I came across a white paper from PriceWaterhouseCoopers (PWC) called “Seizing Opportunity: Linking Risk and Performance”.  In one place, the paper highlights a “global automotive manufacturer” that was “experiencing significant losses due to a key risk in its supply chain:  supplier bankruptcies.”  The company faced the direct costs of those failures, as well as the “indirect costs derived from the poor product quality, unreliable supply, and management distraction” that resulted from the supply chain disruptions. 

Not so coincidently, there was an article in The New York Times yesterday about Delphi, the troubled auto parts supplier, being on the verge of emerging from bankruptcy after almost four years.  According to the article, “The new bankruptcy plan would involve Delphi’s debtor-in-possession lenders—whose loans totaling $3.4 billion have kept the company operating in bankruptcy—taking over most of the supplier’s assets.  The lenders, led by hedge funds like Elliott Management and Silver Point Capital, plan to forgive their loans in exchange for taking control of the company, a process known as credit bidding.”  General Motors (GM), “which spun off Delphi in 1999 and remains one of its biggest customers, would provide more than $3 billion in financing to take back four factories and the supplier’s steering business, according to people briefed on the matter.”  I’m guessing this $3 billion GM investment is probably the “direct costs” referred to in the PWC white paper.

The white paper says that the unnamed auto company now has an “integrated approach” to risk management:  “By analyzing its suppliers’ business environments, identifying leading risk indicators, and conducting risk-adjusted evaluations of its suppliers pricing proposals,” everything is now better.  The automaker can now make more “informed supplier selection decisions [and] also quickly identify troubled suppliers and take early corrective action.” 

GM can see the moon now that the barn has burned down. 

At one level, it is easy to blame the automakers for this problem.  They have squeezed their key suppliers so hard, for so long, that these kinds of disruptions are far from surprising. But arguably, the hard-headed American carmakers just could not help themselves.  Michael Porter’s five forces model, which just about every MBA student learns, identifies some of the industry dynamics that helped lead to this outcome.

One of the five forces is the bargaining power of suppliers.  When your products are not that differentiated, and you have relatively few customers and they represent a very high proportion of your sales, then your company is at a severe disadvantage in procurement and pricing negotiations.  Further, the high union wages complicated the issue for both the Tier 1 suppliers and the automakers. 

There are those who argue that Japanese automakers have managed these Tier 1 relationships better because of Japanese culture, the keiretsu industrial structure (the tight-knit family of industrial companies, banks, and trading partners common in Japan), or just because Japanese executives are smarter.

How could the U.S. automakers have done better?   Hindsight is 20/20, but arguably well structured gain-sharing relationships, also known as performance-based contracts, could have helped to avoid this.  Performance-based contracts can be equated with “lean” principles because finding and eliminating waste, and then sharing the savings, is a key element of these types of contracts (see “Performance-based Outsourcing: What’s in it for ‘We’?”).  My impression is that automakers did almost the opposite:  they demanded their Tier 1 suppliers to reduce prices every year, and told them that if they were just more efficient at manufacturing, they would not suffer any margin losses.    

In any event, performance-based contracts, particularly those focused on outsourced logistics, is a key focus of our research here at ARC.  It will also be the theme of our upcoming supply chain seminar, part of our annual user conference to be held February 8-10 in Orlando (details coming soon, but mark your calendars).