Culture, Strategy, and Supply Chain Management

Purchasing can make or break a manufacturer. If the purchasing group has a culture that differs from that of the company, the overall performance of the company will suffer. If purchasing managers have incentives that drive their decisions away from the company’s overarching strategy, bad things will happen. Why? The behavior of the purchasing department signals a company’s true goals to its supply chain. Quality will suffer if suppliers think that the purchaser talks a “quality matters” talk, but walks a “lowest price over everything else” walk. Purchasing cultures that are out of line with overarching company culture inevitably cause long-term problems for a company.

By Ned Hill, A One-Handed Economist, and Professor of Public Administration and City & Regional Planning at The Ohio State University’s John Glenn College of Public Affairs, powered by The MPI Group

An industrial sociologist who worked for an automotive OEM was once asked by my colleague, Larry Ledebur, about the difference in the culture of his employer and the cultures of their competitors. The sociologist said that in his company, “culture” encompassed everything that was too hard to change. Oh boy!  Therein lies a problem. Today, I am poking at purchasing culture.

Purchasing can make or break a manufacturer. If the purchasing group has a culture that differs from that of the company, the overall performance of the company will suffer.  If purchasing managers have incentives that drive their decisions away from the company’s overarching strategy, bad things will happen.  Why? The behavior of the purchasing department signals a company’s true goals to its supply chain.  Quality will suffer if suppliers think that the purchaser talks a “quality matters” talk, but walks a “lowest price over everything else” walk. Purchasing cultures that are out of line with overarching company culture inevitably cause long-term problems for a company.

In my previous posts on supply-chain management, two different dimensions of managing a supply chain were outlined: The business relationship that exists between suppliers and purchasers, and the considerations used to evaluate the competitiveness of a part or subassembly.

There are two polar supply-chain management models: auctions and relationship bidding; and then there are the four traditional considerations about a quoted price for a part: (1) delivered cost, (2) quality as defined by the purchaser’s specifications, (3) delivery demands of just-in-time production systems, and (4) payment terms.

Matt Tyler, CEO of Vickers Engineering (a Tier 2 and 3 parts supplier that does most of its business selling to the automotive, truck, and oil and gas industries) summarized purchasing culture to the affiliates of the Manufacturing Extension Partnership at its Summit in May. “Lowest cost is all that matters [to the customer]; quality and delivery is assumed.”

While that may be the view from the lower rungs of the industrial food chain, smart OEMs will also give consideration to four dimensions of the risk-adjusted life-cycle cost of the part:

  1. Can a supply disruption stop production? This is coupled with consideration of the cost of expediting the renewed flow of parts. The offset is the cost of dual tooling, managing two sets of supplier relationships, ensuring consistency of the parts, and determining if there is sufficient volume to justify split sourcing between two vendors.
  2. The probability of a supply chain disruption due to weather, natural disaster, strike, seasonality, political disruption, or equipment shortage.
  3. Currency risk.
  4. The difficulty of either correcting quality problems or acting on feedback when there are long delivery times.

Purchasing culture is defined by what purchasers do. This is how suppliers and customers understand each other’s preferences—what is truly valued is revealed by actions. A company that uses an auction model—emphasizing lowest delivered price, extracting extended payment terms, and tolerating low quality standards that will get the finished product past its warranty period and no more—is a company that has a near-term financial orientation.

A company that uses a relationship purchasing model that allows suppliers and the OEM to work together to improve the final product, giving dominant consideration to delivered cost, but also weighing the elements of risk to quality that are related to distance, supply disruption, and currency, has an operations orientation. This is a culture that emphasizes longer-term financial returns. I realize that Keynes’ dictum about the long run is correct [In the long run we are dead—as is also true for companies that do not make money], but investing for longer-term results should benefit customers and the company.

What truly defines a purchasing culture are the incentives provided to its purchasing managers: these are the way purchasing agents are evaluated and paid. Another part of defining and building a supply culture is the degree to which purchasing is integrated with developing and specifying final products. Is it a team, or is the spec tossed over a departmental wall, and purchasing managers told to scurry around and get quotes?

Recent industrial history has demonstrated numerous examples of the substantial risk that a purely financially-driven supply-chain management model can pose. I discuss two: GM’s ignition switch recall and Takata’s explosive airbags.

Switching on the litigators

The liabilities that the new GM inherited from the old GM over the ignition switch primarily used in its Saturn Ion and Chevy Cobalt small cars not only made the news, but have now entered the courts. The switch can fail and turn a car off while it is in motion, disabling its airbags and stranding the driver in the middle of a road.

The problem was originally discovered by GM in 2001; the first known death due to the faulty switch took place in 2005, and 2.6 million cars were recalled in March 2014. The compensation fund administrator acknowledged 124 deaths, and $594.5 million was paid out in compensation in 2015. GM paid a fine of $900 million to settle the case, and the cost of recalls brought the total spent to more than $2 billion.[1] A second round of claims were filed in 2015 around another ignition switch, and GM has recalled an additional 10 million vehicles.

Explosive failure at Takata

We can also look to the expensive misadventures of Takata’s airbags as a cautionary tale about the lure of low cost to purchasers. Takata invented an airbag-inflator technology that reportedly gave it a 30-percent cost advantage over its competitors in the airbag market, Autoliv and TRW.[2] A former Autoliv senior scientist told the New York Times that this was “a potential savings of several dollars per airbag.”

Unfortunately, Takata’s own labs found that the airbag propellant could go off accidentally in hot, high-humidity conditions, turning the inflator into what a former Autoliv scientist described as “shrapnel.” In the U.S., 11 people died due to this defect, 150 were injured, and more cases are under review. In March 2017, Car and Driver stated that 42 million cars have been recalled in the United States and another 7 million in the rest of the world,[3] while in February 2017, the New York Times reported that the recall will involve 70 million airbags in the U.S. and 100 million globally.

The Times also reported that the U.S. Justice Department opened a criminal investigation and stated that four OEMs knew of the defect “for years.” Lawyers for the victims filed a civil suit in Florida in February 2017 stating that emails and internal documents from four OEMs indicate “that cost considerations influenced automakers’ decision to adopt Takata’s airbags in the early 2000s despite safety concerns.”[4]

Allegations made by victims’ attorneys in court documents filed in February 2017 state that four of Takata’s customers—Honda, Ford, Nissan, and Toyota—knew of the problem and did not move to purchase more expensive airbags. In the same article, the New York Times reported that the Department of Justice investigation “so far painted automakers as unwitting victims duped by a rogue supplier that manipulated safety data.” The Times in August 2016 reported that automakers pressed “suppliers to put cost before all else,” focusing its reporting on General Motors.

Is the Takata shrapnel-spewing airbag disaster a supply chain failure? Takata knew of the problem, but was facing an existential business threat: it had no alternative competitive product. The result was that Takata turned a corporate blind eye and moved forward. Courts will decide if Takata’s customers put the cost of the part above the safety risk. Honda, for one, is aggressively disputing the assertion that it knew of the problem.

In both the GM and Takata cases, failed parts killed people, and the accumulation of recalls, compensation and fines paid have proved costly to both the OEMs and the parts makers. The reporting of the New York Times from court documents in the case of the faulty ignitions paints a picture of a bureaucratic decision-making structure that was focused on the price of the ignition system, and avoiding admitting that a problem existed. The latter is a sure sign that lawyerly-concern over liability outweighs corporate concern over customers. The case of Takata is more complicated because the design failure was known to Takata, and what each OEM knew and when they knew, it will be determined in a trial.

However, the reporting clearly implies that initial cost savings caused the OEMs to discount the claims of competing suppliers that Takata’s propellant was unstable in hot, humid conditions. The risks and costs associated with exploding airbags were not considered. And the problem was downplayed.

OEMs named in the Takata case include both Japanese-headquartered OEMs with strong relationship cultures in their supply chains, and Detroit-headquartered OEMs that used auction supply chain models.  So, what is to be learned from these two cases? First, companies put their finances at risk when price trumps all other considerations in purchasing parts.  Second, it is better to stop and correct a failure early. Third, large cost savings will tempt all purchasing systems to go for the lower cost, especially if competitors are purchasing the part.

Companies are especially reluctant to hurt the reputation of a product that is in the market, and thus become more reluctant to publicly admit liability. Short-term cost considerations are an incentive to kick the can down the road and hope that the problem goes away [hope, by the way, is never a good business strategy].

It is important that senior leaders of companies understand the purchasing culture of their firms.  It is critical to understand if purchasing culture is financial or operational. It is paramount that the incentives you provide to your purchasing group align with your culture. If you do not, your purchasing department and your supply chain can damage your customers, your stockholders, and your company. Culture, reinforced by incentives, is the instrument of strategy.

Follow Ned Hill on Twitter at @AOneHandedEcon

 

[1] Boudette, Neal, April 24, 2017. “Supreme Court Rebuffs G.M.’s Bid to Limit Ignition-Switch Lawsuits.” New York Times, https://www.nytimes.com/2017/04/24/business/supreme-court-general-motors-ignition-flaw-suits.html;  Green, Jeff and Margaret Cronin Fisk, July 1, 2015, “Many Ignition Switch Claimants Excluded for GM Compensation Fund. Insurance Journal. National Public Radio, March 31, 2014. “Timeline: A History Of GM’s Ignition Switch Defect. http://www.npr.org/2014/03/31/297158876/timeline-a-history-of-gms-ignition-switch-defect.

[2] Tabuchi, Hiroko. “A cheaper airbag, and Takata’s road to a deadly crisis.” New York Times, August 27, 2016.

[3] Kiley, David. “The Takata airbag recall is now a full-blown crisis.” Car and Driver. June 10, 2016; Atiyeh, Clifford and Rusty Blackwell. “Massive airbag recall: Everyting you need to know, including the full list of affected vehicles.” Car and Driver, March 2, 2017.

[4] Tabuchi, Hiroko and Neal E. Boudette. “Automakers knew of Takata airbag hazard for years, suit says.” New York Times. February 27, 2017.

© 2017 A One-Handed Economist featuring Ned Hill is powered by The MPI Group