Scarcity of raw materials and soaring prices for commodities, the financial crisis and the increasing intensity of natural catastrophes have created a paradigm shift that requires a fresh analysis of how the corporation relates to the global supply chain.
In a stalled or shrinking market, a 10% cost reduction in supply chain efficiency can easily produce more return with less effort than a 10% increase in the sales. The table below represents an average industry (manufacturing) standard profit and loss statement that compares the relative benefit of a 10% reduction in purchasing cost to a 10% increase in sales assuming there is no cost increase in operations and SG&A.
Much can be done to reap the benefits of reduction in purchasing by following a simple principle listen and involve the supplier in the strategy. Sounds simple, but in practice this requires a change in mindset at the end of the company’s management.
From internal innovation to open innovation
Most CEOs put a top priority on responding to customers. In the new post-crisis environment, listening to suppliers can be just as important. Customer satisfaction remains a priority, but insight and innovation can also come from the supply side.
In 2002, the Dutch firm Royal Numico, a leading producer of baby food, tackled a highly competitive, shrinking market by turning to one of its suppliers, Babynov, a former yogurt company, headed by Roger Beguinot, a French entrepreneur. Beguinot had developed an ingenious plastic packaging concept that let mothers save time by preparing easy-to-serve baby food at ambient room temperature. Beguinot realized that mothers, pressed by hectic schedules, would feel guilty at spending less time with their infants, and would consequently be ready to pay extra for a premium brand as compensation. The product innovation enabled Numico to increase its profits dramatically, despite a declining birthrate. Numico’s emphasis on innovation led French competitor Danone to buy the company in 2007 for ‚¬12.3 billion roughly 22 times Numico’s earnings.
Procter & Gamble, one of America’s longest surviving corporations, literally redefined itself from a manufacturing company to a corporation focused on creating and building brands. By 2003, P&G, which had previously manufactured detergents, beauty aids and a variety of products with its own proprietary equipment, had moved towards becoming an aggregator of products made by a wide range of suppliers, and it was outsourcing a growing percentage of its manufacturing.
As part of P&G’s changing corporate identity, CEO A.G.Lafley adopted a connect and develop strategy which called for acquiring more than 50% of its innovation from outside the company. Lafley had realized that efforts to rely on in-house R&D was stretching the resources too thin, distracting from core operations. Innovation, P&G concluded, was the key to providing sufficient value to offset the higher prices of P&G’s premium products.
Apple, a corporate leader in innovation and a company that is notorious for insisting on its own proprietary hardware, also found that some of its best ideas by paying attention to outside suppliers. In 2001, its senior vice president for hardware engineering at the time, Jon Rubinstein, made a routine tour of Toshiba’s computer hard-disk manufacturing facility. Toshiba had just developed a tiny 1.8 hard drive. Toshiba’s engineers complained that they didn’t really know what to do with their creation. As it turned out, Apple did. The drive was the missing component needed to make the iPod possible. It changed the music business forever and the company along with it.
Re-thinking the supply chain
Traditionally companies tried to squeeze the lowest price possible out of suppliers.
- They instead should be embraced. More can be gained by turning the supplier into a partner in innovation than by forcing cost-cutting on materials and labor.
- An even more enlightened approach is to invest in R&D through the supplier.
The potential for increased profit outweighs the risk that a competitor will gain access to the idea through the supplier. The supplier with the best technology is in a better position to help the corporation compete effectively. Knowing how to develop a collaborative relationship is the fastest and easiest approach to improving the bottom line. This is a dramatic change of thinking from business in the past and thus requires the input at the highest level of the corporation’s management team.