World Class Suppliers Need World Class Customers

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As part of their effort to slash the cost of auto parts by 30% over the next three years, Toyota met with its suppliers last week to enlist their help in the process. Based on their reputation for dealing with suppliers, I'm guessing that Toyota will approach the process in a much different manner than most companies, and the process will be very successful.

Instead of squeezing suppliers by beating down prices and lengthening payment terms, companies like Toyota work with suppliers to find improvements in designs and processes that lead to real and sustainable cost reductions. When approached in this manner, the supplier and customer benefit from the process and the savings result in strengthening, rather than weakening, the supplier.

Two Glaring (and Common) Examples

I once worked with a Fortune 500 company that issued a policy for its divisions to lengthen payment terms to all suppliers. Based on the formula, the new policy could result in payment to a supplier being delayed by up to 90 days after receipt of the product or service.

Procurement professionals at a particular division for the company (Division A) implemented the policy and were praised (and rewarded) by the corporate office. One of Division A's suppliers was another division of the company (Division B). As a result of the change in policy, Division B cut off shipments of a critical component to Division A because it paid its invoices too slowly. Because of this, Division A's shipments fell because it couldn't get the component elsewhere; costs increased (due to production stoppages); and profits dropped because of its inability to ship and invoice its customers. Division B's profits also fell because it stopped shipping to Division A.

And another . . .

In another example, a friend of mine owns a company that supplies parts to the Detroit automakers. During a visit to one of the automaker's factories, he noticed a problem in the production line with the assembly of a particular model. As part of the process, the car was flipped to enable installation of a particular subassembly. Problems occurred because the subassembly could not be completed until the car was turned back upright, and it frequently fell apart before it could be secured.

On his own accord, my friend developed an inexpensive grommet that could be placed on the subassembly to properly secure the parts as the car was flipped upright. After the final assembly was bolted together, the grommet could be easily cut away, thereby completely eliminating the problem.

the customer adopted the idea and changed the process to utilize the grommet. Even though the grommet was a very low cost part, the automaker's procurement department - in an effort to further reduce the cost - decided to purchase the grommet from a competitor instead of from the company owned by the person who developed the part. In a situation where a supplier - without direction from the customer - took the initiative to solve a problem that caused delays, extra costs, and headaches for the customer, the customer displayed a lack of respect for the supplier by awarding the business to another company. Needless to say, my friend was not motivated to solve future problems for the customer.

Stop the Madness

The above examples are unfortunately fairly typical of western business. If we are to come out of the recession strong and ready to compete, we have got to learn that the relationship with a supplier is based on more than price and payment terms. A company cannot win if its suppliers lose. Besides the obvious, who wants to do business with a loser anyway?

Practices Leading to a Death Spiral

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Keeping up with business news today can be depressing. Layoffs, plant closings, and job moves continue to occur and have become so commonplace that they don’t warrant much more than a mention in the news. It’s also interesting that, not too many years ago, many of the companies in trouble today seemed pretty much invincible. They were large, strong, and very profitable. So what happened?

Many of the reasons blamed for the downfall of companies are somewhat sensible: poor economic conditions, rising energy costs, natural disasters, terrorism, etc. There is no doubt that these external issues affect company performance. If these are the causes of a company’s troubles, why do competitors in the same industry serving the same customers perform much better?

It comes down to the job of managing – which is to continually build the health of an organization. Just like the human body, an organization has an immune system. As long there are no severe external stressors, an organization with a weak immune system can appear successful (just as a person with a weakened immune system can appear healthy). As soon as something external – and completely out of the control of the business – occurs, the weakened immune system becomes evident and performance drops off severely.

By the time external events occur and a company’s profits and/or market share shrink it is too late. Company decline has begun and executives do not feel they have the time to work on issues that don’t have immediate impact. The company enters crisis-mode and begins to make drastic cutbacks – including plant closings, layoffs, and severe budget cuts – in order to return the company to profitability. Although these items are often well-intentioned, these actions cause damage that often cannot be repaired and the company sinks further into the death spiral.

Companies that continually work on improving their health still have problems. In fact, they recognize that the job of improvement is never done. Toyota is a very strong company, but still runs into problems now and then that affect its performance.

Improving Organizational Health

There are six common practices in organizations that gradually break down its immune system and set it up for failure. Even if the organization appears to be successful, the existence of any of these practices is a sign that troubles are ahead. Stopping these practices begins the process of building the company’s health, thereby reducing the effect of external events on its future.

Practice 1: Losing Purpose

The first practice is forgetting the purpose of the organization and focusing on purely financial results. Companies need profits to survive, but they are not the reason for their existence. An organization is created to serve a need in society. It is vital to remember that need in order for the company to stay focused and successful. The more it strays from its fundamental purpose, the more teamwork breaks down as people define purpose within their own area of specialization (e.g., salespeople define it in terms of sales; accountants define it in terms of cost control and financial results; etc.).

Profits result from sticking to the purpose and doing it well.

Practice 2: Number-Obsession

Number-obsession occurs when managers attempt to run the organization from a spreadsheet instead of through people, processes, and purpose. It is not uncommon today for a manager or executive who spends more time with a spreadsheet than his or her team members.

Meetings that consistently start with review of numbers and financial results is a sign that number-obsession exists. Unfortunately this practice, which was initiated during the 1950s has become pervasive throughout American industry to the point that, a person who is not good with numbers little chance of rising to the executive ranks.

Practice 3: Squeezing Suppliers

Supplier squeezing refers to basing the relationship with suppliers on the basis of price and payment terms. Suppliers are a part of a company’s system and it is important to understand that, when a supplier suffers, its customers also suffer. Squeezing suppliers results in lower quality products and services, longer leadtimes, and a breakdown of trust with your suppliers.

To measure suppliers accurately, it is important to include the costs of extra inventory due to quality and delivery problems, longer processing time due to variation in incoming materials, cost of incoming inspection, rejections by the customer, and nonmeasurable costs like design support and expertise that a supplier can provide.

Practice 4: Undervaluing Employees

Balance sheet aside, companies that treat employees as an expense do not value their contributions. On the employee side, there is little pride of association with the company. Employee turnover is high, layoffs are common, and employee morale is low.

On the other hand, companies that treat employees as assets invest heavily in training and development. Employee turnover is low and morale is high. The management team is made up of people who have risen through the ranks and have a great deal of experience with the company’s products, processes, culture, and customers.

Practice 5: Dirt, Clutter and Damage

Workplaces that are dirty, unorganized, and equipment is worn and broken. Productivity and quality is usually low, while accidents rates and costs are high. Companies that do not respect their assets – do not respect their people.

There is an unfortunate preventive maintenance paradox characteristic of American companies: When business is good, there is no time for preventive maintenance – When business is bad, there is no money for preventive maintenance.

Practice 6: Operational Fragmentation

Operational fragmentation occurs when the organization is managed by breaking it down into individual departments and setting separate objectives for each component. All to common, objectives are set for individuals and departments that conflict with each other. People meet their objectives – especially when tied to compensation – which does damage to the organization as-a-whole.

Organizations need to be led as a system – not as individual components. Objectives should be organization-wide so everyone can work together for the good of the company.

More detail about the practices, including how to identify their existence and eliminate them, is available in my book, Avoiding the Corporate Death Spiral: Recognizing & Eliminating the Signs of Decline (Quality Press, 2006).