Point #4: Don’t Award Business Based on Price

“Price has no meaning without a measure of the quality being purchased” p.32- Out of the Crisis by W.Edwards Demming. MIT Press edition, Published 2000

Why is this important?

There are so many dimensions that can and should be considered when choosing a supplier, price is definitely one of them but by no means should it be the only consideration.

Shall we go car shopping?

A good way to illustrate the importance of considering total cost of ownership rather than initial price is to think about buying a car.

When you buy a car, do you just buy the cheapest one that suits your size and performance requirements? Or do you take other factors in to account like:

• Reliability of the vehicle
• Fuel consumption
• Cost of ongoing maintenance
• Cost of replacement parts
• Insurance costs
• Resale value
• Depreciation

By doing this, you are taking in to account the cost of ongoing ownership as well as initial price; this gives you a total cost of ownership. In addition to these monetary costs, there are emotional cost to owning an unreliable car. This is in the form of stress, both while you are waiting for it to break and then having to deal with all of the things that go with having a broken down car.

Now let’s choose a supplier:

So if you’d consider total cost and the ongoing “emotional” cost of owning a car, why wouldn’t you do the same thing when choosing a supplier?

What other things are important beyond initial cost?

• Reliability of delivery
• Product quality
• Defect rate
• Quality of relationship
• Customer service
• Their commitment to continuous improvement

All of the above have direct costs and knock-on costs that are also important to consider, for example:

Say you go with supplier A who is 30% cheaper than supplier B. Things go well for a while after they won the tender but then you realise that they have a 15% defect rate.

You might still consider this “good value” as the price per useable unit is still less than supplier B. However, you need to consider the following hidden costs:

• Cost of down time in your process when the defective parts go through your system
• Cost and time to inspect the parts on arrival to mitigate the above
• Cost and time to store and dispose of non-conforming parts
• Cost of replacement and reputational damage if the defective parts make it to your customer
• Cost of damage to your equipment by these defective parts and increased maintenance costs

Do you still think that awarding business based on initial price alone is a good strategy for long-term success?

Finally, beware the risk of cost-plus. This is where work is awarded to the cheapest supplier but when a change in specification is required because of something unforeseen the supplier doubles the cost…by now it’s too late, you already have the supplier contract in place and have likely already invested many resources to get to this point. This is one reason why many large infrastructure projects cost so much more than originally expected (Think HS2 & the Sydney Opera House).

How do we end up here?

“So what’s at the root of this issue?” – I hear you ask…

The things is, the further away you are from the place where the work actually happens, the less detail you have to go with the numbers that you see on your balance sheet. When looking to reduce costs, those at higher levels of management who see numbers on a spreadsheet will look at the biggest numbers and ask for them to be reduced (usually labour, maintenance and raw material costs).

Once again, you need to consider the knock-on effects to doing this as we’ve discussed above. If you are far removed from the place where the work happens (or you simply don’t care for details) then it’s harder to consider those knock-on effects (see Deming point #2 for more on this change of mindset).

When cutting costs in this way, you rarely get the result you are looking for & often by doing this, your costs will in fact go up.

If you want to reduce your costs, work to improve quality and reduce variation throughout your business rather than setting arbitrary 5% or 10% reduction targets for your raw materials / headcount / maintenance budgets.

I was working at a large food company in Norfolk and the business went out to tender for its cardboard packaging supplier. We got 3x companies to tender for the work and we went with the cheapest one as the quality seemed comparable during the tender process. Lo and behold, no sooner had we awarded the work, the quality of the product dropped, our machines struggled to run it and the level of customer service was very poor. The consequences of this “cost saving exercise” was cheaper cardboard, poorly running machines and disengaged people in the factory. The one who awarded the work was not close to the manufacturing operation and thus didn’t have to deal with the consequences of choosing a cheaper supplier.

What can we do about it?

“The best solution to improvement of incoming materials is to make a partner of every vendor and to work together with [them] on a long-term relationship of loyalty and trust” p.43- Out of the Crisis by W.Edwards Demming. MIT Press edition, Published 2000

Aim to build long-term relationships:

What sort of things would you want from a supplier that you were going to have a long-term (say 10+ year) relationship with?

Here are some things that come to mind:

• They frequently ask for feedback on the performance of their product
• They would come to site when we experience big issues with their product
• They attend site as a matter of course to do check-ins, even when there aren’t any problems
• They actively work with us to find solutions to our problems
• They take the time to truly understand our process and help to optimise it by making their supply fit seamlessly within our process
• They are constantly working on continuous improvement within their own systems

If you always go with the cheapest supplier each time you re-tender then you will likely be a shorter customer. How is your supplier supposed to invest in their production process to better meet your needs if you are going to be a short-term customer?

Between you and your suppliers, who is likely to know more about the materials they sell? Don’t underestimate the power of building these relationships and offering the work to someone who will be your long-term partner, rather than someone who will sell you the cheapest product. Otherwise you may end up in a situation where the supplier just meets the specification, rather than actually offering you what you want.

We’ve seen this with so many of our customers at Smurfit Westrock, we want to build partnerships with our customers and have on many occasions, enhanced our offering based on what the customer actually needs rather than simply meeting the specification that they sent us. It is part of our operating model, that we do what we can to improve the performance at our customers sites with what we supply so we can grow together.

Have clear specifications:

It is likely that you already have specifications for the material that you can check verify upon delivery however, how many of you have specifications for how the material should perform within your process?

When going out to tender, take your potential suppliers to the place where the work is done and get them to speak to those who do the work so they can get an understanding of what is important to them within the process. You can then make these things part of the product specification and work with the potential suppliers to come up with the best solution. This way of working helps to build understanding between you and your suppliers.

What about continuity of supply?

Down time from lack of raw materials can be very costly to any business so it might seem prudent to have multiple suppliers for the same raw material “just in case”.

As a customer you will likely experience variation between batch numbers of the same product from the same supplier. Although the batches may well all be within specification but they won’t all be exactly the same as each other. If you receive variation from one supplier, imagine how much more variation you’d get from multiple suppliers offering the same product to you?

This is where you need to pick your sole suppliers carefully & be sure to enquire about their built in safeguards to ensure continuity of supply. For example, many larger companies will have multiple machines within the same factory and within a network of production facilities who can manufacture your product should there be an issue at the primary factory. You could also keep stock of your biggest runners just in case. Though stock building ties up cash and is effectively a waste within Lean, very few manufacturers are reliable enough to have just in time manufacturing so holding a small level of stock might be prudent.

Don’t forget to ask about the OTIF (On Time In Full) metrics of your suppliers, both as an average and for their customers of similar size and product portfolio as yours.

Talk to your suppliers about continuous improvement:

When choosing a supplier, make sure to talk to them about their continuous improvement strategy. You’d want your suppliers to be relentless in their pursuit of excellence through continuous improvement so that they become even better suppliers over time.