Results of a new study show the major automakers as well as most manufacturing companies, could significantly increase profits by improving supplier relations.
The results are determined by the development of an economic model, says the report, which proves and predicts a direct cause and effect relationship between an automotive OEM’s supplier relations and the OEM’s profitability, or in other words, an automaker’s return on supplier relations.
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The study – OEM Profitability and Supplier Relations – is by John Henke – president and CEO of Planning Perspectives in Birmingham, Michigan and Professor of Marketing at Oakland University, Rochester.
Henke collaborated with his co-researcher, Professor Sengun Yeniyurt, at Rutgers University Business School, New Brunswick, New Jersey and his work is based in part on data gathered during the past 13 years from Henke’s annual Working Relations Index Study.
For the past 25 years, Henke has specialised in studying and reporting on OEM buyer and supplier relations in the automotive and 17 other industries, while for the past 14 years, he has published an annual ranking of the six major North American automakers, known as the Working Relations Index, which ranks the relations the Detroit three and three Japanese automakers each have with their suppliers.
German automakers were also recently added.
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By GlobalDataAccording to the study, Chrysler, for instance, which went through a decade of ownership changes from 2000-2012, would have booked on average US$2bn more in annual operating profit and US$1,052 more in profit per vehicle if, during those years, it had maintained the higher level of supplier relations it achieved in 20112012.
This equates to a total of US$24bn in unrealised income during the period, says the report.
Similarly, annual profit gains could also be realised by all the automakers by improving supplier relations.
For instance, if each of the six automakers had scored only 10% higher on the 2014 Working Relations Index, each would have gained an additional US$58 to US$152 in profit per vehicle, or US$98m to US$400m in operating profit, which can be attributed to the increase in better relations according to the study.
“While Chrysler is a dramatic example because of its history of extreme volatility in supplier relations under various owners during the past 20 years, all of the major automakers could be making hundreds of millions dollars more annually if they focused more on improving their supplier relations,” said Henke.
“For years, academics and management consultants have suggested companies focused on developing positive relations with their suppliers and other major stakeholders will perform better financially. Many CEOs and purchasing executives intuitively agree with them.
“Consultants have tended to support their conclusions with anecdotal information, while academics have used rigorous statistical methods to support the many benefits they have identified that result from good supplier relations.
However, no one has been able to show, let alone prove, a cause-effect relationship between supplier relations and customer profits. We have now done it.”
The study reveals for the first time, claims Henke, three critically important characteristics of supplier relations: It proves a causal relationship between supplier relations and OEM profit; the better the relations with suppliers, the greater the supplier contribution to the OEM’s profit, while the more adversarial the relations, the less the contribution to OEM profit.
It also quantifies the economic value of suppliers’ non-price benefits to the OEM for such things as suppliers sharing new technology, providing ‘A team’ support to the OEM, going beyond the supplier’s contractual obligation and other ‘soft’ benefits.
It also establishes the fact the economic value of the suppliers’ non-price benefits can greatly exceed the economic benefit realised from suppliers’ price concessions. On average, this can be up to 45 times greater and often much more.
“If the automakers – especially the US automakers – really want to improve their profitability over the long term they need to reprioritise their efforts,” said Henke.
“While adversarial tactics, such as beating up suppliers for lower prices, work in the short-term, they don’t offer nearly the benefit in the long-term that improving supplier relations does.
“Our study shows if the OEMs focused their energy on improving working relations with their suppliers – working with them as trusted partners for the long-haul – the OEMs would realise much greater profit improvement than any adversarial efforts may generate. Toyota and Honda are proof of this.”
Supplier no-price benefits include advanced technology, more supplier resources committed to businesses and higher quality parts and components. These can make a significant contribution to reducing OEM operating costs including lower warranty and recall costs – and increased profit per vehicle.
Determining the economic value of suppliers’ profit contribution to an automaker was a challenge, says the report.
While each automaker’s annual financial and production data are publicly available in several forms (annual reports, 10K filings, media reports and others), the study required all the OEMs’ financial measures to be standardised for domestically-manufactured and sold light duty vehicles for each of the six major automakers across each of the 14 years of the study, which ranged from 2001-2013.
Next, a model was created relating the OEM supplier relations to the OEMs’ gross profits per vehicle and another to the OEM’s operating profits (EBIT) per vehicle. Then the economic value of price concessions suppliers provide the OEM, had to be determined for each OEM.
The report notes this was relatively easy because price concession data is among the proprietary information PPI has gathered from suppliers since 2001 in its annual Working Relations Index Study.
The most elusive value – the supplier non-price benefits contribution to OEM profitability – had to be determined. This was the most difficult problem to solve, because there is no way to directly measure the economic contribution of each of the various non-price benefits.
Supplier price concession contribution is only a fraction of the total supplier contribution to OEM profits. When added to the supplier non-price contribution, the total exceeds the OEM’s managerial contribution to OEM profits.
However, because both the supplier price concession and the total supplier contribution can be calculated, it essentially becomes an algebraic equation that solves for ‘X’ – the supplier non-price benefit contribution. With this value, all three annual supplier contribution figures can be determined for each OEM.
“Our study proves that the most significant economic impact a supplier has on its OEM customers’ profits comes from the non-price related benefits it brings to the automaker,” said Henke.
“In fact, our calculations show across the six major automakers, on average, 51% of the automakers’ profit per vehicle can be accounted for by the relations the OEM has with its suppliers.
“That contribution is comprised of supplier price concessions, which are as little as 5% of the total supplier profit contribution when relations are particularly good.
“The results clearly show the OEM interested in improving its profitability should definitely look to its suppliers, not to squeeze them for lower prices, but to work toward achieving better relations with them, and by working to develop and then maintain sustainable long-term positive relations with them.”
It is important to note, said Henke, while the OEM Profitability and Supplier Relations Study focused on the auto industry, the results clearly apply to companies in every manufacturing industry.
