating steps as possible in one location, either close to the customer or within trucking distance.

The path beyond margin squeezing is no less relenting. But it needs leadership from the customer to reshape its supplier base and to build a deeper relationship with fewer suppliers, each with a deeper knowledge to solve bigger problems with you on a continuing basis?