Innovation doesn't have to be limited to technological developments
November 9, 2012
As this Q&A with Plante Moran's Jeff Mengel reveals, an innovative approach to a customer relationship can lead to a very successful supply chain partnership.
Innovation has been said to be at the heart of business success, but in a contract fabrication company that often doesn’t work with product development or design, where is that innovation? According to the Innovation Quotient (IQ) survey from CPA and business advisory firm Plante Moran (www.plantemoran.com) in Cincinnati, and executive education and training institute NewNorth Center, innovation doesn’t necessarily apply to just products. It also can be about process innovation, like innovative manufacturing methods or technologies. And then there are innovations within supply chain relationships.
Jeff Mengel, partner and a leader in Plante Moran’s manufacturing group, described how such innovation can change a customer relationship from one that’s simply a matter of convenience into one that is intimate—not in the romantic sense, of course. Instead, Mengel uses the word intimate to describe a business relationship that would be very inconvenient and disruptive to break.
So how does a company develop such a relationship? The FABRICATOR talked with Mengel about one contract fabricator that did just this. The company accomplished it not just by applying continuous improvement methods and changing part flow on the shop floor, but also by changing the very foundation of its business model.
The FABRICATOR: First, what is innovation, and how does it manifest itself in manufacturing?
Mengel: In our report we define several levels of innovation. First, there’s the product innovation, which everyone can identify. Second, there’s service innovation, which involves unique services a company can provide. Third, there’s process innovation, which allows manufacturers to make a component better, faster, and to a higher quality than the competition can.
Process innovation can occur if you have a unique process capability, or it can be about reducing the cost of manufacturing. Note that this is not a price adjustment; it’s a cost adjustment. There’s a difference. Anyone can have a lower price, but not everyone can have a lower cost.
Manufacturers need to differentiate themselves. But in a lot of places, manufacturing is fairly commoditized, and it’s really difficult to differentiate. I call these “convenient” business relationships, and we saw a lot of these convenient relationships blow up during the recession a few years ago.
The FABRICATOR: So, convenient business relationships usually hinge on price alone?
Mengel: Not necessarily. Say a purchaser for a large OEM buys several million dollars’ worth of goods annually from 500 suppliers, and you are a fabricator that supplies $50,000 of that. That small amount of work may not be incredibly price-sensitive. The purchaser isn’t going to spend a lot of time looking for an alternative unless there is a reason to look for an alternative.
It’s convenient for the purchasing agent to maintain the relationship with you, just because he’s got other things to do. But as soon as something happens that makes the relationship inconvenient—be it poor quality, poor delivery, or bad financial results in an economic downturn—the OEM purchaser wakes up and scrutinizes everything. If you and the OEM have an intimate business relationship, it would be disruptive for the OEM to find an alternative resource, not just from a workload standpoint, but also from a strategic standpoint.
The FABRICATOR: So how does a metal fabricated products supplier go about developing this kind of relationship?
Mengel: We have a client in the automotive space. I can’t mention the names, but I can describe the situation. It’s a Tier 2 contract fabricator that supplies parts to a Tier 1 customer. The customer was concerned about the fabricator’s capacity, so they asked the fabricator if it could build a new plant to handle the work. We’re talking about a $10 million investment. The customer also wasn’t interested in a long-term, multiyear agreement, and for good reasons. There are pros and cons for everybody for such agreements.
From the fabricator’s perspective, there was obvious risk, which is why they analyzed the customer relationship. Years ago the fabricator’s prior owners had developed a good friendship and close connection with the customer. But when the fabricator was passed on to new leadership, the close relationship wasn’t maintained. In fact, the relationship had evolved to the point where the customer viewed the fabricator as a low-cost supplier. It was a relationship of convenience. Managers determined that before they would invest in a new plant, they wanted to transform that convenient business relationship into an intimate business relationship.
At the time the customer represented about 70 percent of the fabricator’s sales, so the fabricator did not have much leverage. They couldn’t tell the customer what to do, and if the customer were to leave, it would have seriously hurt the business.
So to build this new relationship, the fabricator promoted openness of communication and transparency. As you may know, in the automotive world the schedule often gets broadcast to suppliers via EDI [electronic data interchange]. The suppliers get a notice that instructs their plant to produce a certain number of parts by a certain date, but it doesn’t provide the full story behind the schedule.
But what if someone from the fabricator were at the customer location to identify true levels of inventory and demand? More than that, what if the fabricator hired other people to work at the customer facility? By the way, the customer wasn’t next door; it was 120 miles away.
The fabricator eventually had various personnel working on-site at the customer: manufacturing people, quoting engineers, program launch engineers. At the same time, the fabricator rearranged its shop floor and designed manufacturing cells dedicated to the customer. This helped identify how much flexibility the fabricator really had. Representatives from the customer knew that the cells at the fabricator’s floor were dedicated to them, and they would not be used to satisfy the demands of other customers.
Long story short, the fabricator never had to invest in a new plant. Managers found alternative ways of meeting customer demands without putting their own company at risk, and the customer was happy about it. The fabricator reorganized its business model to be more customer-intimate.
The FABRICATOR: How does such a business strategy—developing those close customer relationships—work with the quest for diversity in a customer base?
Mengel: Yes, this is an issue. If this had been the fabricator’s sole strategy, then even more of its eggs would have been in one basket. The primary customer, which at first made up 70 percent of the fabricator’s business, continued to give the fabricator more work, which, if the company had done nothing more, would have represented 80 percent of revenue.
But the fabricator did something else. It diversified and brought in new work. These new customers had lower-volume orders, so they didn’t consume a lot of machine time, but the parts were of higher value, with higher margins. The jobs required the fabricator to work with customers in getting their design requirements. Again, such collaboration helped make the relationship intimate, not just convenient.
The FABRICATOR: Still, can such a close relationship backfire, especially if a lot of business is tied to one customer?
Mengel: It all really comes down to risk abatement, and it applies to everyone in the supply chain. A Tier 1 should be concerned with giving too much business to a Tier 2. What if that Tier 2 goes out of business, or is purchased and changes direction? Supply chain transparency can mitigate this risk. Customers and suppliers need to be willing to open the kimono.
In recent years supplier alliances have helped mitigate these risks too. Alliance member companies may compete with each other on, say, only 20 percent of the goods they sell. But for the remaining 80 percent, they don’t compete directly, so they can work together. They can have a contractual agreement to help another company for a period of time. And if they use a technology that is proprietary, they can arrange a license agreement. The other company can continue to use the technology for its own benefit, but it has to pay a fee for the privilege.
The FABRICATOR: Does being physically close to customers help spur close collaboration to develop those customer-intimate relationships?
Mengel: Geography really is a convenience factor. In a convenient business relationship, a customer may be 30 miles away from a supplier. That customer may have poor scheduling, but it doesn’t worry, because it knows its supplier is close by and will be responsive. When that customer gets its act together and becomes better at predicting schedules and other requirements, it can turn to the world, really. It can be truly global.
But if a company is innovative, it can develop intimate customer relationships that aren’t governed by mere convenience. This occurs not just by being physically close to a customer, but through the sharing of knowledge and supply chain transparency. Like the automotive supplier I described, fabricators can help quote, develop programs, and get in on the ground floor of product development. Again, it would be truly disruptive to break that kind of supplier relationship.