Develop Suppliers and Partners as Extensions of the Enterprise

Table of Contents

Supplier Partners in a Globally Competitive World

It’s a tough time to be talking about supplier “partnerships.” With companies throughout the Western world looking at the prices of parts from China, India, Vietnam, Russia, Eastern Europe, and other low-wage countries, it’s hard to imagine looking beyond price. Radical attempts to cut costs by suppliers, including automation, plant consolidation, and even lean techniques, seem in vain when the purchase price of raw materials for production in a typical Western company is greater than the price a supplier in a remote province in China is charging for the finished component. If the problem is competing based on cost, and the solution is to chase the lowest price in the world, then the supply chain problem becomes a straightforward logistics exercise: Get the latest software, run the optimization models, and figure out the lowest cost way of getting the best total cost of piece price plus logistics.

But the critics will argue that quality will suffer. The low-wage countries are low wage for a reason. They do not have the same high quality of labor as the developed countries and thus cannot produce the consistently high levels of quality that have become the price of entry into modern business. Even that argument breaks down. Education levels are high and getting higher in these countries, people work hard and long hours, and they are eager to learn. Their acceleration up the learning curve has been nothing short of miraculous.

So if you can’t beat them, join them—right? Certainly for some commodity parts and even high value parts and tools, that will be the inevitable conclusion. But Toyota has not gone in that direction for their core components. They have invested deeply in supplier partnerships over decades, and any new suppliers added to the mix must pass stringent tests and prove they can earn their way into the partnership network slowly over time. Existing suppliers doing a good job aren’t fired because of cheaper alternatives, and they have job security similar to Toyota’s own employees.

Short-Term Cost Savings vs. Long-Term Partnerships

Why does Toyota make these investments? Why sacrifice short-term cost reductions for longer term supplier partnerships? This is a complex issue and there are multiple parts to the answer.

First, there’s quality. Quality is more than having start-of-the-art equipment and ISO-9000 documented quality procedures. It starts with the people doing the value-added work. As we saw in Chapters 8 and 11, training your people in the specific steps required to do the job is only a small part of the equation. Training them to see quality problems, to immediately alert the team leader, to participate in root cause problem solving, and to find opportunities for improvement regularly requires building a culture of quality. Hire a firm in China to make your parts, check quality procedures, look at the equipment, and you still know very little about the people who build in quality. Toyota wants its suppliers to have a compatible culture of finding and eliminating problems through continuous improvement.

The quality movement of the 1980s, driven largely by the overwhelming success of the Japanese model, purportedly marked the end of antagonistic buyer-supplier relationships. Most big firms purchased a large portion of the products they sold, and the final quality of their products were only as good as each component part purchased from suppliers. Supplier quality became purchasing’s chief marching orders. In fact, investing in quality would also produce the lowest costs, as repeated inspections, rework, and warranty costs went by the wayside. Even more important, customers will come back if the product is of the highest quality. The bottom line was that treating suppliers as partners in the business was a key to long-term success. The Malcolm Baldridge Award, the gold standard of quality companies, added “key supplier and customer partnering and communication mechanisms” as a major criteria for the award.

Second, there is the engineering of products and processes. Toyota has made a living on the overall quality of design and the precision, as well as the flexibility, of its manufacturing processes. The integration of product and process in the design and engineering stages has a huge impact over the life of a product.

Get it right and every unit up to the last car rolling off the line is better quality and yielding higher margins. And even for years after the last car is produced, warranty costs can kill a company if there were mistakes in engineering before the first car was ever produced. Since suppliers are manufacturing the components, high quality design and manufacturing can be best done in close concert with or even by the suppliers. Integrating engineering between Toyota and its suppliers, and integrating the engineering of the product and process of the supplier, is a critical success factor, and it takes many years of investment to get right.

Third, there is the precision and delicacy of the just-in-time system. As we have learned, JIT is not just about reducing inventory. It is about exposing problems so that people will solve them. It is a “fragile” supply chain system. Toyota extends that system and its underlying philosophy to suppliers. Suppliers are simply extensions of the assembly line, and waste anyplace in the value stream from raw materials to delivery to the customer is still waste. It must be driven out. Toyota has worked since it was founded to learn how to eliminate waste. Having suppliers who do not have this capability creates weak links throughout the value chain. Toyota wants every link to be equally strong and capable. Remember, lean is about connected flows between stable processes. The supplier needs to be stable and connected to your stable plants.

Fourth, Toyota wants innovation. The core of their long-term success has been innovation—in products, processes, and countless small improvements throughout the enterprise. Toyota sets specific targets for innovation by its suppliers. For example, Denso has done projects in radiators and alternators with the goal of putting those products at the forefront of performance relative to cost in the industry for 10 years.1 As they approach the 10-year mark, they come up with more radical improvements to keep them ahead for the next 10 years. Toyota works with suppliers to set specific plans for investment in R&D to put innovative technologies on the shelf that will maintain Toyota as a leader in the technologies of tires, batteries, climate control systems, exhaust systems, lubricants, and so on. “On the shelf” means the technologies are proven and ready for chief engineers to pick off the shelf to design into mass-produced vehicles.

Fifth, Toyota realizes that the overall financial health of the Toyota enterprise depends on the overall financial health of each part of the enterprise. While a weak supplier may be able to inspect and build inventory and ship good parts just-in-time and provide price reductions, at some point the weak supplier will be driven out of business. Toyota wants suppliers that are strong and capable of contributing to the entire enterprise.

There is probably a sixth, seventh, and eighth reason as well. The point is, there’s a huge amount of work involved to align the capabilities of suppliers with your own internal capabilities. And the huge benefits to doing so go beyond immediate savings based on undercutting price.

The best way to describe the situation facing companies today is that many are confused. Is there a payback to investing in supplier partnering? Does “partnering” truly lead to the best quality and ultimately a competitive advantage? Is partnership another way of saying we will be soft on our suppliers and they’ll take advantage of us? Does supplier partnering lock companies out of opportunities to find the lowest costs globally? What does it actually take for supplier partnering to yield competitive advantage for the long term?

To address these questions, let’s examine Toyota’s supplier management up close. Toyota provides an object lesson in the benefits of supplier partnering. For example, working closely with their suppliers, they were able to reduce the total cost of manufacturing the Camry by over 25 percent in the mid-1990s. To deal with competition from companies in low-wage countries, Toyota asked its suppliers to reduce cost by about 30 percent by the next new model introduction in its CCC21 program. The suppliers worked hard and mostly accomplished the goal. This seems brutal, yet in the end, suppliers tell us they prefer working with Toyota (and similar customer Honda) over any other car companies.2 How have they done it?

Supplier Partnering the Toyota Way

When Toyota first set up shop in North America there were questions about whether they could reproduce the supply system that contributed to their phenomenal success in Japan. There were many reasons to prefer local sourcing: pressure from the U.S. government, the operating philosophy of just-in-time, and a philosophy of contributing to the communities that buy their cars and trucks. Relationships built up over decades in Japan had to be developed in years in North America. In response, Toyota began to develop local sources through a combination of joint ventures with traditional Japanese suppliers and carefully selected local suppliers.

What made this task so challenging was that Toyota was not satisfied with simply finding companies that could build parts. Supplier partnering meant much more. When we began to examine the essential features of the elaborate system of supplier relations Toyota needed to establish, a picture emerged of a complex set of systems, controls, and in fact a cultural connection. Many articles written about supply chain management emphasize the use of a particular tool like target pricing or the use of kaizen workshops or inventory reductions through clever uses of information technology, but Toyota has built a much deeper foundation of relationships to allow continuous improvement to thrive. We view Toyota’s supply chain as a pyramid3 that we call a “supplier partnering hierarchy.” We use the term “hierarchy” because some of the features in the seven levels form a foundation for others (Figure 12-1).

Figure 12-1. Supplier partnering hierarchy

As an example, many companies have attempted to develop supplier metrics in order to improve supplier performance. The famous balanced scorecard was touted as a supply chain solution that would significantly improve quality, cost, and delivery. Yet in implementing the balanced scorecards, companies often did it in the context of conflicted, adversarial relations with suppliers. These conditions made the balanced scorecard a punitive measurement system to identify underperformance. Suppliers would placate the customer through short-term actions, not to solve the root cause problem, but to make the numbers look good. In contrast, though Toyota also uses rigorous measurement systems to help control supplier performance, they do it in an environment of open communication and trust. In short, jumping up to particular control systems without a foundation of mutual understanding and a structure that supports cooperative behavior leads to game playing and short-term responses.

Of course, supplier partnering is not all fun and games. Being a partner to Toyota is not about Toyota being soft or forgiving. As pointed out in The Toyota Way, fairness, high expectations, and challenge characterize how Toyota treats suppliers. This is business, and the goal is to make money, but not at the expense of suppliers. As Taiichi Ohno, father of the Toyota Production System (TPS), stated:

Achievement of business performance by the parent company through bullying suppliers is totally alien to the spirit of the Toyota Production System.

The key word is “parent.” It implies leadership and long-term relationship. It connotes trust, caring, and mutual well-being, yet also signifies discipline, being challenged, and improvement.

Seven Characteristics of Supplier Partnering

Building a Lean Extended Enterprise

Traditional vs. Lean Models of Supplier Management

There are many pressures on companies in the hypercompetitive global economy: pressures for cost reduction, unprecedented quality levels, and responsiveness to niche market demands, and all of these at hyperspeed. If a company has become big and bureaucratic and finds it difficult to adapt, it’s appealing to push these requirements for change onto suppliers. This may mean using some of the new technologies for reverse online auctions or chasing parts in low-wage countries. But these short-term solutions create their own sets of problems. The supply chain infrastructure is not getting leaner and better, and in fact gets weaker. Using brute force will only work for so long before your company is paying in warranty claims and lost market share for low-quality products.

Figure 12-2 illustrates the traditional underlying model these companies follow in their relationships with “vendors.” The philosophy is to seek low piece price. The assumption is that vendors are vendors, and without pressure they will seek to drive up price and drive down service. The job of purchasing agents is to counter this by being “tough” on the vendors and squeezing them on price. Mechanisms like reverse-on-line auctions are powerful price pressure methods. The supplier can directly see the competition, and in the desire to “win” continues to underbid not only the competition, but sometimes even his own costs. Delphi refers to buyers under this model as “hunters and gatherers” (see case study). They lack any significant professional understanding of the suppliers and go out with a big club to hunt up and bring home the spoils.

When suppliers are forced into low-balling the bids, they have to find ways to make money. One way is to charge for engineering changes or any special service required. Or suppliers may minimize investment in the product and process. Purchasing must try to counter this through measurement of the supplier and using the numbers to beat up the supplier. The threat is always there to pull the product and resource it to a lower-cost competitor, perhaps in a lowerwage country. The result of sourcing on price is short-term cost reduction, but there are many unintended negative effects, like parts shortages, quality problems, high warranty costs, and little investment in product innovation, which in the long term add up to higher total cost.

Toyota is not striving to be the low-price automaker. The goal is to produce cars at a fair market price that the customer would think has value. Why is this distinction so important? This philosophy suggests that cost reduction efforts should not be a one-way train toward the lowest possible cost. Toyota sets target costs, not just prices. Target costs means the suppliers must operate at cost levels that allow them to make a profit at the prices the customer pays for parts. The lean supply chain model is illustrated in Figure 12-3.

Figure 12-2. Traditional vendor management

The goal is to eliminate waste not only in Toyota plants but in the supplier plants and in the connecting processes in between (e.g., the logistics system). Suppliers are extensions of the learning enterprise participating in kaizen. For key components, Toyota selectively chooses two to three strategic partners for each component and encourages competition between them. Each will typically get an exclusive contract for that part for one car model but knows they can lose Toyota market share in the future if they do not perform. There are many tools for managing cost and improving the product, process, and supplier’s capability. By investing in the partnering characteristics in the supplier partnering hierarchy, Toyota over the long term is getting the annual price reductions from suppliers that are necessary to be globally competitive, but without sacrificing quality or innovation.


Cost, quality, delivery metrics

Figure 12-3. Lean supply chain process

Is Toyota actively seeking to replace American supplier partners with lowcost suppliers in China and other low-wage countries? They may purchase an occasional commodity part in these regions, but this is not a core part of their strategy. A Toyota North American purchasing executive explained:

We get some savings from tier-two and tier-three suppliers sourcing overseas that are passed through, but it is pretty rare for us to consider it directly because of the supply chain complexity and risk. Distance and the political environment create

high levels of complexity. Our initial approach is to try to understand what that competitive level is. We have global vehicle programs so we can work with Europe and Toyota Asia Pacific and understand what is the Toyota competitive level and challenge people in North American to get to that level.

It’s important to realize that there is no “one size fits all” strategy for developing these characteristics of partnering. Some companies might start out with information sharing and some with supplier development. However, they shouldn’t forget the long-term vision of developing all of these characteristics as a system. The ultimate goal should be to create a lean learning enterprise.

Case Study: Developing a Lean Supply Chain at Delphi

Delphi is a world leader in mobile electronics and transportation components and systems technology with approximately $28 billion in annual sales, 185,000 employees, and 171 manufacturing sites in 40 countries. Delphi purchases from over 4,000 direct material suppliers. Since becoming an independent company in 1999, they immediately started on a lean journey. It was a top priority to shed the waste and high costs impacting Delphi’s operations. As Donald L. Runkle, the former vice chairman, often stated, “Lean enterprise is Plan A! There is no plan B!”

Delphi’s first step in becoming lean focused on its manufacturing sites. For several years they had been studying and embracing the Toyota Production System. Delphi developed and documented its own system, structure, and processes, and called it the Delphi Manufacturing System (DMS). It’s a common, global production system that embraces all functional areas and focuses on creating lean products, lean purchasing, and lean internal and external manufacturing.

Though it was a rocky road, over time Delphi enjoyed considerable success, with a relatively deep penetration of lean in most of its plants. Every plant had done a considerable amount of work, and an impressive 20 different plants were awarded the Shingo prize for excellence in manufacturing. Applying for the award has been encouraged by Delphi to provide a stretch target and provide recognition for achievements, along with external visibility. The Delphi Manufacturing System was strongly supported up to the level of the chairman and CEO, J. T. Battenberg III, and the message was clear: DMS is not optional.

In 2002, Delphi hired R. David Nelson as vice president of global supply management with the charge of spreading lean through the supply base. A former vice president of purchasing for Honda of America, Nelson had a deep understanding of the “Honda Way.” He brought that to

John Deere in converting a traditional purchasing organization into a lean supply chain. With that background he was well suited to help Delphi extend DMS to what it calls “outside manufacturing.” Delphi avoids the term “supplier,” to emphasize that the quality of manufacturing is important whether it takes place inside or outside the corporate boundaries of Delphi.

“Inside manufacturing” currently encompasses about 30 percent of the total cost at Delphi, while “outside manufacturing” makes up 50 percent. Delphi buys about $14 billion worth of goods annually. So the opportunity was clear.

Besides DMS being a well-developed system with strong training programs and internal lean expertise, Delphi had two other sources of expertise for lean supply chain. One was a set of consultants formerly with Toyota, and the second was direct support from Toyota, which has become a major Delphi customer. In fact, Toyota sent one of their TPS experts in purchasing to work full-time for two years within Delphi and to teach the Toyota Way of supplier development.

In this case study, Delphi’s strategic sourcing system is illustrated as a work in progress. The case reflects Delphi’s lean supply chain progress after working with the process for almost three years, when Dave Nelson’s team rated themselves in an embryonic stage compared to Toyota. But Delphi felt it was headed in the right direction, and their approach is comprehensive, hitting all aspects of a lean supply chain.

Nelson learned from Honda that a cornerstone of a lean supply chain was a strong cost management system, the heart of which was a set of models of key manufacturing processes. Putting various input costs into the model leads to a predicted total cost for a component part. The models are detailed, and very accurate in reflecting actual costs to make a part. Nelson hired a former Toyota manager who had over 25 years experience in purchasing and with Toyota’s cost management system. As Delphi’s director of cost management, he became the internal expert, setting up and teaching a cost management system modeled after Toyota’s. He was assigned a team of 30 full-time people as “disciples” to learn and spread the cost management system, which Delphi considers the cornerstone of its lean supply chain.

The Toyota veteran estimated that it would take five to six years to meet a minimum level of acceptability as a lean supply chain, and nearly three years into the program in 2004, he felt Delphi was on track. According to this cost management expert, a minimum requirement for success was to have the unwavering support of senior executives, which Delphi demonstrated through the supportive efforts of J. T. Battenberg III and Dave Nelson.

It was clear to the senior management team that Delphi had too many suppliers to have a focused, lean supply chain. Delphi was challenged to develop close relationships with like-minded suppliers dedicated to cost reduction. So they set out to identify “strategic supplier partners.” This turned out to be a more onerous task than it appeared at first glance. It was a matter of meeting with the CEOs of candidate suppliers one by one and explaining the challenges associated with being a strategic supplier. In fact, about 10 percent of the suppliers interviewed chose not to join Delphi in the lean journey. It took about two years to develop an initial set of “core” and “near core” suppliers, and more work remained to be done.

In the meantime, a lean supplier development engineering group was formed, and knowing Delphi could not wait years to get started teaching lean to suppliers, developed a list of suppliers likely to make the strategic supplier list. Delphi began working with a subset of core suppliers, and in two years had done projects with 70 suppliers. The approach was modeled after Honda’s best practices model and Toyota’s approach, through its supplier support center.

Target model areas are selected through this approach. Lean experts from Delphi, supplemented by outside consultants who formerly worked for Toyota, act as sensei. They do not do the work for the supplier’s plant, but guide them through teaching and coaching. The approach is:

1. Get a solid commitment from the supplier’s CEO.
2. The CEO must appoint an internal lean champion (either full- or part-time, depending on the company size).
3. Select a product family.
4. Develop current and future state maps along with detailed action plans.
5. Post the maps, plans, and key metrics in a war room.
6. Implement.
7. The Delphi sensei visits regularly and reviews progress by walking the floor and comparing progress to plans in the war room.
8. Delphi expects to share in the supplier's cost savings resulting from the product (typically 50-50 for a specific product family only).

As Delphi anticipated, project results were similar to those of Honda, Toyota, and its own plants—double or even triple digit performance improvements on all key metrics. For traditional thinkers, lean supplier development engineering is simply about cost savings. However, for lean thinkers it’s about developing relationships, trust, and building highly capable suppliers.

Most of Delphi’s second-tier suppliers are comparatively small companies (e.g., $150 million in annual sales). Often, the CEO is the company founder. Typically, these suppliers are aware of lean manufacturing and have sporadically applied several of the lean tools. But the companies never experienced lean as a system and were amazed to learn firsthand of the real power of the Toyota Production System. It was a significantly different experience, leading to a collaborative “win-win” approach to operating the entire business. Delphi encouraged a number of these suppliers to apply for the Shingo prize.

The comprehensive lean supply chain approach is represented by Delphi as a model with nine interdependent gears:

  1. Strategic sourcing (selecting suppliers with a broader set of expectations for R&D)
  2. Lean supplier development engineering
  3. Cost management (in-depth understanding of specific elements of cost)
  4. New model flawless launch
  5. Quality (at less than 20 ppm range at the time of the case study, and lower ppm for more serious problems)
  6. Systems infrastructure (Information Technology)
  7. People development (each Delphi supplier management employee has 80 hours of training in cost management and lean approaches)
  8. Supplier relationships (changing the mind-set so suppliers are viewed as valued assets, not disposable commodities)
  9. Communications

Many companies get enamored with some pieces of the lean process, e.g., “Let’s just do supplier development.” Delphi concluded that these “gears” were all interdependent strategies. It needs to have the right suppliers, with the right capabilities and the right internal purchasing group, and those suppliers must understand real cost.

The biggest challenge for Delphi is moving from its traditional pricebased sourcing heritage from GM to a strategic sourcing approach learned from Toyota and Honda. Traditionally, Delphi has relied on competitive quoting to get lowest prices. It is moving to a more holistic

view of extended value stream excellence. Part of this process is transitioning from a focus on price to that of a cost-based reality.

In 2004, aggressive three-year targets were set:

  1. Single digit ppm quality and flawless launch
  2. Thirty percent model-to-model cost savings and focus on total cost
  3. Developing lean processes with core and near core suppliers
  4. Investment and product coordination with business lines
  5. Faster design cycle times
  6. See technology early in products
  7. Discontinue relationships with marginal suppliers

Moving away from marginal suppliers seems like an obvious thing to do. However, Delphi buyers were not always encouraged to do this.

To select strategic suppliers, Delphi developed a matrix and sorted commodities into four cells: core, near core, niche, and commodity. For core and near core-commodities, Delphi is gradually developing a set of strategic suppliers who sign a master supply agreement modeled after Toyota and Honda. This several page agreement lays out principles of working together (such as recall and warranty responsibility, financial terms and conditions, R&D responsibility, and long-term commitments to source from the supplier). It is not a specific contract for specific parts, but a set of detailed agreements on how each will behave. When the strategic sourcing agreement is established, purchasing decisions are almost nonevents. The cost model basically locks the supplier into a price.

Delphi’s director of cost management describes the cost management concept as “reality improvement.” Unfortunately price-based purchasing is not based in reality. In many instances market prices were established and buyers chose an arbitrary target for price downs (e.g., 5 percent price reductions across the board next year). Toyota’s system is based on cost-management models that reflect the reality of actual costs, with target prices based on what customers are willing to pay for automobiles. Toyota sets a target profit and proceeds to develop the car to meet the cost targets necessary. Suppliers are given target costs to meet and must develop their components to meet these targets, building in their own profits. When Toyota asks for price reductions, it is based on actual knowledge of true costs, so they know where it’s necessary to reduce costs and where suppliers are in danger of losing money. Price is important, but behind price is cost, and behind cost is reality.

Purchasing must look with trained eyes and see opportunities for cost reduction.

Cost-profit planning is the ultimate form of cost management. Delphi is training its buyers to be able to estimate cost more precisely, identify opportunities for improvement, and lead cost planning projects. The previous approach to buying was like the “caveman who is hunting and gathering.” There were multiple rounds of bidding and poker playing. Delphi is now moving to “modern agriculture”—based on logic, science, and reality changes. The game changers are cost standards, creative improvement plans, and master supplier agreements.

In the real world, Delphi has found that suppliers’ quotes are much higher than these cost models suggest they should be, even after repeated price-downs. A cost model group is producing forms on cost standards—price tables, price curves, and cost standard templates— with data drawn from suppliers, supplier meetings, government and industry data, Delphi internal sources, benchmarking, and competitive analysis data.

Price reductions should reflect reality changes—materials (challenge cost, design), labor through lean workshops, transportation (level scheduling), warehousing (inventory reduction), and so forth. The important thing is to change realities. Each buyer for each commodity must develop creative improvement plans. Nothing is left unchecked. Cost management means working very closely with suppliers to achieve these realities.

Since design impacts 70 percent of the total manufacturing cost, Delphi must involve suppliers early in the design development process. To this point, Delphi had mostly focused on the 30 percent in manufacturing because it was easier to work on. The next frontier is for suppliers working with Delphi’s product engineers to move up front to product and technology development. The goal is to reach a level where engineers can use cost standards to evaluate the impact of different design options.

Delphi views this process as a major cultural change. It wants buyers to be more than just “hunters and gatherers,” and instead to become change agents thoroughly versed in cost management. It has developed a list of 70 items that buyers should be able to see as they walk through suppliers’ plants, and it expects them to have expertise in everything they buy. As an example, a Honda buyer came into one of Delphi’s plants for two days and listed 130 items that needed to be improved. What is Delphi’s key to the success? In a word: trust! Suppliers will never agree to use true costs as a basis for price setting unless they trust Delphi to think about them as true partners.