Supply chain strategy gone wild

When it comes to best practice supply chain strategy, conventional wisdom is shifting.  Historically, companies – particularly automotive, electronics and telecom original equipment manufacturers (OEMs) – have outsourced most of their non-core operations.  Some firms outsource so much of their operations that they do almost nothing themselves except for design and quality control. This approach, however, has not delivered the hoped for benefits. Many supply chain leaders are now rethinking how they craft and manage outsourcing relationships and whether these continue to be aligned with their core business strategy. 

Inspired by the Japanese, virtually every North American OEM aggressively shifted to an outsourced and tiered supply chain so that they could reduce costs, minimize capital and focus on their core competencies.   As part of this strategy, managers reduced the number of suppliers a firm directly deals with; gave these tier 1 suppliers the mandate to design, produce and deliver major components and; off-loaded the responsibility of managing lower tier vendors to their tier 1 suppliers.

These blanket outsourcing deals, according to supply chain experts Thomas Choi and Tom Linton, are problematic.  Costs rarely fall significantly, and will often rise.  Moreover, firms may also experience declining competitiveness due to reduced access to emerging innovations and vital market information.  How does this happen? 

Less control over bill of material costs

When the OEM delegate’s control over a product’s BOM, the total delivered cost of the product (including items like inventory management and logistics) become opaque and difficult to manage.  This lack of visibility makes it difficult for the OEM to leverage further volume discounts and to switch suppliers to get better pricing.

Reduced OEM control can also lead to decreased supplier compliance.  When working with an automotive manufacturer, we discovered that tier 1 suppliers often veered from the approved vendor list (of the companies from which top-tier suppliers are supposed to buy parts and materials) when it served their interests.  This was most common with standardized materials and where they could keep most if not all of the cost savings.  Better management of tier 1 suppliers is possible, but it is a challenging and potentially confrontational exercise.

Restricted access to market and technology information

Paying no attention to lower-tier suppliers who serve multiple industries shut the OEM out of potentially important technology and market developments. For example, without close supplier relationships at the raw material level, companies may miss opportunities to adjust orders and lock in favorable prices as well as gain access to the newest technologies. Tight collaboration with lower tier suppliers has enabled companies like Apple and LG Electronics to incorporate the newest chip designs into their products before their rivals do, and to secure these technologies at advantageous prices.

Tier 1 suppliers should be the conduit of market information and innovation.  However, they often don’t have the inclination or time to monitor the technology landscape below them. Furthermore, tier 1 suppliers may pursue a different strategic agenda than the OEM.  For example, tier 1 suppliers could knowingly withhold market information in order to improve their bargaining position with their customers or to use the information to sell to other business prospects.

There are ways to get more out of your supply chain while reducing risk.  For example:

  1. Retain purchasing and technical control over items that have the most significant impact on the total cost of goods sold.  For many products such as a mobile phone, TV or a PC, a few inputs could make up more than 50% of its total BOM cost. Just a 1% reduction in the price of such items translates into considerable savings.
  2. Get more visibility into your supplier networks. Innovative firms like Apple play close attention to what is going on in their entire supply chain’s R&D pipeline.  Five years ago, Apple understood that HMI (human machine interface) technologies would play a strategic role in future products, so it maintained close relationships with companies in that space. The move paid off.  Apple now has excellent visibility into a sub-system that accounts for more than 40% of the iPad 2’s total cost and is crucial to Apple’s goal of delivering meaningful product differentiation.
  3. Pay close attention to lower tier vendors that serve multiple industries.  Some suppliers, particularly in the technology, services and commodity sectors, provide inputs to multiple industries.  These firms can provide early warning signals around technology, pricing and regulatory changes. To lock-in preferential supply arrangements, our automotive client secured contracts with strategic lower-tier vendors.  The OEM then stipulated that their tier 1 suppliers use those vendors exclusively and execute the strict terms on their behalf.

To drive supply chain performance and reduce risk, firms must optimize their outsourcing partnerships.  Our experience shows that many tier 1 suppliers and their vendors are amenable to closer collaboration if given the chance and presented with tangible business benefits. Where outsourcing ends up being too problematic or inconsistent with long term corporate goals, CEOs may want to consider vertical integration as a more appropriate business strategy.  Many companies have, with impressive results.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.


2 comments so far

  1. […] leaders should consider more sophisticated cost reduction strategies such as complexity reduction, supply chain re-engineering or in-sourcing expensive outsourced functions.  Not only can these methods produce compelling cost […]

  2. […] leaders should consider more sophisticated cost reduction strategies such as complexity reduction, supply chain re-engineering or in-sourcing expensive outsourced functions.  Not only can these methods produce compelling cost […]

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