In "the 1950s, the Ford Motor Company under Henry Ford II had a new idea, which, as it turns out, was actually an old idea. Ford put out to bid to completely independent supplier firms many categories of components formerly supplied from within the company.... This was, in fact, the world Ford had left around 1913; the world of arm's-length, market-based, short-term interactions with independent businesses." [Womack, p. 139]
Between 1913 and 1950, Ford Motor Company made every effort to manufacture as many components as possible in-house, so that the firm would have full control of both production and costs. After nearly four decades of this, and with automobiles becoming increasingly complex, Ford Company had had enough. So, Henry Ford II reversed direction and went back to buying many components based on bids from other suppliers.
Most supply chains have been stuck in “the world of arm’s-length, market-based, short-term” relationships ever since. Of course, a few have tried Henry Ford’s original approach—bringing everything in-house; and a very few American innovators have actually ventured into more open relationships with their supply chain partners.
As far back as the mid-1980s, however, studies revealed that it really makes very little difference whether the supplier is in-house (a subsidiary, department or division) or a completely separate company. The most successful supply chains are successful, not because of the legal constructs between the parties, but success comes from the ways in which the trading partners interact. It’s all about relationships.
Here is How the Most Successful Supply Chains Collaborate
Involve the Supply Chain Early in Product Design and Development
Instead of designing a product end-to-end and then handing off design specifications and drawing to suppliers for bids, the most successful supply chains typically select their suppliers and involve them very early in the product development cycle.
These suppliers are not selected based on “price.” After all, they can’t be at this point, because no one knows what the price-point is going to be for the components the suppliers will provide for the new product under development.
The suppliers are not selected based on price, but upon two other critical criteria: their experience working in similar integrated design and development projects for similar products, and the record of their performance as a supplier in terms of quality and reliability.
Advisors from the tier-1 suppliers are frequently incorporated into the product design and development team at the assembler’s operations. There, working closely together, the team decides how the components should be packaged (in terms of functions and interfaces), and the suppliers team is provided with a set of performance and quality specifications—not a set of materials specifications and design drawings.
It then becomes the tier-1 suppliers’ responsibility to design, develop and even prototype the components meeting the functional and quality specifications and compatible with the design interfaces.
In the best-performing supply chains, the tier-1 suppliers frequently replicate this approach in working with their tier-2 suppliers.
This process helps assure that the product design also incorporates all the ideas that might lead to lower cost of production (i.e., manufacturability) while delivering the highest performance and quality, as well.
Take Time to Learn
Successfully integrating supply chains and creating an atmosphere of collaboration across a supply chain takes time. It is imperative that the trading partners take time to learn about each other and about their operations, costs, methods and quality.
In order to get to this level of cooperation, the relationships cannot be built at arm’s-length and predicated only on lowest-cost.
Create a Rational Framework for Collaboration
Achieving the openness required for deeper levels of supply chain integration and collaboration requires that, first, there be frank discussions between the trading partners during which they create a rational framework for determining costs, prices and profits that serve to encourage both the buyer and the seller to work together for mutual benefit. This kind of openness and trust must supplant an atmosphere of mutual suspicion before significant progress can be made.
One simple way to move in this direction is to have the discussions around Throughput, where Throughput (T) is defined as revenue per unit less (only) Truly Variable Costs (TVC) per unit. This should eliminate all allocations of overhead and even labor (which is variable with efficiencies, utilization, number of set-ups, and so forth).
Placing your discussions in this realm makes both Investment and Operating Expenses something to manage within each trading partner’s organization and not, generally, a part of the cost-price framework discussions. This simplifies the discussion down to the trading price and TVCs (generally, just raw materials and per-unit outside processing costs).
Mutuality can then be focused on increasing Throughput for both trading partners involved. Increasing T can be achieved in several ways:
- Increasing the quantity sold
- Increasing the trading price
- Decreasing the TVCs
Negotiations should focus, not on driving the price down, but on how to reach the goal of increasing Throughput for the trading partners involved, thus helping to assure that all the supply chain participants are making reasonable progress on profitability.
On a Mutual Process of Ongoing Improvement (POOGI)
Over the lifecycle of the product, the trading partners should work together to find ways to reduce the cost of manufacture without sacrificing quality. This should be done through a dedicated POOGI efforts.
When cost-reductions or other savings stem from collaborative efforts between trading partners, these savings should be shared between the partners involved. However, when an individual trading partner, working entirely on its own, finds ways to reduce TVCs, reduce Operating Expenses or drive down the need for new investment or reduce inventories, the additional profits from these efforts should accrue solely to the trading partner making the POOGI effort.
A Better Cycle
Properly done, this kind of supply chain integration and collaboration can reap huge benefits for all its participants. It does so by replacing a vicious cycle of mistrust with a virtuous cycle of cooperation and collaboration.
Perhaps in a later article we will have opportunity to address how this kind of supply chain collaboration can contribute to making your supply chain increasingly agile in its response to changing customer needs and demand volatility.
In the meantime, we would like to hear from you. Please leave your comments here, or feel free to contact us directly, if you prefer.
Womack, James P., Daniel T. Jones, and Daniel Roos. The Machine That Changed the World - The Story of Lean Production: How Japan's Secret Weapon in the Global Auto Wars Will Revolutionize Western Industry. New York, NY: HarperPerennial, 1991. Print.
