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New squeezes on the small metal fabricator
Is it time to rethink the working structure of the fabrication industry?
- By Dick Kallage
- December 18, 2014
- Article
- Shop Management
We are all familiar with big-box retailers and their sourcing strategies that redefined consumer behavior and expectations in North America and, indeed, the world. Many of us also are familiar with the world of OEM automotive and consumer electronics supply. These are tough, bare-knuckle neighborhoods.
The common denominators were closeness to the consumer and the total focus on price. This focus put significant pressure on the supply base. Suppliers who once commanded price premiums based on certain strengths experienced a decline in that premium—sometimes to zero.
Along with the focus on price came the demand for superior quality levels as well as new standards for logistics and support, even design. With their spending power, big-box retailers, automotive manufacturers, and the electronics companies got what they wanted. The suppliers who met the demands survived, some even thrived. The ones who couldn’t or wouldn’t, didn’t.
Price has been the major driver for at least 25 years in these industries and has caused major shifts in their overall supply structure. Beyond offshoring production, especially in electronics, the biggest changes have been in the number of suppliers (fewer) and their average size (bigger). As consumers, we love the benefits. It’s hard to dispute the fact that over these 25 years, quality, design, features, and performance have really improved, especially in the automotive and consumer electronics industries. For the suppliers, the shift has been challenging, to say the least. For some it has been the end of the road.
As an industry, stampers have been tightly connected to automotive especially and consumer electronics. The survivors are familiar with these structural changes. But most custom fabricators have been somewhat (though not entirely) insulated from them, since they deal mainly with producers of military, aerospace, industrial, chemical, energy, and agricultural equipment. They are usually several layers away from the consumer.
I sense that change is coming. In fact, I see more and more cases among my fabricating and machining contacts where it has already arrived. The change is the single-minded focus on price, along with new demands on performance in quality, delivery, service, responsiveness, and payment terms.
Two Purchasing Strategies
OEMs use either a price-focused or cost of ownership strategy when making purchasing decisions. In a price-focused strategy, the OEM bases the purchasing decision on the quoted price alone from among two or more suppliers that—in theory, at least—can meet the requirements. Customers award jobs based on the quoted price and then immediately impose on the supplier ever-increasing service and quality demands, if they need improving. I call this “demands creep,” and it’s kind of a “swing and hope” strategy. It works well if the supplier is easily aligned with the OEM’s needs. This is characteristic of purchases from a commoditized supply base, at least in the view of the buyer.
With the cost of ownership strategy, the buyer purchases based on a risk-adjusted price, which is the quoted price adjusted for the risk of a supply failure (poor delivery, quality, reliability, etc.). This typically is how build-to-spec suppliers differentiate themselves, and it’s this differentiation that disappears in the price-focused strategy that views everything as a commodity.
OEMs have used the risk-adjusted model for decades. It is economically proven and sound. But it has been under attack over the past few years by certain purchasing cognoscenti as a cause of higher-than-necessary spending. The cost of ownership strategy would seem to be a must for certain applications involving very high costs of failure. But, sadly, I’ve seen moves toward a more price-focused strategy even in these cases.
Two Questions
To even begin to figure out available strategies to deal with this, we need to review two questions:
1. Is this price strategy part of a necessary competitive strategy, or is it a brazen attempt, as some suspect, to strong-arm money from the small who are dependent on the large and powerful? Corollary question: Will the price-focused strategy last, or is it driven by temporary conditions?
2. What is the risk to the individual OEM in deploying a price-focused purchasing strategy versus the cost of ownership strategy?
The first question sets the stage. What is the state of the OEM buyer’s industry, and what are the financial and market conditions of that individual OEM? A company under stress from either industrywide or self-inflicted problems must take certain actions to stabilize itself financially. Clearly, the fastest actions are to reduce staff and to reduce spending on purchased material. Suppliers are hit with price-focused strategies and longer payment terms from necessity. While certainly hard to swallow, the actions are at least understandable.
Far less understandable are similar actions being taken by healthy companies in healthy industries. I sense that this is happening now on a broader scale than in the past. Evidence for this unfortunate state lies in the quarterly and annual reports of large public industrial companies and the performance of Wall Street. Companies have been generating year-on-year profit increases for at least four years. The amount of cash being generated is truly remarkable. All of this is fine … except for one thing. Sales increases have not been all that rosy—surely not enough to drive all of the profit increases. The real drivers have been cost-cutting and avoidance, including aggressive price-focused sourcing.
The large OEMs are driving their supply bases hard for two reasons. First, the OEMs remain under pressure from the investment community to increase profits in a slow-growth economy, where revenue is not supplying the traditional fuel. Second, they can get away with it; the supply base sees the same revenue sluggishness. They have few options.
Strategic Questions
It does not help that, as I noted in a previous column, many segments of the fabrication industry are becoming commoditized, due mainly to increasing machine and equipment capabilities. A commoditized supply base is a necessary condition for a price-focused purchasing strategy to work. It is also not helpful that some view the fabrications, no matter the complexity or sophistication, as a commodity. They learn differently only if the price-driven strategy fails badly.
No matter the reasons or environment for a price-focused strategy, once in place it tends to stick until some catastrophe wrecks the strategy and removes the people who initiated it. This answers the second question: If the supply base is commoditized and the application can be readily served by that base, the risk is low and the price strategy will work—and stick. It will not under any other condition.
The custom fabricating industry is not yet totally immersed in the world of price-focused sourcing, and some elements probably never will be. But the issue is real, and if the strategy becomes sufficiently broad-based, it brings up some strategic questions:
- What minimum revenue is needed for a supplier to be able to afford the investments and overhead increases necessary to compete in price-focused markets that not only systematically drive prices down, but also continually raise the bar for quality and service? Clearly, the higher the revenue, the easier it is to absorb the increased costs without fatally damaging margins.
- In industries like fabrication and machining that have been notoriously resistant to consolidation, are there workable ways for privately owned sub-$10 million companies to become effectively larger in order to more easily spread costs and risks?
- Are there realistic means of combating a price-focused strategy from one or more top customers without losing the business?
The custom fabricating industry always has been made up of small, fiercely independent companies. It’s classically fragmented. This has been a good thing for suppliers and customers. But operating in a purely price-focused environment is different. Small, fragmented, and commoditized can be ruinous.
Should we rethink how custom fabricators are structured and how they operate to offset what in the future could be fatal weaknesses? Perhaps we should. Thinking is free; the consequences of burying our heads in the sand are anything but.
About the Author
Dick Kallage
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The Fabricator is North America's leading magazine for the metal forming and fabricating industry. The magazine delivers the news, technical articles, and case histories that enable fabricators to do their jobs more efficiently. The Fabricator has served the industry since 1970.
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