Taking Suppliers Outside of Their Box

A had a conversation yesterday with a consultant who is in the process of structuring a bid for a critical direct material input for an industrial manufacturer. This commodity happens to be in a market with a somewhat fragmented supply base, which tends to have a low level of sophistication.

It's a Mad Max sourcing market. Switching costs are virtually nothing. Suppliers come along each quarter, hawking their wares with a new price sheet, and buyers switch and churn through suppliers like Saddam churned through wives and mistresses. In other words, the category does not exactly fall into the "partner" quadrant ...

Traditionally, because raw material costs comprise between 40-60% of the price of each item (and the commodity price is tied to the fluctuation in global energy markets), prices shifted up or down, quarter to quarter. Yet suppliers rarely shared a direct cost breakdown with buyers, opting to indirectly pass on additional costs or savings in an aggregate amount across line items and invoices (with a lot of play either way). The only thing keeping suppliers honest was knowing that their competitors would show up in the next week with a new price sheet.

The consultant's idea -- which is nothing revolutionary, yet quite astute -- is to break down the labor and material inputs and create an open book system with suppliers. Suppliers will bid on the non-material price components, and the buyer will assume the risk on the material side (and possibly hedge the risk by purchasing options contracts on the underlying commodity).

It sounds simple, but it’s a revolutionary idea for this specific market. But success is not a given. In fact, I spoke to another colleague who suggested that change management on the supplier side is absolutely critical to the bid structure. He recommended "socializing" the concept with suppliers even before the RFI phase to bring them on board with it, which is what the consultant is doing.

In this case, I'd argue, the suppliers are as much the consultant's customers as the buyer (even though the buyer is paying the bills). Stay tuned in the coming months to see if it works!

-Jason Busch

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