Surviving cost-cutting pressures from OEMs

During an economic downturn nothing is more important to manufacturing executives than reducing costs. To do this, a manufacturer must explore all avenues of cost curtailment, including motivating the work force to work more efficiently.

The Squeeze on Suppliers

Early this year Chrysler unveiled plans to require its suppliers to make 5 percent price concessions on parts and subassemblies. Ford and General Motors followed with similar strategies to reduce their component costs.

Showing considerable resistance to the automaker's move, some suppliers halted shipments until Chrysler rescinded its price reduction requirements. Many more of Chrysler's 900-plus direct suppliers still are negotiating the cuts, which the automaker insists are necessary.

Dennis K. Pawley resigned as CEO of automotive lighting supplier Guide Corporation in 1999, protesting similar cost demands from GM. "The trouble is," he said, "the Big Three can pass on a 5 percent price cut to their big Tier 1 suppliers. But Tier 1 guys can't just pass that off to their Tier 2 and Tier 3 suppliers. The Big Three are trying to solve their own problems by passing them off to suppliers."

This year Delco Remy International, Inc., an Indiana-based maker of starters, generators, and alternators, announced a plan to cut its material costs by 50 percent over 10 years. The plan is based on implementing internal cost improvements and leaning on the company's own Tier 2 and Tier 3 suppliers to reduce their costs. "We want to see how far we can push the envelope on cost," said Lowell Limpus, Delco's director of supply change management.

Other large Tier 1 automotive suppliers are doing the same, including Delphi Automotive Systems Corporation (the GM parts spin-off), Visteon Corporation (the Ford components spin-off), Dana, TRW, and Robert Bosch GmbH.

This trend has spread to OEMs in aerospace, agricultural, and off-highway construction equipment; big-ticket consumer appliances; heavy industrial machinery; and the like. Suppliers to those industries—for example, specialty stampers, welding shops, and fabricators—now must cut their costs to survive.

Dun & Bradstreet reports that supplier costs have risen about 1 percent annually since 1994. Since OEMs refuse to share those increases, suppliers' margins fell 1 percent a year between 1994 and 1999. Part of this squeeze results from just-in-time (JIT) deliveries.

For instance, if a supplier contracts to deliver 2,000 tractor cabs to an agricultural equipment maker at $750 each, and then the OEM demands smaller deliveries more often (such as 40 units a week) to avoid expensive and bulky inventory, the supplier must adjust its operations to absorb the increased per-unit costs associated with small-quantity production while maintaining the inventory of cabs for the OEM.

Smaller suppliers must deliver JIT up the supply chain, with zero defects and improved productivity. But the greatest pressure is to curtail costs. A supplier who meets all the quality and delivery reliability standards will not necessarily get the job, because the OEM's purchasing department has the last word, which is price.

As one supplier described a Motorola purchasing department conference, "They sing quality, prompt delivery, and dependability in the morning. But in the afternoon its price, price, price. That's the tune they sing as you leave."

Using Gainsharing to Reward Good Ideas

One strategy for improving plant performance is to motivate workers and unions to cooperate. Jack Welch, chairman and CEO of General Electric, said in The Wall Street Journal (June 21, 1999), "The one most important job I have is motivating employees to give their best ideas and best effort to the company. Efficiency, cost-cutting, and motivation go hand-in-hand. You must reward good performance with money as well as trophies."

To maintain efficiency and lower prices, many major companies and suppliers use the incentive of pay-for-performance, or gainsharing, plans. These plans empower workers to perform more efficiently and cost-effectively and to share the savings generated.

GE uses such plans in many of its plants, as do TRW, Emerson Electric, Whirlpool, Rockwell, and a host of their suppliers. One supplier, Wrought Washer Manufacturing Co., is a Milwaukee-based stamper of specialty fasteners, primarily automotive. Wrought has used gainsharing for years with excellent results, according to company President Paul Schulz: "Productivity has improved substantially, and so have our relations with the Steelworkers union."

A gainsharing plan is a group pay-for-performance program whereby an entire factory works together, earning a bonus when certain production and quality goals are met. When properly engineered and implemented, a gainsharing plan can motivate employees to improve performance by 17 to 22 percent on average, according to a 1995 study done by the Minnesota Precision Manufacturing Association.

Bottom Line

The trend to extend cost curtailment efforts to suppliers continues to grow. Even smaller OEMs are exerting pressure on their suppliers to cut costs—without reducing product features.

To survive and prosper, suppliers need to trim costs wherever possible and encourage their workers to seek cost savings in every operation. Sharing the cost savings through pay-for-performance gainsharing programs can benefit employees and the entire company.

Dr. Woodruff Imberman is president of Imberman and DeForest, 1740 Ridge Ave., Evanston, IL 60201, phone 847-733-0071, fax 847-733-0074, e-mail IMBandDEF@aol.com, Web site www.imbdef.com. Imberman and DeForest is an international management consulting firm specializing in compensation and incentive systems linking employee pay and performance. Articles cited may be obtained by contacting the author.