The following article appears in the journal JOM, 50 (12) (1998), p. 80. JOM is a publication of The Minerals, Metals & Materials Society

Outsourcing: Pressure on Suppliers to Expand Services and Lower Costs

As the trend for original-equipment manufacturers (OEMs) is to outsource as many functions as possible beyond their core activities, machine tool suppliers are working hard to improve plant services and efficiencies to keep pace with the OEMs' demands. In this outsourcing environment, many machine tool suppliers have expanded to gigantic proportions through the acquisition of smaller suppliers in order to offer a broader scope of services.

Outsourcing in the machine tool industry no longer covers the mere purchase of parts by OEMs. It includes the purchase of design and product assemblies, product testing, inspection, and sometimes even sales and customer service. OEMs ask suppliers to provide logistics and materials supply, services covering technology, material requirements planning, procurement, inventory monitoring, accumulation, and replenishment.

Outsourcing since the 1970s has been booming, totaling $100 billion in 1996; it should expand to about $325 billion by 2000, according to the Outsourcing Institute. The demand for expanded (and lower cost) service from suppliers is strongest in the durable goods industries because that is where global competition is keenest.

According to Robert Miller, head of the Motor & Equipment Manufacturers Association, "We will see fewer and fewer direct firsttier suppliers in automotives, machine tools and machinery, but they will become much bigger and show lower costs." At Motorola, for example, the number of tier-one suppliers has been cut from about 6,000 in 1982 to approximately 1,300 in the latter half of this decade, even though the corporation now buys three times more outsourcing.

The greatest pressure to cut costs is on the suppliers, and it is interesting to see how that pressure is applied. Assume, for example, that a supplier in the machine tool industry meets all the conditions established by an OEM in the basic quality standards document QS9000. The document demands that suppliers achieve zerodefect level output, improve productivity, and shave prices from year to year. Assume further that the supplier has achieved a QS9000 qualifying certificate. Does that mean the supplier will get a contract from the OEM? Not yet. There is still another hurdle according to the QS9000 manual: "Regardless of the scoring method (pass/fail or point score on the auditor's quality report), each cus-tomer's purchasing department will establish its own policy for using assessment results in sourcing decisions."¹

This means that the OEM's purchasing department"looking for as many bids as possible to get the optimal price"will decide which supplier gets the contract. A purchasing department proceeds typically on the basis of price. As one participant describes the process after spending a day at a Motorola Purchasing Department conference for suppliers: "The song they sing in the morning is quality, prompt delivery, dependability. But in the afternoon, it is Price, Price, Price. And that's the tune they sing loud and clear as you leave."² This is common in many industries.

The pressure to reduce prices has affected some suppliers adversely. A Dun & Bradstreet survey covering 1,023 durable goods suppliers indicates that suppliers' costs have risen about two percent annually. With OEMs refusing to share many of these increases, suppliers' profit margins fell an average of one percent annually between 1985 and 1995. The profit margins of larger, more-diversified suppliers showed less-severe erosion.

The just-in-time delivery concept, which provides an obvious benefit to OEMs, also squeezes machine tool suppliers. For example, a supplier may produce and deliver 10,000 machine tool components to an OEM at $5 per unit. If the OEM begins demanding smaller, more frequent shipments (e.g., 1,000 units) to avoid inventory accumulation, a price increase is rarely accepted. The supplier has to adjust its operations so as to absorb the increased unit costs associated with producing smaller batches. It must also maintain an inventory of those units.

Suppliers that survive in this environment will no longer be mere component producers; instead, they will be more flexible, more diversified, and more cost efficient. This outlook helps explain the growing trend among OEMs and suppliers to utilize incentive plans that motivate employees and, correspondingly, improve plant performance. One such plan, as has been reported in past editions of this column, is gainsharing. Unlike piecework, which is an individual-incentive plan, gainsharing is a group-incentive program whereby the entire factory group earns a bonus as a unit if certain numeric and defectfree goals are achieved.

Suppliers that use such payforper-formance plans to motivate the work force not only boost productivity and quality but save materials, limit inventory, cut lost-time accidents, speed throughput and deliveries, save on energy costs, and so onideal conditions for a supplier attempting to excel in today's cost-conscious outsourcing environment.

References

1. QS9000 Manual (Ann Arbor, MI: American Society for Quality Control, 1995).
2. "How to Improve Your VendorSupplier Efficiency," CNCWEST (August/September 1995), p. 33.

For more information and articles on how gainsharing can be applied to your company, contact W. Imberman, Imberman and Deforest, 1740 Ridge Avenue, Evanston, Illinois 60201; telephone (847) 733-0071; fax (847) 733-0074; e-mail IOMB@aol.com and DEF@aol.com.