Suppliers — A Source of Profit or an Extension Your Company?

By Bill Michels

There is little doubt that companies and supply management professionals will always have pressure to achieve continuous cost and value improvements year after year. This goal is very achievable, but the approach taken to meet this goal will have long-term implications for the supply chain.

Detroit's automakers are learning this lesson the hard way. Over the long haul, you can't make money in any industry unless your suppliers can make money, too. For too many years, domestic automakers have used their volume leverage and power to focus on driving the tier-one supplier price down, a practice that is carried down the supply chain. Many suppliers in the domestic automotive supply chain, caught by large investments and the need for volume, have conceded on price, resulting in margin erosion. Margin erosion year after year leads to lack of investment, cutbacks in research and development, lack of innovation and failure to invest in facilities — and eventually to a bankrupt industry.

In contrast, automakers from Japan have taken a different approach. They focus on cost and cost transparency rather than on price. These automakers make supplier development and joint problem solving a key priority. While still demanding cost and value improvement, the Japanese automakers also focus on cost-out activities like specification change and waste elimination, not just price. Using approaches like target costing and working closely with suppliers on key projects, they achieve continuous cost and value objectives, and the suppliers see healthy margins. The lesson: Profit is essential for suppliers to remain in the supply chain and for companies to achieve competitive advantage.

From studying the automobile and retail supply chains, a pattern emerges. It is clear that a "northern" supply chain is evolving to supply the domestic suppliers, and a "southern" supply chain is developing to serve the international automotive industry. In the past suppliers were independent supply chain links serving several competitors. We can now envision that future supply chains will evolve to exclusive, linked competing supply chains. The broad implication of this model is that the leanest, most competitive supply chains will dominate the industries and markets they serve. Perhaps this occurs when supply chains evolve, as it is essential that both manufacturers and suppliers lean out together. This process includes elimination of waste, minimization of inventories and work in process (WIP), the development of a multi-functional workforce, elimination of work queues, reduced set-up and change-over times, and the ability to respond quickly to demand changes. This lean supply chain, with quicker response times, will consist of customized manufacturing capability, synchronized scheduling with final demand, controlled supply processes, capability integration with trading partners and concurrent product development.

When companies see their suppliers as extensions of their own manufacturing capability, they can take that longer view of their relationships. One good example of continuous cost and value improvement can been seen in the pharmaceutical and biotech industries. Working from patented processes and technological breakthroughs, it is typical for companies to enter a 15- to 20-year relationship with suppliers and employ lifecycle pricing models.

The choice for companies is usually framed as being between serving stakeholders or serving shareholders. Successful executives realize that over the medium to longer term, such a forced choice is inappropriate. It is in the interest of both groups to pursue value-added strategies in line with customer expectations and to align business strategies. Suppliers — are they a source of incremental profit or an extension of manufacturing capability? It is clear that exclusive competing supply chains will demand customer-supplier integration at all levels.

About the Author: Bill Michels is CEO of ADR North America LLC of Ann Arbor, Mich., a global consulting firm specializing in supply chain. More information at