Much has been said about Japanese automakers and their ability to build close ties with their suppliers. However, in times in which the gap between strategic suppliers and all others is becoming even bigger, and strategic suppliers that will have a much greater influence on a company’s growth agenda, it is worth re-examining what companies like Honda and Toyota are doing right when it comes to turning their suppliers into profit machines and what others can learn from them.
With 60%-80% of total organisational revenue spend now lying with a few strategic suppliers in many companies, the need for alignment, collaboration and joint problem-solving has never been more critical than today.
Matthias Gutzmann, Founder of Digital Procurement World, takes a look.
Whenever I speak to procurement folks and ask them if their organisations collaborate with suppliers, everyone responds affirmatively to this question. But often these are empty words at best. Building highly collaborative supplier relationships require a great deal of effort from both suppliers and customers. Typically, these relationships are few in number and focused on those that can make a competitive difference. So, what does ‘supplier collaboration’ really mean and what are the implications for the Chief Procurement Officer (CPO)?
Are Japanese companies better at building superior supplier relationships than their Western counterparts?
I must admit that the quote in my headline is old (from 2002) and some of Detroit’s Big Three have since improved the relationships with some of their top suppliers by moving away from non-exclusive and arms-length arrangements (for example, attempting to save costs by encouraging intense supplier competition) to a more (Japanese) relational partnership model (for example, developing long-term relationships with suppliers by implicitly guaranteeing future business). In fact, according to a Supplier Working Relations Index study by Planning Perspectives Inc., GM has improved its supplier relationships by leaps and bounds: its score is up from “Poor” two years ago to the high end of “Adequate” this year, closing in on “Good”. That said, Honda and Toyota have been the gold standard for building highly collaborative supplier relationships that are based on mutual trust, commitment and with a focus on results. At least this is the opinion of more than 400 North American suppliers after being asked to grade each automaker on five metrics:
1. Relations with suppliers
3. Efforts to help suppliers cut costs
4. Willingness to share savings
5. Avoidance of hindrances such as late engineering changes
Collaboration isn’t a black-and-white process
Thinking of collaboration as a binary process (a relationship is either collaborative or it is not) is a dangerous over-simplification. Successful collaboration is not black or white; it rather contains many shades of grey.
IMD Business School sees four levels of collaboration between customers and suppliers, ranging from no collaboration to very high levels of collaboration, where a company actively contributes to the success of a supplier and its competitive position:
1. Combative: a classic purchasing approach wherein procurement uses combative negotiation to achieve results. The main emphasis is on playing hard-ball with suppliers to bring down prices or to leverage vendors.
2. Co-operative: each side strives for co-operation. Relationships, typically, exist as an ongoing joint business exchange for goods and services, but they rarely go beyond mutually-acceptable working terms.
3. Partnerships: creating mutual benefit rather than trying to gain control of the relationship or focus on price reductions. Through collaboration, each party aids the other in developing and/or leveraging their joint intellectual property, thereby maximising the value of the relationship.
4. True supplier collaboration: both companies truly collaborate. A customer focus on supplier collaboration is a commitment from the entire company and all of its functions to create significant competitive advantage for the selected suppliers in exchange for the suppliers creating significant advantage for the company. The central theme here is that trust and commitment encourage long-term relationships between suppliers and buyers.
The ultimate goal for each side in a truly collaborative relationship is to create significant competitive advantage for both the customer and the supplier as an absolute measure, not a relative one.
Honda as an example that (true) supplier collaboration works
One of the reasons why Honda constantly delivers higher profit margins than its competitors is the inclusive relationships with their strategic suppliers in which these suppliers are literally considered extensions of Honda.
Leaders in supplier collaboration average 2x EBIT growth over peers – McKinsey
Over a period of six years and through collaborative relationships, Honda of America’s consumer price index rose by 11% and a big competitor was feeling good, as they limited their materials cost increases to only 7% during this period. Through collaborative relationships, Honda was able to reduce costs by 19%. The overall competitive gain was 26%. The performance of Honda illustrates how efforts made to create and sustain collaborative relationships can achieve benefits that vastly outweigh typical arms-length customer-supplier relations. Honda achieved significant cost reductions and increased market share through forging linkages with a few key suppliers and cultivating these relationships.
Implications for the CPO
So, if supplier collaboration works for Honda, why don’t all companies increase their top-line growth by working more collaboratively with some of their top suppliers? Well, because building and cultivating collaborative relationships requires a great deal of effort – on the parts of both suppliers and customers. In fact, the entire company. Such partnerships, despite all of the benefits that they can create, are costly in financial terms but they also cost in leadership time and commitment to establish and maintain relationships. They may also reduce the customer’s ability to switch away from inefficient suppliers. On top of that, many companies are not set up to work collaboratively externally and many of the current business models are to hold all steps of the process internally.
Here is a checklist outlining the activities that a company should have completed prior to starting to collaborate:
1. Procurement has a strategy, measures and a charter for competitive advantage that goes beyond taking down price.
2. A buying category has been identified wherein a market opportunity exists for a collaborative relationship.
3. One supplier that could be a good fit for supplier collaboration has been identified. Start small and with one supplier only. This should be a supplier that can generate the expected benefits if the efforts were successful and a supplier with which mutual trust can be generated and preferential treatment can be obtained.
4. All functions in both organisations can be committed to the relationship. Supplier collaboration is a business-to-business strategy, not a procurement-to-supplier one.
5. A governance structure has been established that will continuously evaluate, communicate and improve the collaborative relationship. It will handle the continuous communication and alignment internally, and with the supplier.
6. An empowered and well-respected procurement organisation that can be the broker of this change exists – the most difficult change for driving supplier collaboration activities is internal.
In order to develop relationships and working closer with suppliers, Honda and Toyota applied what they called a “supplier partnering hierarchy”, a six-step instruction to reach the maximum potential in a buyer-supplier relationship (Liker & Choi, 2004):
I believe that supplier collaboration and innovation is the next big break for procurement and their businesses, and that organisations that fail to deliver on supplier collaboration and innovation programmes are less competitive, less agile and miss huge revenue generation opportunities. Building supply chains as a shared system, rather than as our system and that is based on a mentality of joint ownership and trust, will allow us to work as one efficient organisation with our suppliers, be more resilient to unforeseen events and adapt quickly to changing demands. Procurement already delivers on the efficiencies, compliance and cost savings that our businesses need. The next step is to deliver on the innovations that will drive the next level of growth. Companies like Honda and Toyota have shown us that superior relations with suppliers are paying off and lead to superior performance.