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In today’s business environment, where every firm has to focus intensely on the ways in which they can achieve a cost structure that is acceptable to their own customers, tremendous strains can emerge between suppliers and customers, even ones that have had a long history of shared successes. It takes a significant effort on the part of both suppliers and customers to ensure that such strains are avoided and that there is a common focus on the contributions that in fact create value.
The message in the case study and comments to follow is an important one. If your firm is involved in a CoDestiny relationship, one that has yielded value through shared successes and one you want to have survive and thrive, you need to be proactive in planning for the possibility of storms in the future. Such storms can take on many shapes – new people, profitability problems placing pressures on key executives, a deliberate change in strategy, an acquisition, among many examples. It’s not enough to do “good works” and to deliver value. You must anticipate the inevitable storms that will someday appear, and prepare for them with frequent discussions, information exchanges, scenario plans, and, occasionally, tough messages. When the storm hits, previously calm waters can quickly become troubled, and at that point, it will be too late to do anything other be taken wherever those troubled waters take you. To avoid the adverse possibilities of a future storm, several specific recommendations are provided.
The case study that follows describes one strong supplier-customer relationship in which the waters unexpectedly became troubled. The ingredient supplier involved in this case study described the deterioration of a key customer relationship as follows.
“We have been a loyal supplier [to a certain customer] for years. We have innovated and allowed this customer to develop new products and grow to become the dominant player in their industry. Even though we have a great working relationship with all of the engineers and product development teams, a new purchasing executive arrived, introduced a totally new culture to his department, and began to run Internet auctions. These procurements gave no recognition to the value we create and there was only a 10% weighting in the formula for the quality of product and service that this firm gets from a supplier. This firm gave us their Supplier of the Year Award three years prior to this time, and we think our contributions have increased since then. In these Internet auctions, we are being compared side-by-side to suppliers who don’t belong in the same room.” [Ingredient Supplier Sales Executive]
Between technology changes and globalization, the tools available to modern purchasing departments for cost reduction are indeed powerful. By writing specifications and using modern outreach tools to identify possible suppliers, a buyer can receive bids from suppliers across the world and choose the lowest cost supplier among those deemed to be qualified … and even groom an unqualified candidate into a future low-cost supplier with a modest effort. In cases of low switching costs, this can be repeated almost real-time each time that another purchase occasion arises, substantially reducing costs as technology and competitive changes occur. Some buyers have become even more creative by holding multiple rounds of bidding to drive costs lower.
It can seem to the suppliers involved in such situations like a game being played with loaded dice. Moreover, from the supplier’s perspective, the customer that ignores everything other than price often ends up worse off, failing to sustain leadership along dimensions such as product quality and innovation. The same executive made these points in describing the outcome of the auction run by this customer:
“So, we played along and put in our bid. What else could we do? We cut to the bone, reducing our margins and substituting cheaper materials where we could do so without reducing the quality we typically engineer into our products. We managed to get our bid to the point where we were confident that it would be the lowest, so our internal celebration began because we thought that there was no way we could lose given our aggressive bid and the superior quality of our product. But then, we got a call saying that we had lost to another supplier. We later learned that the winning supplier had put in a bid that was only about 1 ½% lower than our bid. We learned that they got the exact same score in the 10% element for the quality of product, even though this supplier has a history of quality and delivery problems that are well known by everyone in the industry. At this point, we concluded that this was no longer a customer that valued us or that we could be successful with, if they were willing to pass us over with a process like this. From our perspective, they were willing to make a horrible long-term decision, trading off all the contributions we had made to their success in order to gain a very small price concession up front.” [Ingredient Supplier Sales Executive]
Unfortunately, case histories like this one emerge all too frequently in discussions among suppliers about their experiences with customers that are implementing new approaches to purchasing. In this instance, we also had the opportunity to speak with executives in the organization that was making the purchase decisions described by this ingredient supplier sales executive. Like most stories, there were two sides to this one.
“Our business was changing, and even though we were the industry leader, we had tremendous concerns about our competitive position. Most of our customers had been regulated in the past, and were able to get approvals for their pricing based upon their cost structure. Now, as they go through deregulation, they are fighting it out over price and that’s impacting on their choice of suppliers. Some of the things that were important to our customers in the past are now ‘unnecessary bells and whistles’. So we have to do the same thing they are doing, and make the tough decisions to get our own cost structure to the point where we can win. There were a lot of things we had to change, often to the great disappointment of our own engineers who were used to being rewarded for upgrades rather than for cost savings. And in the case of the ingredient we buy from [the supplier in question], it’s such a significant part of our cost structure that every percentage point of savings there is huge in the overall scheme of things. And it was one of the areas where both our customers and we felt there were some of those ‘unnecessary bells and whistles’.” [Customer General Manager]
When we talked with the purchasing executive that had run the Internet auction in question, we got even more insight into this situation:
“I’ve heard a real earful about this situation, both from our own engineers and from [the supplier in question]. They did have a long history with us, but they somehow stopped listening to us. Maybe the history got in the way. We had a bidder meeting that they attended and we were very clear about the direction we were heading, about why getting to a lower cost point was the focus of our procurement. We said over and over that our world had changed. Most of the bidders heard that message. I don’t think [the supplier in question] heard it very well, maybe because it was a new message, not the one that they’ve heard over the years and probably not the one that they hear even today from their friends in engineering. Or maybe they just assumed we were posturing for the other bidders in the room, thinking the message wasn’t oriented to them. And while they do have a great track record, we have confidence that we’ve put in a structure with which we can succeed with [the winning bidder]. They’ve committed to funding sufficient inventory with us so that we aren’t worried about delivery and they have the ability to produce the ingredient according to our specifications.” [Customer Purchasing Executive]
The first two recommendations emerge directly from this case study. The first recommendation is that it is essential that the key principals in a CoDestiny supplier-customer relationship get together regularly and ask the following questions: In terms of your expectations and priorities, what has changed since we last met? Looking forward, what changes do we have to anticipate and address? What new nightmares are keeping you up at night?
The second recommendation reflects the fact that in any significant supplier-customer relationship, there are going to be many “touch points” between the two organizations. That’s almost always a very good thing, as the insights necessary to spark value contributions often emerge from unexpected connections across the two organizations’ departments and staff. But there can sometimes be a downside to such unconnected exchanges of information. The second recommendation is therefore that the principals in the relationship must regularly say to each other, “This is what we’re hearing from your organization and how we plan to react to it. Are we all on the same page?”
The “two sides to the story” that were so sharply illustrated in this case study are especially dramatic in supplier-customer relationships that involve products with long life cycles in which total cost of ownership calculation is complex. In such circumstances, the focus on purchase price or “first cost” is often the basis of tension and the root cause of the differences between the perspectives of the supplier and the customer. That was an important part of the problem in the case study described above, where the ingredient supplier’s focus and confidence was based upon the life cycle contributions that they were making to this customer through both the quality of their product and the contributions that they were making through the relationship. The customer’s focus, on the other hand, was driven by their belief that their own customer’s cost calculation was skewed towards first cost and that their customers had relabeled other factors as ‘unnecessary bells and whistles’.
This fact leads to the third key recommendation. Within significant supplier-customer relationships, best practice organizations implement processes to ensure that there is a common understanding of what creates value – and what doesn’t. This process involves formal meetings, information sharing, and interaction about what should and shouldn’t be included in the valuation calculation. The third recommendation is to always ensure that both organizations are on the same page in terms of the calculation through which value is assessed, with the processes oriented towards that goal recycled regularly to see if the metrics and weights given them have changed since the last discussion. Had such a process been employed between the two firms involved in the case study, that should have enabled them – and others in similar relationships – to have created a solid foundation for a sustained “win-win” relationship.
As an example, in the case study described here, we investigated the specific product elements that had been given the ‘unnecessary bells and whistles’ categorization. What we found was that the end customers in this market didn’t see any advantages to these product elements. They didn’t help those businesses to gain more customers, to realize higher prices, or to reduce costs in other areas. So these end customers made a solid sharp-pencil determination that those product elements weren’t ones that they should pay for. Moving back one stage in the customer chain, it appears that the customer that ran the Internet auction heard this message, and incorporated similar thinking into their own decision processes. But the ingredient supplier failed to hear that message, and continued to engineer its products to include those ‘bells and whistles’.
Someone was wrong, as this inconsistency suggests. Either the ‘bells and whistles’ had value from a total cost of ownership perspective, and the ingredients supplier should have marshaled information and arguments to convince their direct customer and the end customer of that fact. Or the ‘bells and whistles’ were in fact unnecessary, without value in the total cost of ownership equation, and the ingredient supplier should have been as aggressive as was their direct customer in trying to ensure that they didn’t unnecessarily drive up costs.
A key lesson is that each participant in an important supplier-customer relationship, at every stage of the customer chain, should carefully examine the value contribution calculation being made by the other participants in the customer chain, and, when an inconsistency is observed, accept as an action plan the need to work through and create a fact-based resolution to that inconsistency. If there is any value to a solid relationship of the type that was described here between this supplier and their customer, it should have allowed for such a discussion to take place. And that statement isn’t based on concepts of kind treatment of long-term suppliers. It’s a statement that reflects the fact that both suppliers and customers should be intensely focused on what creates value in their relationship, especially in a relationship of significance.
There is a second example of an inconsistency in this case history. The ingredient supplier in question talked at great length about the contributions that they had made over the years to this customer through speeding product development processes, helping them to incorporate new technologies, and even to reduce costs by careful linkages in the manufacturing and distribution systems of the two companies. Some of these contributions were suggested in the quotes above. And, in other interviews that we did with the engineers in the customer’s organization, we heard very compelling statements about these contributions. Such factors clearly should enter into a calculation of value contributions, but in this instance, they were not given any material weight in the purchase decision that was made. That was, in fact, one of the reasons why the purchasing manager who we quoted earlier had “heard a real earful” from his own engineers, who in fact felt that their own organization had lost a supplier who had a history of making high-value strategic contributions.
One particular example was cited by in both interviews with the supplier and with the engineers in this company. That example involved an initiative several years earlier in which the supplier came up with an idea that shaved a significant amount of time from the product development process. As a result, their customer was able to get to market quite rapidly, and in fact enjoyed a period in which they were the only one among their competitors out with the “next generation” product. All of the individuals that discussed this event did so quite positively, noting that the firm had realized a significant and sustained gain in market share as a result of being first to market.
There are many examples in which significant contributions involve initiatives that “take time out” of processes such as product development, facilities construction, or equipment commissioning. The contributions from reducing the time required for such processes can involve both direct cost savings and benefits in terms of sales and revenues. While always a challenge to evaluate, time is an important factor in the value creation equation, and efforts to identify ways in which suppliers and customers can manage “take time out” are often rewarding.
The supplier involved in this case study recognized that they had made these contributions, and believed that they had made their customer better off as a result. They felt that these elements were a significant element in the correct calculation of value creation. Their disappointment with the customer was largely defined by the customer’s failure to recognize and value these contributions. The inconsistency in the supplier and customer views about such contributions was another instance that should have been spotted and triggered action on both companies’ parts to reconcile from a fact-based perspective.
The final recommendation drawn from this case study reflects the fact that in strong relationships, many of the most important contributions aren’t explicitly connected to the products and services sold by the supplier to the customer, and therefore aren’t formally embedded in the prices of such products and services. Such contributions may be connected to those products and services, but only in an indirect way. It is therefore essential that the principals managing an important CoDestiny relationship discuss these “adjacent” contributions and explicitly address the issue that the value associated with them isn’t reflected in product and service prices. The discussion must be explicit, reflecting an opening statement of the form “Both of our organizations know that such contributions are a key ingredient in our shared successes, and both of our organizations want to ensure that they continue into the future. How do we jointly recognize such contributions and ensure that the value created is translated into rewards for both of our firms’ shareholders?”
This is not a step that is appropriate in every supplier-customer relationship, but it certainly is appropriate in instances in which the supplier’s contributions go beyond simply delivering a product that meets spec’s on time. In this instance, there was agreement that the relationship had been one of a strategic supplier and a strategic customer. It was a failure on both organizations’ part that they did not invest in processes and discussions to ensure that the contributions that were strategic were jointly recognized and appropriately reflected in decisions about the relationship.
Bridging the troubled waters that can separate suppliers and customers begins with consistent views as to what factors contribute to value creation. Many horror stories that we have heard about failed supplier-customer relationships have boiled down to the two organizations making different calculations, reflecting different beliefs as to what elements enter into value creation. And, as this case example suggests, once this problem surfaces, it can quickly turn into the business equivalent of Class 6 rapids in which the relationship is quickly swept away.
Formally engaging in supplier-customer discussions as to what creates value is not an easy process, especially when everything seems to be going well, but it is far easier than losing a valued customer or a valued supplier because the discussion didn’t take place and the storm hit. Best-in-class organizations, on both sides of supplier-customer relationships, must take the steps to create a dialogue to ensure that both firms understand the other and to form the basis for an effective information and communications flow that establishes the foundation for shared successes. The firms that do so are well-positioned for success, with outcomes far more likely to be translated into bottom-line rewards for their shareholders.
Author: George F. Brown, Jr.