In many industries, competitive advantage is rapidly shifting to the management of suppliers, which can account for as much as 60 to 80 percent of manufacturing costs. Suppliers also exert a strong influence on throughput time and work-in-process inventory, and play an often critical role in new product development. Companies that integrate their supplier base effectively with their internal engineering, manufacturing, and purchasing operations benefit from reduced costs, shorter lead times, lower development risks, and compressed development cycles.

Many businesses have recognized the strategic importance of optimizing their supply management processes. Companies as diverse as Toyota, Honda, Ford, Harley-Davidson, Detroit Diesel, Black & Decker, Yamazaki Mazak, Motorola, Bose, and Xerox are developing effective new ways for their internal functions to work together with suppliers in optimizing product design, development, manufacture, and distribution. Such improvements have enabled some to slash their development times by as much as 40 percent, increase inventory turns from six to over 50 a year, and reduce the cost of purchased materials by between 15 and 35 percent.

At the other end of the spectrum, companies that have failed to recognize the strategic importance of their supply management processes are paying price and performance premiums. Often, such companies have unintentionally set up conflicting objectives between engineering, manufacturing, and purchasing that form barriers to good supply management.

Engineering emphasizes meeting or exceeding technical targets in developing new products, but sees cost as secondary. Manufacturing typically wants to maintain constant utilization levels in production facilities, using suppliers to absorb fluctuations, whereas purchasing prefers to keep suppliers’ production levels stable so that they can minimize changeover costs and pass the savings on to the company. Even at companies that charge purchasing with reducing the cost of materials, such conflicting objectives limit its ability to deliver savings (Exhibit 1).

In a survey of companies noted as leaders in supply management, we found that best practice in sourcing requires that three major elements of the supply management process be optimized:

• Product development/specification
• Sourcing
• Contract execution.

By mastering these elements, companies have achieved both dramatic improvements in productivity and substantial cost savings (Exhibit 2). A major designer and manufacturer of mechanical equipment with sales in excess of $5 billion reduced its operating cost by $280 million a year through improved supply management (Exhibit 3). A major electronics firm with sales of approximately $10 billion slashed its operating cost by between $500 million and $1 billion.

Each element of supply management overlaps and interacts with the others. In product development and specification, leading companies select their suppliers before designing a new product so that they can become an integral part of the product development team. Such suppliers typically provide assemblies rather than piece parts, reducing the complexity of managing a vast supplier base and multiple parts. To make this work, companies need to help their suppliers develop and maintain advanced technical capabilities. They must encourage their suppliers to invest in technology, but should be prepared as a last resort to take on new suppliers when their existing ones are not able to keep pace with developments.

Companies should make great efforts to avoid duplication of capabilities between their suppliers and themselves

The next element, sourcing, is the way in which companies select their suppliers, determine the number they will work with, and define the type of contractual agreements that will exist. Best practice suggests that companies should make great efforts to avoid duplication of capabilities between their suppliers and themselves. Where there is an emphasis on single-sourcing of parts, a strong relationship can be developed, founded on multi-year contracts and part ownership for life.

Contracts tend to be simple, based on trust that has been built over the years. Harley-Davidson, for instance, has recently moved from simple one-page contracts to having, in effect, no contracts at all. This was possible because the company has developed a partnership with its suppliers over the past eight years in which each party knows what the other expects and there is no longer a need for formalized agreements.

The last element, contract execution, concerns how companies work with their suppliers on a day-to-day basis. Leaders in supply management such as Honda emphasize continuous improvement. Honda has dedicated teams working with its supplier base to reduce costs. Once achieved, cost savings are shared equitably so that each party gains.

To promote continuous improvement, some successful companies have implemented supplier rating systems that are easy to understand and give immediate feedback to the supplier. They are used to improve performance by identifying problem areas and developing methods to eliminate or mitigate any difficulties, but they are not used as a tool for penalizing weak performance.

High-performing companies also stress establishing and adhering to schedules. In the past, many companies merely informed their suppliers of any scheduling instability and expected them to respond. Today, the focus is on stabilizing internal schedules and working with suppliers to achieve just-in-time delivery.

Product development/specification

Traditionally, when a company developed a new product, the engineering department would design it single-handed, and pass the final blueprints on to purchasing for quotes. By then the company had created the "definitive" design, so if suppliers suggested modifications that would reduce costs, engineering was reluctant to make them. Because the design neglected to take suppliers’ capabilities into account, the company would end up paying a premium for a new part.

Many companies now select their suppliers before drawing a single line on a plan

Many companies today have changed how they work with suppliers in new product design. They now select them before drawing a single line on a plan. Suppliers are typically chosen by a cross-functional team from engineering, manufacturing, purchasing, and quality control. Responsible for the design and development of the new product, the team discusses it assembly by assembly and piece by piece and chooses suppliers on the basis of past price, quality, and delivery performance. The team ensures that each component has a single internal or external supplier that will be used for the life of the part during both development and production.

As well as selecting suppliers, the team sets target prices for each component, drawing on its members’ previous experience with similar parts. Using target prices ensures that a company will be able to produce a product with features and functions that customers want, at a price that is acceptable and competitive in the market. The team then meets the selected suppliers to discuss specifications and costs.

Following the meeting, the suppliers respond to the target prices. If they think a given target is unattainable, the price can be adjusted, but the total cost of the new product is a zero-sum game. If the cost of one component is allowed to increase, a corresponding saving must be found in another component.

The ability to develop target pricing is critical to the success of this approach. Companies that handle it well have costing groups capable of developing target prices based on global benchmarks. They compare data from the world’s leading suppliers for the most critical manufacturing processes, using these benchmarks to work out a target cost for new components.

The cost quoted by the supplier must compare favorably with the "should" cost

With a stamping, for example, the costing group will project its cost by adding together the costs of each feature. They derive them from the global benchmarks, calculating each part’s expected yield within the given tolerances; its processing time (determined by the number and accuracy of bends and the weight of the part); and the number of features that can be developed during each press cycle. This intrinsic process cost is then adjusted for regional labor rates and transportation costs. The cost quoted by the supplier is then reviewed, and must compare favorably with the "should" cost.

If there is any disagreement over cost, supplier and company together review their respective cost estimates item by item until a discrepancy is found and the difference is resolved. If for some reason the supplier’s quote is higher than the target price but correct, an alternative means of reducing the cost must be found or a compensatory saving made in another component, in keeping with the zero-sum philosophy.

Bose Corporation, a major supplier of high-end audio systems to the automotive industry, has taken the process a step further. Bose identified several key suppliers which now have offices actually on the company’s premises. The suppliers’ staff work with the company’s design and manufacturing engineers during the conceptual stage of new product development. Honda has taken a similar approach. It recently built 30 offices in its engineering and new product development departments to house representatives of major suppliers who work with the company during new product design.

Co-location facilitates superior communication between company and supplier base, and leverages suppliers’ knowledge

Such a co-location of company engineers and suppliers benefits both parties. It facilitates superior communication between company and supplier base, minimizes the possibility of designing a part that is difficult to manufacture or that does not take advantage of suppliers’ manufacturing capabilities, and leverages suppliers’ knowledge so that new process technology can be incorporated into product development. Company designs that are considered proprietary are protected through the long-term relationship between company and suppliers. In rare cases, a company may even purchase a part of those suppliers that provide strategic services or material.

Sourcing

Companies concerned to improve their supply management are embracing single-sourcing and thereby consolidating their supplier base. Consolidation alone, however, does not provide a competitive advantage. The advantage comes when limited resources can be focused on a manageable number of suppliers, which can then receive the attention they need to achieve top performance. Similarly, suppliers receive enough volume from the company to warrant investing their own internal resources to optimize their production process and thus produce a component at a more competitive price.

Companies that have traditionally used vast numbers of suppliers have successfully made the transition to best practice in supply management by reducing their supplier base by 50 percent or more.

Strategic parts

Single-sourcing by leading companies is systematic. Take Yamazaki Mazak, a world leader in machine tool design and manufacturing: it first lists all the components for a new machine tool and the manufacturing processes that will produce them. It analyzes the components to determine which ones genuinely contribute to maintaining a technical lead over competitors. The company normally decides to manufacture these strategic components in-house. If there is no internal manufacturing capability, the company sets out to develop it. For this company, the design of its spindles and motor drives gives it a competitive advantage by allowing it to produce better surface finishes at higher speeds. Therefore all spindles and drives are designed, manufactured, and assembled in-house. All nonstrategic components are outsourced. Once the company outsources a part, its supplier keeps the part for life unless a quality or delivery problem arises.

Eliminating redundancy reduces overall costs, cutting out dual sourcing, dual tooling, and dual process development

With this approach, no duplication of suppliers occurs, whether externally or internally. Neither does the company duplicate its suppliers’ production capabilities or compete with its supplier base. The benefits are many. First, eliminating redundancy reduces overall costs, cutting out dual sourcing, dual tooling, and dual process development. Second, relationships with suppliers improve since there is no competition between suppliers and company. With the security of part-for-life agreements, suppliers are much more open to suggestions about cost reduction and are more willing to invest in optimizing their processes. Third, single-sourcing yields higher volumes to each supplier, justifying supplier investment in new tooling technology and other resources (Exhibit 4).

Supplier-base consolidation

As companies gain experience with single-sourcing, they tend to move beyond individual parts to entire part families, further reducing the complexity of supplier management. Many have successfully consolidated their supplier bases by using a phased approach. One firm had over 300 suppliers in the late 1980s. It identified the following problems: many suppliers were low-quality manufacturers; many were geographically dispersed; and there were multiple suppliers for the same part family, so that suppliers saw no long-term economic gain in working with the company. The results were high costs for purchased materials and low profitability.

The company undertook a three-part initiative to consolidate its supplier base and upgrade its approach to supply management (Exhibit 5):

1. Eliminate irreparable relationships. The first phase eliminated suppliers that were poor-quality performers or whose relationships with the company were irreparable. The company also identified and dropped suppliers that had philosophies incompatible with its new direction. The future emphasis was to be on just-in-time, so it stopped using suppliers located more than 200 miles away from its major assembly plant. This process eliminated approximately 80 suppliers.

2. Train and invest in suppliers. The next phase was to train the remaining suppliers in just-in-time, statistical process control, and continuous improvement. The company asked its suppliers to develop plans to show how they would meet the new cost, quality, and delivery goals required for just-in-time. After evaluating these plans, it eliminated more suppliers. The company now has approximately 100 suppliers that are so well trained in all aspects of just-in-time that the company does not inspect delivered parts and effectively has no receiving inventory. Since there is now only one supplier per part family, and most suppliers are within a 100-mile radius, the company can use a just-in-time pull system to control incoming material. Suppliers have sufficient volume to justify making improvements to tooling and operations and investing in value engineering to reduce the cost of the part to the company.

3. Continuous improvement. The last phase consists of continuous supplier improvement. Here the company supports its supplier base through dedicated teams who visit suppliers’ factories and help improve their manufacturing operations.

This approach has improved both the quality and the delivery of products, allowing the company to advance from a declining 17 percent market share in 1982 to the 83 percent (and still increasing) market share it enjoys today.

Supplier relationships

In the past, companies mistreated their suppliers. They kept them at arm’s length, pitted them against each other, and broke their promises, creating an atmosphere of mistrust. To move from here to a shared sense of partnership and respect is not easy.

As shown in Exhibit 6, most companies and suppliers go through three phases before achieving a healthy partnership. In the beginning, an obvious distrust exists: the company is evaluating its suppliers’ performance and deciding whether to retain or drop them. During the second phase, successful companies develop long-term agreements with their best suppliers as a basis for good relationships. Over time, such agreements will, in conjunction with supplier training and dedicated company teams, build a strong supplier base with high technical capabilities and greater willingness to share information.

In the third phase, all suppliers are treated equally, whether they are internal or external. Developing this type of relationship generally takes a five- to eight-year effort for both parties. After this stage has been reached, long-term agreements are no longer required (and most will have expired); all parts and many part families are single-sourced; and suppliers have parts for life.

Suppliers set their own goals and evaluate their own performance. The company monitors their goals and encourages them continually to improve their performance. Where it feels the goals are too low, the company provides support for process and operations improvement.

Orders are understood to be placed at current prices and there are no annual price renegotiations. Company and suppliers constantly work together to reduce the cost of purchased materials. Using this approach, most companies are able to cut material costs by 5 percent per year. Suppliers are expected to make up for any increases in the cost of raw materials that arise from normal inflation, but they are compensated for unusual swings in the raw materials market.

Relationships built on trust and mutual understanding have allowed companies to simplify their contracts

Relationships built on trust and mutual understanding have allowed companies to simplify their contracts to straightforward two- to three-page agreements. That the supplier has the part for the life of the product is understood.

Contract execution

Successful day-to-day collaboration between a company and its suppliers relies on supplier evaluation, investment for improvement, integration of suppliers, effective use of transportation, and open communication.

Evaluating suppliers

Effective supplier performance reporting systems focus on a limited number of factors, such as quality and delivery

Effective supplier performance reporting systems focus on a limited number of factors, such as quality and delivery. Wherever a problem is identified by the supplier reporting system, it is followed by an offer by the company to arrive at a solution. The system is used as a tool to help suppliers improve performance, rather than as a weapon to punish those that are not meeting current requirements.

Exhibit 7 illustrates a performance reporting system used by one company. Its output is a single-page report that is sent to every supplier every month. This particular company emphasizes delivery and quality. Designed to be easy to read and interpret, the report shows the supplier’s goals for delivery and quality in parts per million, how it performed in the last month, and how it has performed in the year to date. The company’s vice president of purchasing reviews the report before sending it to the supplier’s senior management. If they disagree with the performance report, they can talk to the company representative who detected the problem. They then jointly discuss how to prevent any recurrence in the future.

Some companies require their suppliers to provide monthly self-evaluations. As a benchmark, a supplier compares itself to the best in its class. It then plans corrective action to bridge the gap it has identified between itself and the top performers. Specific annual goals are negotiated with the company, and can be tailored to its specific needs.

If a company and its suppliers choose to emphasize just-in-time, for example, they might decide on four major goals: setup time reduction, inventory turn, process capability studies, and employee involvement. The company will then track suppliers’ self-evaluations, indicating where improvements are needed, but accepting the self-evaluations as valid. The key to the success of such a program is for the company to have sufficient resources both to monitor the monthly reports and to assist if the supplier is unable to meet agreed goals.

Investing in suppliers

Best practice in supply management means dedicating full-time resources to continuous supplier improvement

Companies that exemplify best practice in supply management have full-time resources dedicated to continuous supplier improvement. When a supplier asks for help, the company has a highly structured approach to providing support. A company team responds whenever a supplier seeks assistance, or if the performance system indicates a problem. The company team consists of full-time staff from purchasing who are dedicated to making suppliers more globally competitive, typically reducing manufacturing costs by 15 percent or more, doubling productivity, and improving quality. The company finances its teams and the supplier pays for any improvements that are needed to achieve the agreed goals. If the supplier is financially healthy, the benefits are shared between the two. However, the company will allow the supplier to keep a disproportionate share of the benefits if it needs it in order to maintain reasonable profits.

Companies such as Honda and Harley-Davidson have successfully used continuous improvement to reduce cost and improve quality to such a point that there is now essentially no incoming inspection when parts are delivered.

Integrating suppliers to mitigate schedule instability

Many companies are caught in a scheduling "doom loop," where a change in demand causes a change in the assembly schedule. Manufacturing communicates a change to purchasing, which asks suppliers to expedite materials to meet the new schedule. If they fail to deliver the parts on time, they will cause another change to the production schedule. The "doom loop" is the continuous cycle of changing schedules that results.

Some companies give suppliers direct access to their inventory of parts, allowing them to monitor usage rates on a virtually real-time basis and anticipate needs

Some companies have extricated themselves from the doom loop through a combination of stabilizing their schedules and working with suppliers to implement just-in-time. Others find it helpful to separate out those parts which are volatile so that the remaining schedule is stable. But total stability is seldom possible, so some companies give suppliers direct access to their inventory of parts, allowing them to monitor usage rates on a virtually real-time basis, so they can anticipate the company’s needs without ever having its manufacturing and purchasing departments involved in the loop.

Other companies go a step further by giving suppliers daily point-of-sale information about product sales by store or by customer. This acts as a pull system for restocking distribution centers and stores, and provides suppliers with detailed data for forecasting future production requirements.

Successful implementation of these concepts has allowed some companies to achieve work-in-process turns in excess of 50, compared with traditional performance levels of four to eight turns per year.

Using transport to reduce WIP

Careful control of the transport of materials is important in good supply management. Bose, for example, has an in-house company that monitors all incoming and outgoing road freight. As soon as a supplier ships a part, Bose tracks it and can reroute it if required. For incoming shipments from abroad, the company employs an international freight forwarder that can clear freight with US Customs by computer link 92 percent of the time. By using such a system, Bose can keep internal inventory levels low, but still meet fluctuating customer demand.

Open communications

Successful companies use various methods to improve communications with their suppliers. Black & Decker and Honda employ supplier councils who represent the supplier base and provide feedback on issues of mutual interest. The companies use this input, when appropriate, to modify their dealings with suppliers (see Exhibit 8).

Other companies have gone so far as to ask suppliers to rate them as customers and compare their supply management practices with those of their direct competitors. Such surveys improve companies’ interaction with their suppliers. Indeed, so effective can they be that one company plans to resurvey its supplier base twice a year.

In the past, many companies have overlooked the importance of supply management. Those that have taken steps to optimize it are now enjoying a strategic advantage over their competitors. The benefits amply justify the effort and time involved. Best practice in supply management provides lasting competitive advantage along the three critical dimensions of cost, quality, and time.