This is one of many ways in which far-reaching manufacturers like Honda and Toyota rewrite the conventional rules of procurement. Their methods add up to a form of procurement based on shared information and insight: One could call it knowledge-based sourcing. With this approach, manufacturers and suppliers share a long-term commitment to improving each other’s capabilities, starting by working together to eliminate wasted effort and inefficiencies. The two sides, instead of being at odds, collaborate openly on lowering costs and raising overall performance, with the expectation that this mutuality will continue over many years, benefiting both companies. They use sophisticated costing tools and industry data, as well as discussions with other suppliers, equipment manufacturers, and competitors to produce realistic cost targets that change over time. They set prices that reflect the supplier’s true economics for each process, part, component, or system. These prices include a reasonable profit margin for the supplier as well as incentives for lowering costs, improving quality, expanding innovation, and making design changes in subsequent years.
Contrast this with the alternative ingrained in many companies’ purchasing departments: price-based sourcing. Essentially, this approach pits the interests of the supplier against those of the manufacturer. Each side reveals as little information as possible, for fear of giving the opposing side an edge. Components, parts, raw materials, and finished goods are purchased through competitive bidding, with specific volumes and deadlines spelled out in advance (hence those agonizing negotiations). The primary cost-cutting option available to manufacturers is to squeeze every possible cent out of procurement contracts. Purchasing managers focus exclusively on attaining cost savings greater than those of the previous year; their compensation hinges on it. Suppliers, in turn, focus on calculating bids that will win them the jobs.
Once they have made a successful bid, suppliers are stuck with its terms. They have no reason to speak openly about their true costs, because they believe their customers won’t pay a penny more. They have no incentive to improve their product, its design, or its manufacturing processes. They thus feel they have no recourse except to game the system by overstating their expenses or charging exorbitantly for design changes. Both sides lose, and mutual suspicion and resentment are rooted so deeply in the system that they’re almost impossible to overcome. This all-too-common story ends with rising costs, increased time-to-market, a loss of any shared innovation practice — and ultimately, supplier bankruptcies.
Indeed, many suppliers today are in serious trouble. With raw material prices rising, margins cut to the bone, and purchasing departments struggling to meet corporate expectations for cost reductions, suppliers feel pressure from all directions. In the motor vehicle industry, Delphi, Dana, Dura, Tower Automotive, and Collins & Aikman have all filed for bankruptcy. Even suppliers with a long record of success have been squeezed, with profit margins often falling below the cost of capital. These financial crises are causing, in turn, a huge cost to buyers. Expenses associated with bankruptcy can swamp any perceived savings.