After a two year struggle to stabilize a product with their ODM (Original Design Manufacturer) supplier, our client was fed-up and decided to move the business. The product, a medical device which had been previously co-developed with the ODM, was facing shipment delays, quality problems, and capacity shortages. This impacted customers across the board leading to lost sales opportunities, customer satisfaction issues, and a great deal of management time allocated to damage control. The executive team finally decided it was time to cut the cord and find a new manufacturer to build its products. Soon after this decision, however, they woke up to the reality that the ODM would not release the product specifications that would enable a successful transfer to a new partner. The supplier claimed that some of the design was an investment on their part and not paid for by our client, prohibiting its transfer unless our client agreed to pay exorbitant fees for their development efforts, not to mention lost profits for terminating the relationship prematurely. Although a contract was in place, the provisions were so generic and gray that each side could interpret them to their own benefit. The supplier exercised its power so heavily that our client conceded and continued to deploy resources to deal with an unstable product, making the best of an undesirable situation.
The scenario described above is not uncommon whether you are outsourcing the manufacture of your products (especially in an ODM or OEM model), installing a new ERP system, or having your IT infrastructure hosted and managed by a service provider. When the supplier wields so much power that you cannot respond to changing business conditions, you are exposed to risk. So what are some steps that you can take to address excessive supplier power?
Negotiate before you seal the deal
Technology companies move at lightning speed and make quick decisions to introduce their products to the market in a highly competitive environment. Time to market is critical and we understand why most companies behave this way. The fact is, however, that some suppliers take advantage of this behavior because they know that speed does not provide enough run way for a customer to negotiate the best terms. Since companies have been conditioned to this frenetic pace, they make snap decisions even when it is unnecessary. In other words, it has become second nature for them to jump into a commitment by initiating action with a supplier (e.g. building prototypes, customizing software, investing in hard tooling, starting pilot projects) before addressing some of the tough questions. Once you have made a commitment of resources, time, money, or image – the balance of power shifts towards the seller. Following a formal supplier selection process, understanding the long-term roadmap for the relationship, negotiating a contract, and discussing important business issues upfront can help balance this power. It can also help you meet your timelines since important, high risk issues are known and addressed upfront, reducing the chances of derailment mid-stream. In IT environments, we have repeatedly seen how a small deployment with only a handful of trial software licenses worth only a few thousand dollars suddenly mushrooms into a multi-million dollar expenditure when there’s full adoption. Incidentally, these contracts often fly below the management radar when they’re in the tens of thousands of dollars and end up governing the terms of the full blown investment once the software is fully deployed in millions. At that point, negotiations become much tougher because of the sunk costs.
Do not let intellectual property rights become a trap
There are two facets to Intellectual Property with which you need to be concerned: (1) controlling your IP so that no one supplier has access to the full recipe, and (2) keeping your access to important IP that the supplier controls. In the first scenario, you may want to architect your supply chain so your IP is not known to one entity and distributed across multiple players. For example, if you are outsourcing the manufacture of your product, it may be prudent to have more than one manufacturer in your supply chain performing different functions. It is not uncommon to see a company split the work across multiple ODM/CMs or perform the final integration in-house. In the second scenario, you want to fully understand your rights to any supplier or jointly developed IP that is important to your product and its functionality. This was the issue in the example we gave at the beginning of the newsletter. Manufacturing techniques, design specifications, assembly documentation, and process data are all examples of information that your supplier might claim as their property. By addressing these types of issues in a thorough and well-structured contract, you can avoid situations where your ability to maneuver is unreasonably limited by your supplier.
Proactively look for early warning signs of trouble
Often times, companies do not understand the predicament they are in until a catastrophic event occurs with visibility at the executive management level. Usually, this means that one or several important customers are impacted and the problem gets escalated. The old saying of “information is power” applies here. By making information flow proactively and consistently through the use of early warning metrics, you can gain the power of timely information. In a manufacturing environment, for instance, there is a metric we use called “misalignments”, which can pull information from your MRP system and flag shipment delays that will occur several months down the road if no action is taken. Depending on the supplier and the importance of the product or service they provide you, it may be prudent for you to regularly monitor their financial health and how they run their operation on a periodic basis. One of our clients has recently carved out a subset of their key products and asked us to conduct a risk assessment on suppliers of critical components and subassemblies used in those products. This exercise – focused on ensuring continuity of supply – has shed light on some fundamental problems with several suppliers and some previously unrecognized risks with certain parts. Issues such as capacity constraints, material shortages, process deficiencies, and changing business conditions can all be ferreted-out by access to appropriate information.
Summary
Your key suppliers are a true extension of your business and should be treated with fairness. That being said, ensuring that the power equation is not out of balance in your supplier’s favor can be critical to your ability to survive and thrive as a business. Strong negotiation skills, emphasis on protecting your IP, and proactive monitoring of important business parameters are a few of many approaches you can take to manage supplier power. Structuring win/win supplier relationships through an effective balance of power is an area of expertise for Symphony. If you feel that we can help address some of these issues for you, please do not hesitate to contact us at info@symphonyconsult.com