Prof. John Henke and proof that supplier relationships drive profitability

In our previous article, we discussed the new report from Prof. John Henke of consulting firm Planning Perspectives and Oakland University (Rochester, MI). Henke is also a keynote speaker at the ProcureCon Europe conference in Berlin, November 3rd – 5th.

In the report, he uses data from 25 years of surveys and analysis of supplier relationships (the “Working Relations Index®) in the US automotive industry, to prove a direct link between the state of those relations and the profitability of the auto manufacturers (OEMs). I caught up with Prof. Henke recently to discuss his work further.

These are important findings - most of us in procurement believe this link between good relationships and profit to be the case, but is this the first real quantitative proof?

Yes, it is. There has been a lot of anecdotal evidence of good supplier relations from consultants for 25 years and much academic research that has shown the value of good supplier relations. However, no one has provided hard evidence of the bottom line impact of good supplier relations. The reason for the lack of evidence is that no one has gathered the multi-year relations data that is necessary for such analyses.

In terms of anecdotes though, give us an example where you have seen poor relationships having a direct effect on profitability?

One supplier called up the CPO of an OEM recently to say that one of their suppliers had been shipping them unacceptable parts recently and that they only had three days of inventory and would stop delivery to the OEM after that. This shut the OEM plant down for several days - and when we spoke to the CPO, he admitted that relations with this supplier weren't very good. With better relations the OEM would have been warned of the possible shutdown by its supplier and could have taken action to prevent the shutdown.

Back to the new report - obviously there is difference between data that correlates and true causality. Are you confident this direct link between supplier relationships and profitability stands up?

Your point is well taken. Correlation does not imply causation. What we did, and what is typical of good academic research, is find overwhelming evidence that there is a causal relationship between supplier relations and OEM profitability. We've got over 20 years of data now - that enables us to have high confidence in the analysis.. To show the link between relationship health and profitability, we first determined how much of the OEM's profit is driven by suppliers rather than internal management capability. We then were able to split the supplier contribution into price concessions and other added value.

So you say that around 60% of OEM’s operating income (EBIT) profitability can be attributed to supplier contribution. Does that seem a lot?

Not really when you consider that for these firms, 70 or 80% of their revenue is spent on supplier costs.

Is anyone arguing with your findings? Other academics, or the industry?

No. Before we published this, we met with each of the OEMs - their procurement people, supplier relations folk and even their financial and investor relations analysts. We took them through our work and analysis, the numbers from the company's financial data that is in the public domain and so on. While we needed to correct some of the numbers for two EOMs, nobody disputed the work.

Do you think these results would apply in other sectors?

If we take into consideration differences in the cost of goods ratios and typical operating income (EBIT) profit margins in other industries, the answer is yes, it looks like there is a clear relationship between profitability and supplier relations.

Finally, given these findings, why do so many procurement functions - and indeed organisations generally - still seem obsessed with cost reduction?

Working on supplier relationships is difficult and long-term. Also, adversarial cost reduction approaches appear to get quick results. It's like hitting your dog when you want it to do something - you get an instant response, but it isn't the way to get good long term results. Sustainable supplier contributions to a company's profits will occur only from strong supplier relations.

 

Thanks to Prof Henke and we very much look forward to hearing him speak about this important work at ProcureCon in Berlin (November 3rd – 5th)

 

First Voice

  1. bitter and twisted:

    I have two questions:

    -Couldnt the causation be the other way round ?
    Losses lead to cost cutting demands and bad relations, while profitability lends everything a halo.

    -Do carmakers sole source and do component makers sole sell?
    And is this structure common to other industries?

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