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Choosing Appropriate Suppliers may be Counter-Intuitive

The QD and QV Methodologies start from the fundamental premise that the key to success for practitioners is the ability to find better ways to manage buyer and seller relationships so that value can be appropriated more effectively by buyers or sellers from, or in conjunction with, their trading partners.

One of the most common difficulties faced by clients is avoiding the problem of adverse selection. Adverse selection refers to a process by which buyers fail to understand the pre-contractual power situation. Because of this failure, they make inappropriate sourcing decisions and select the wrong suppliers.

This case, based on a Robertson Cox procurement strategy project, involves a large manufacturing company that needed to source a standard low technology component for a complex product that was sold in a highly competitive global market place. In this marketplace there are many suppliers globally because this technology can be easily copied, but there are global, regional and local suppliers who are large and small scale.

Working with this company it became clear that the buyers believed that they were operating in the buyer dominance quadrant of the Power Matrix. Furthermore the buyers had decided that the best way to manage the supply market was to use naked leverage against the suppliers. The standard form of sourcing relationship was, therefore, focused on short-term leverage of the supply market, using annual competitive tendering and aggressive price negotiation. These tactics normally resulted in annual price reductions of 5-10 cents on components costing over $10 each.

By working with the buying company we were able to demonstrate that this approach was sub-optimal. It was clear that while the buying company had been able to reduce its annualised input prices it still experienced high defect rates and poor quality of service level delivery. The major reason for this was because the suppliers selected had no real commitment to the buying company. This was due to short-term contracting and, more importantly, the tendency to source only from larger supply companies that normally had many other customers to work with than our buying company.

In effect the QV Methodology® demonstrated to the buying company that rather than being located in the buyer dominance quadrant the sourcing relationship was actually located within the independence quadrant. In practice there was a stand-off between the buyer and supplier which benefited no one. This was a classic example of adverse selection.

Using the QV Way the thinking of the buying company was refocused so that it was able to avoid adverse selection. This was achieved by encouraging the buying company to look for smaller suppliers, who were highly motivated to become attached to a major global manufacturing company. Three smaller suppliers, who had the capacity and willingness to grow with the manufacturing company, were eventually selected. They were awarded longer-term three years contracts, with two year extension clauses for good behaviour.

By doing this, and ensuring the supplier’s dependence on our business for a substantial share of their total revenue, we were able to transform the power relationship into one of buyer dominance. In return for longer-term contracts and assistance with technical development the three suppliers agreed to open-book sourcing and allowed the buying company to pro-actively work with them on waste reduction and quality improvement.

By focusing, in this way, on cost rather than price the buying company now has three loyal suppliers, who are heavily committed to the buying company’s business. It has also increased the quality of on-time delivery by 25%, reduced defects from a 20% to 3% unsatisfactory level and, in the last two years, reduced the costs of purchase by 15%.This is real buyer dominance with appropriate, rather than adverse, supplier selection.