LOW-BIDDING IS NO WAY TO LOWER COST

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From the book A Build-to-Order & Mass Customization Copyright 8 2016 by Dr. David M. Anderson

Going for the low-bidder is something we management consultants have been trying to discourage for years, but now it has seen a resurgence just because it is easy to do on the internet. This comes at a time when many purchasing functions are under heavy pressure to A use the net@ and A get into e-commerce.@ 1

Bidding for the cheapest parts is not only an ineffective way to achieve real cost reduction, but it can substantially raise less-obvious costs and compromise other important goals like quality and delivery, which are especially important for Lean Production, Build-to-Order, and Mass Customization. Quality usually takes a back seat when buying decisions are focused on purchase cost, especially in bidding situations. Some say that quality A standards@ can be set for all bidders, but it is a dangerously naive assumption to believe that quality can be assured simply by setting a metric. Further, focusing cost reduction efforts on part bidding distracts attention from real cost reduction opportunities, summarized on the Cost Reduction Strategy on the home page.

Dick Hunter, Vice President of Fulfillment and Supply Chain Management for Dell Computer says that on-line auctions are no A silver bullet:@

COUNTERPRODUCTIVE A COST REDUCTION@

In old-paradigm companies, A cost reduction@ efforts are focused primarily on parts and materials (hereafter called parts) because that is all that most cost systems are able to quantify, besides labor. Many manufacturers, especially the U.S. automobile companies, beat up their part suppliers for repeated cost reductions. And now B2B internet web-sites are able to conduct competitive bidding auctions to offer the A lowest cost@ parts.

But before manufacturers fall for a magic elixir, they should consider how part costs really would lowered under such pressure. One assumption is that either purchasing agents have naively offered to pay too much or that cavalier part makers have been gouging their customers. While this may have been true in sleepy industries of the past, it is rarely true in today= s dynamic marketplaces.

Another assumption is that supplier inefficiencies can be somehow be corrected after a supplier A wins@ a contract at a lower-than-usual price. However, soon after a supplier wins a bid, it is expected to deliver the goods, and there will not be time to implement any meaningful cost reduction program, like that presented on this site. Thus, without a real means to lower costs, the supplier will either have to cut its margins (which will be resisted from the corner office all the way to Wall Street), cut corners (as discussed below), or do the same to thing to its suppliers, who may have the same difficulty achieving real cost reductions. Further, if suppliers are either making disappointing profits or struggling to reduce costs, they will not be very receptive or cooperative with Lean/BTO assemblers= needs for on-demand part delivery, which compromises their responsiveness and real cost reduction efforts.

In some cases, suppliers will temporarily lose money to A buy into the business@ with the expectation of raising costs later, once they are A in.@ And there are even suppliers out there whose strategy is to bid jobs at zero profit and plan to make all their money on the expected change orders.

In other cases, low-bidders A win@ because they don= t understand the problem and then are ultimately unable to deliver at all. In other cases, winning bidders are A vapor@ companies, whose goal is keep bidding down until they win, and then patch together a A virtual@ network of alliances to somehow fulfill the order. This phenomenon came out at an in-house seminar, when the discussion topic was if anyone had noticed any problems with on-line competitive bidding. Within seconds, the purchasing manager was jumping up and down waving both hands in the air. They discovered that one bidding competitor was working out of an apartment and its strategy was to win the auction and then figure out later how to deliver the goods! He also said that a corporate dictate to do part bidding was alienating their valued suppliers with whom they had good relationships.
 

PRESSURING SUPPLIERS FOR LOWER COST

Pressuring suppliers for drastic part cost reduction is what J. Ignacio Lopez de Arriortua tried at GM, which not only failed to generate real, lasting cost savings, but also alienated its supplier base and drove the best suppliers to its competitors. The suppliers that remained put their best people on Ford and Chrysler projects and withheld their newest developments from GM, since Lopez was using proprietary supplier information to press all suppliers for lower prices. Further, the so-called A savings@ in purchasing cost caused severe cost to be incurred elsewhere. An ill-fitting ash tray from a new low-bidder caused a six-week shutdown in one Buick plant! In another incident, managers had to beg for help from a supplier Lopez rejected because of a 5% A savings@ from the low-bidder whose parts failed quality tests 50% of the time.3

When the once high-flying Rubbermaid first encountered cost pressures from the now-powerful lean retailers, its first response as a A leading@ company was to make sure customers understood the necessity of price increases! When they realized that they really had to reduce prices, they tried what didn=t work for Lopez and got the same alienation of the supply base, according to the largest research project ever devoted to corporate failures, Why Smart Executives Fail, and What You Can Learn from Their Mistakes:

Bidding creates a standoffish relationship between buyers and sellers that inhibits cooperative cost reduction efforts, which are the key to real cost reduction. An extensive study that analyzed deficiencies in the American automobile industry concluded this about the effects of bidding on suppler relations:

THE VALUE OF RELATIONSHIPS FOR COST REDUCTION

Another common assumption is that if suppliers know they will have to bid, they will implement effective long-term cost reduction efforts. However, the most successful real progress in cost reduction in supply chain management has come from long-term relationships where manufacturers work together with suppliers. 6, 7

The book that launched the lean production movement in the U.S., The Machine That Changed the World, notes that in lean production companies, suppliers A are not selected on the basis of bids, but rather on the basis of past relationships and a proven record of performance.@ Honda= s criteria for selecting suppliers is the attitudes of their management.9  As a philosophy-driven company, Honda feels it is easier to teach product and process knowledge than to find a technically-capable supplier with the right attitudes, motivation, responsiveness, and overall competence.10

Much of the real cost reduction opportunities are not just at the assembler or at the supplier, but rather in their relationship. In a thorough study of Japanese lean manufacturers, When Lean Enterprises Collide, Robin Cooper states that A it is no longer sufficient to be the most efficient firm; it is necessary to be part of the most efficient supplier chain.@ The key to accomplishing this is inter-company cooperation, summarized by Cooper as follows:

Cooper recommends partner companies A create relationships that share organizational resources, including information that helps improve the efficiency of the interfirm activities.@ 11

Such inter-company cooperation offers significant cost reduction opportunities, especially if suppliers can build parts on-demand for build-to-order assemblers. Then both avoid all the cost and risk of parts inventory in addition to minimizing many categories of overhead for procurement, material overhead, expediting, warehousing, internal distribution, and so forth.

However, switching suppliers every time a competitor drops its price is incompatible with this strategy and can jeopardize ongoing relationships. A Fortune magazine analysis of dot-com failures summarized the failure of an on-line bidding site:

The same article also revealed some realities about the purchasing process that question how welcome bidding would be for typical buyers:

Another article that proclaimed B2B auction sites as A yesterday= s darlings,@ said that:

CHEAP PARTS B SAVE NOW; PAY LATER

Actually, this phrase should be, more precisely: save a little now, pay a lot later. Many times trying to save money on purchase cost has the unintended effect of driving up other costs many times the assumed savings, like the old English adage: penny wise, pound foolish, or the more colloquial A you get what you pay for.@

Cheap parts are usually just that B cheap parts that usually earn the stereotypical image of poor quality, which will add significant cost in the plant and cost even more if bad products get out, not to mention hazards to life and limb and loss of corporate reputations. A Wall Street Journal article published in 2001 had the headline: A Ford Says Last Years Quality Snafus Took Big Toll B Over $1 Billion in Profit.@14

Even though quality disasters may look like infrequent anomalies, these costs must be included in the company= s cost of quality metric, not just considered a one time A charge.@ Programs that aim to improve quality should be justified on their ability to prevent all quality costs, from an accumulation of many to A the big one.@

Ford= s enormous problem with tires is not surprising coming from an industry historically obsessed with bidding on part cost and later enthralled with on-line bidding. An Industry Week article described the procurement process for tires at Ford. Although the millions of recalled Firestone tires may have been made before these on-line auctions, the low-bidder paradigm has been prevalent in Detroit since before the time of Lopez. Here is a description of the tire bidding process in early 2000:

In the 1990 J.D. Power rating of automobile reliability, Mercedes-Benz received the top rating. But by 2003, Mercedes= rank slipped to 26 out of 37 cars ranked.16   One of the reasons for the drop in quality was cited by European analysts:

REDUCE TOTAL COST INSTEAD OF FOCUSING ON CHEAP PARTS

In addition to the cost ineffectiveness of part bidding and its detrimental effects on relationships, there is the compelling argument that other cost categories provide much greater opportunities for real cost reduction, as is emphasized throughout this site. This site= s Cost Reduction Strategy presents many ways to minimize total cost and easy ways to quantify total cost.

One of the cover stories of an Industry Week issue on B2B exchanges pointed out the disappointments of auction-based exchanges and how they distracted focus away from programs that promise real promise:

There are enormous opportunities to reduce total cost throughout the supply chain, without any negative consequences, by designing for manufacturability, specifying off-the-shelf parts, eliminating the costs of setup, inventory, and obsolescence and substantially reduce the costs of quality, distribution, and material overhead.
 

The Value of High Quality Parts

Receiving high quality parts is especially important to lean and build-to-order operations because:

Of course, there are suppliers that practice kaizen continuous improvement and can provide both high quality products at a low price. But because they value cooperation and have a A big picture@ orientation, these companies would naturally align with customers who value long-term relationships instead of participating in the bidding process.

Another related trend is becoming apparent: The best suppliers are shunning B2B auctions. Philip L. Carter, professor of purchasing at Arizona State University, Temple, and executive director of the Center for Advanced Purchasing Studies (CAPS) concludes that:

THE VALUE OF ON-DEMAND PART DELIVERY

For manufacturers to build products spontaneously, suppliers must be able to deliver parts on-demand. Since the best Lean/BTO manufacturers will be building products without forecasts or inventory, their suppliers will also have to build parts without forecasts or inventory B in other words, suppliers will also have to practice build-to-order techniques. Relationships will not evolve if suppliers are selected based on purchase cost and suppliers are switched often. A recent business week article summarized the views of Michael R. Katzorke, senior VP for supply-chain management at Cessna Aircraft Company:

Ironically, suppliers who practice this site= s cost reduction strategy principles will actually provide lower cost not only for purchases but also for several categories of material overhead. And since these suppliers will probably have good relationships with customers who appreciate them, they will start losing interest in A old paradigm@ customers that want them to bid on purchase cost.

Another problem with procuring parts though competitive bidding is that usually the bid is for a batch of parts, which will probably be built in a batch and then drawn from inventory with all the problems of forecast inaccuracies, inventory costs, and obsolescence risks.

Low bidders will probably prove to be disappointing with respect to supply chain coordination, adjusting for demand variations, quality issue resolution, customization, bar-coding, radio frequency ID tags, labeling, shipping bin reuse, and help with customer service at the user level. All these services may be inadequate if either the low bid is forcing suppliers to eat into their margins or the suppliers are too stretched trying to satisfy the bid commitment.
 

EFFECT OF PART BIDDING ON PRODUCT DEVELOPMENT

A key theme of Concurrent Engineering is multifunctional teams with active and early participation from suppliers, who are in the best position to help design the parts they will be making.  However, suppliers will not participate in early design team efforts - and provide valuable assistance designing their parts - if they do not have some assurances that they will get some business out of it.  See      Vendor/Partnership article .

Michael R. Katzorke, senior VP for supply-chain management at Cessna Aircraft Company said: A With auction bidding, alignment is damaged. And integration into design and manufacturing is out the window.@22
 

NO SUCH THING AS COMMODITIES IN LEAN/BTO

Even companies that value relationships still justify competitive bidding for A commodity@ parts and materials. However, for Lean/BTO, there are no commodities B even the most basic parts and materials must be made available spontaneously, so the service of supplying these on-demand becomes a very important aspect of supply chain management. And accomplishing this will require supplier/partner relationships, not switching suppliers on every procurement for a lower purchase cost. Companies like GE brag about how much money they think they have A saved@ by bidding on commodity parts like nuts and bolts, but the fact still remains that they are still purchasing them, with overhead costs that must be far exceeding the cost of the fasteners for material overhead and distributing a year= s worth of fasteners to GE divisions.

Even for high-cost purchases, B2B transactions still don= t reduce material overhead. Dave Oppenheim, e-business director for Cessna, summarizes the situation for big-dollar items:

Instead of competitive bidding, there are many ways to lower the total cost of A commodity@ parts and materials. For low-cost parts, the strategy would be to eliminate the much greater overhead costs, such as all the costs of forecasting, bills-of-material, MRP, purchasing, shipping, receiving, and internal distribution. One of the authors favorite lecture props is a bag of three screws that one company issued to the assembly area. Not only did the issuance cost hundred of times the cost of the parts, but the assemblers complained that if they lost one of those screws, they had to fill out forms to get one replacement screw!

Kanban, breadtruck, and min/max resupply techniques, discussed in this chapter, can automatically resupply parts and materials and make them always available in all points of use and in the process avoid considerable overhead costs.
 

ENDNOTES/REFERENCES (see below)

For more information call or e-mail:

Dr. David M. Anderson, P.E., fASME, CMC
www.HalfCostProducts.com
phone: 1-805-924-0100
fax: 1-805-924-0200

Copyright © 2017 by David M. Anderson

e-mail: anderson@build-to-order-consulting.com

 

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ENDNOTES/REFERENCES

1. Philip L. Carter, professor of purchasing at Arizona State University, Tempe, and executive director of the Center for Advanced Purchasing Studies, was cited in Industry Week (February 12, 2001, p. 43) as observing that “Many purchasing organization are under heavy pressure form the corporate brass to implement some form of e-commerce.”

2.  John H. Sheridan, ‘Proceed with Caution,” Industry Week, February 12, 2001, pages 38 - 44. One of the cover stories on Manufacturing Exchanges.

3. For more on the counterproductive effects of this type of “cost reduction” see page 37-38 of “The Connected Corporation,” by Jordan D. Lewis (1995, Free Press).

4. Sydney Finkelstein, Why Smart Executives Fail and What You Can Learn from Their Mistakes, (2003, Portfolio/Penguin), p. 62.

5. James P. Womack, Daniel T. Jones, & Daniel Roos, The Machine that Changed the World, The Story of Lean Production, 1990, Harper Perennial, p. 142.

6. Yasuhiro Monden, The Toyota Production System, Second Edition (1993, Institute of Industrial Engineers).

7. James P. Womack, Daniel T. Jones, & Daniel Roos, The Machine that Changed the World, The Story of Lean Production, (1990, Harper Perennial), Chapter 6, “Coordinating the Supply Chain.”

8. Ibid., p. 146.

9. Jeffrey Pfeffer and Robert I. Sutton, The Knowing-Doing Gap; How Smart Companies Turn Knowledge into Action,(2000, Harvard Business School Press), p. 23.

10. John Paul MacDuffie and Susan Helper, “Creating Lean Suppliers: Diffusing Lean Production through the Supply Chain,” California Management Review, Summer 1997, pp. 118-150.

11. Robin Cooper, When Lean Enterprises Collide, (1995, Harvard Business Press), Chapter 9, “Interorganizational Cost Management Systems.”

12. Jerry Useem, “Dot-Coms: What Have We Learned?” cover story, Fortune, October 30, 2000, p. 92.

13. “Lessons from the Dot-Com Crash,” cover story, Fortune, October 30, 2000, p. R8

14. Gregory L. White, “Ford Says Last Years Quality Snafus Took Big Tool – Over $1 Billion in Profit,” Wall Street Journal, January 12, 2001, p. A3.

15.  Industry Week, August 21, 2000, p. 39.

16.  Lee Hawkins, Jr. “Finding a Car That’s Build to Last,” Wall Street Journal, July 9, 2003, page D1.

17. John O’Dell, “Even Mercedes Hits a Few Speed Bumps,” Los Angeles Times, July 13, 2003, pages C1 and C4.

18. John Sheridan, “Proceed with Caution,” Industry Week, February 12, 2001, p. 38.

19. David M. Anderson, Design for Manufacturability & Concurrent Engineering, (2010, CIM Press; 1-805-924-0200); Chapter 10, “Design for Quality,” Section 10.3, “Cumulative Effects on Product Quality.”

20.  John Sheridan, “Proceed with Caution,” Industry Week, February 12, 2001, p. 43.

21.  ibid. p. 40.

22. John Sheridan, “Proceed with Caution,” Industry Week, February 12, 2001, p. 40.

23. Ibid., page 44.