Not to be confused with open book negotiation, cost-focused collaboration requires only that the parties agree on what the cost drivers are for the products to be purchased, and which of these they can work together on to minimize or reduce. Savings from this collaboration, when accomplished, are shared between the parties and realized via reduced invoice pricing. This results in lower costs for the OEM while preserving margin for the supplier. Examples of collaboration that have resulted in savings are:
- Coordination of delivery to support staged releases rather than a single, very large delivery. This collaboration is most often associated with new product kit releases. For some companies, this could be a major paradigm shift from a “Won’t release unless I have 100% of total market requirements on hand” to a coordinated delivery for release strategy that matches the suppliers delivery commitment with the actual release timeline, which is often over a period of time, not all at once. For the supplier, delaying a portion of the total delivery for as little as four to six weeks can enhance their equipment and labor scheduling, reduce total cost and significantly reduce risk of missed or late deliveries. This savings must offset the potential increased cost to the OEM for inspection of multiple deliveries reduced by the savings from avoiding the internal expediting cost often experienced with these large volume orders and risk of missed deliveries.
- Providing projected demand to let the supplier plan and smooth its manufacturing schedule, which will improve capacity utilization and cost as well as stabilize and often reduce delivery lead time. This is most relevant for post-release instrument requirements, which some may say are not “forecastable. The alternative is reliance on PO-as-needed purchasing which, other than volume based tiered pricing, offers little opportunity to reduce price or lead time. In a number of cases, it has been found that by using historical information on similar instrument replacement requirements, you can project this demand and establish guidelines to minimize risk for both the supplier and the OEM.
- In addition to providing projected demand, you can develop a simple pull-based replenishment report that can be updated frequently and shared with the supplier. Real time usage information, combined with minimum inventory level guidelines and blanket orders, can reduce lead time and risk of stock outs and expediting. This can be completed without capital investment using your ERP system combined with commonly-used business software.
- Engaging suppliers early in the design phase for items that will be outsourced, when design for manufacturability can be incorporated into specifications and drawings. This has become more critical for achieving optimum invoice pricing as the “cost” of making post-release changes has risen. When implementing this strategy, parties must agree on what price would be without this effort without gaming the system, as well as agree on how to claim and get credit for the savings attained.
Supply Agreement Considerations
All of the above initiatives require that the OEM/Supplier relationship move from a purchasing-based to a relationship-based system of collaborative business interaction. The terms and basis of this relationship are best captured contractually with what is generally referred to as a master supply or service agreement. In addition to the terms and condition to cover liability, intellectual property, indemnity and other legal concerns, you should include terms specific to the cooperative business relationship. These typically include:
- OEM obligation to provide forecasts on a regular basis. This should specifically state that the forecast is not a commitment to purchase, but may include a binding period equal to the typical delivery lead time in which the OEM can increase the forecast by a maximum percent equal to the supplier’s capacity flexibility as well as a lower percent reduction limit, so that the supplier can schedule more effectively.
- Statement of commitment to collaboration between the parties with specific timing, such as annually, and areas to be reviewed, such as cost reduction, lead time reduction and supply chain enhancements, all focused upon achieving year-over-year price reduction while maintaining or improving margins.
- If included, terms concerning supplier and OEM risk of forward building based on projected demand, e.g., prior to PO, which minimizes financial risk to both parties and substantially reduces lead time from PO issue to receipt.
- How to manage early engagement with supplier in design phase which does not violate the OEM’s purchasing policy and assures that pricing resulting from this engagement is competitive. This may include engagement selection based on prior competitive RFQ and performance and understanding that the final design may be used for competitive RFQ with a defined allowance to cover the participating supplier’s initial investment in that design.
- Unless there is an underlying business reason, there is no guarantee of a minimum annual purchase, but if based on process efficiency and price concession, a minimum order or batch quantities are acceptable.
In summary, OEMs and suppliers can reduce cost and lead times while preserving or improving margins by using numerous initiatives that do not require material or design changes. These require a cost-focused collaboration commitment to be incorporated into the terms of a master supply or service agreement.