Why Relationships Matter

By Robert J. Trent -- Supply Chain Management Review, 11/1/2005

A recent visit to a medical equipment producer revealed a surprisingly simple and traditional model of supply management. This model, which has not changed in many years, focuses almost exclusively on obtaining year-after-year price reductions from suppliers. Under the model, the company threatens to replace those suppliers that refuse or are unable to comply with the price demands. Over time, this approach has produced its intended effect of lowering prices, especially when supply capacity exceeded demand. Now, however, supply markets are tightening and more internal capabilities are being outsourced. As a result, power has begun to shift from the buyer to the seller, making this model much less effective. The medical equipment producer's continued adherence to adversarial relationships and its obsession with price now look tired and uncompetitive.

Like the medical equipment provider, most firms would benefit from a more enlightened approach to managing their supplier relationships. As a diverse set of research shows, relationships matter to the point where they can be a source of competitive advantage.¹ Recognizing this, many firms are pursuing supplier relationship management (SRM), a broad-based management methodology and set of practices that describe how a firm manages its supply base. SRM provides a philosophy, shared throughout an organization, that supplier relationships are important.

Yet, while supplier relations are important, not all relationships are equal in value. A major part of supplier relationship management is differentiating supplier relationships and understanding when and where to apply an appropriate relationship. This differentiation is crucial because a number of industry trends and changes are pushing SRM to become an increasingly important part of the strategic planning process. Managers should be aware not only of these trends but also of what suppliers want from their buyer-supplier relationships and what buyers should do to exceed those expectations.

While most people would agree that buyer-supplier relationships are important, we should not believe that all relationships are special or unique. Supply chain professionals can bring value to their organization by knowing when, where, and how to apply an appropriate relationship.

Various models have been developed that provide some order or logic to industrial relationships.² Exhibit 1 presents one approach that characterizes buyer-supplier relationships based on behavior rather than legal structures, such as joint ventures or partnerships. This model segments relationships into four behavioral dimensions and recognizes that different approaches to supplier management apply to different settings. There is no "one size fits all" buyer-supplier relationship. The potential to create value from a relationship differs dramatically as we move through the four levels.

Counterproductive Relationships. In counterproductive relationships—also called antagonistic or lose-lose relationships—the parties actively work against each other's interests. In addition, neither party feels a need to assume responsibility for anything that transpires. This scenario not only fails to create new value but also frustrates short- and longer-term success.

Counterproductive relationships are not recommended, but this does not mean they don't exist. Over the last several years, some buyers have taken legal action against their suppliers to prevent material-price increases that the buyer contends violate contractual agreements. Relying on the judicial system to settle disputes is an indication that a relationship has become counterproductive.

Competitive Relationships. Competitive relationships—also referred to as distributive, win-lose, or adversarial relationships—see supply chain members acting in their self-interest to capture a larger share of value from a relationship. The parties compete over a fixed amount of value rather than pursuing activities that create new value or mutual opportunities, such as cost reductions that would lead to an increase in market share and, in turn, more business for suppliers.

Buyers usually pursue competitive relationships with suppliers that provide standard or lower-value items or services in a supply market that offers substitutable products and services with low supplier-switching costs. Competitive bidding or price comparisons, shorter-term contracting, regular market testing, and reverse Internet auctions are often used to obtain these items.

While it may seem counterintuitive, many supplier relationships should be competitive. Pursuing a higher level or more intense supplier relationship is often prohibitive as the cost of managing the relationship would likely outweigh any benefit. The reality is that a majority of a buying firm's relationships, in terms of the total number of suppliers, should be competitive. These relationships, however, will likely not comprise a significant portion of total purchase dollars.

Cooperative Relationships. Cooperative relationships—also referred to as integrative or win-win relationships—recognize the potential value of closer interaction and open sharing of information. These relationships are most often associated with suppliers that are expected to be longer-term members of a reduced supply base. Relationships with these suppliers are often formalized through longer-term contracts that lead to discussions about how to improve cost, quality, delivery, packaging, inventory management, product innovation, and service—all of which can affect supply chain performance. Cooperative relationships often feature early supplier involvement during product development.

Collaborative Relationships. Collaborative relationships, sometimes called creative relationships, involve a limited number of suppliers that provide items or services that are essential to a company's success. A willingness to work jointly to identify new and better ways to operate or compete in the marketplace is characteristic of such a relationship. For example, General Electric helped fund the development of Boeing's long-range version of the 777, a plane that customers can order only with GE engines. GE's logic for collaborating with Boeing is quite simple—working with Boeing to develop innovative planes that create value for airline customers enables GE to sell and service more engines.

Collaborative relationships represent the most sophisticated and intensive relationship possible between a buyer and seller. They feature executive-to-executive interaction, joint strategy-development sessions, and an intense sharing of resources. Supply chain alliances and partnerships, for example, are collaborative by design. The parties ideally share a co-destiny and recognize that the value they receive would be far less than if the collaborative relationship did not exist.

Part of the value that supply managers add to an organization is their ability to create the most appropriate supplier relationship for a particular requirement. Pursuing a cooperative or collaborative relationship when a competitive relationship may be better will likely create no new value. Conversely, pursuing a competitive relationship when a cooperative or collaborative relationship makes more sense will likely leave some value unrealized.

Our experience and research, which includes focus groups with dozens of companies, confirms that supplier relationship management will become an increasingly important part of a firm's strategic planning process. To put it simply, relationships matter because almost every industry is facing changes that make suppliers a critical part of a firm's value chain. The following eight reasons show why supplier-buyer relationships—particularly those that will benefit from a cooperative or collaborative approach—will grow in importance.

1) Relentless Pressure to Improve

It is difficult to identify an industry that has not seen an increase in global competition over the last 15 years, leading to ever-increasing pressure to improve. Even in industries, such as aerospace, where the number of major competitors has decreased, companies still must deal with sophisticated customers presenting their own set of demands. Relentless customer and competitor pressure to reduce prices, improve quality, shorten cycle times, improve delivery, rapidly innovate, and be responsive to change has become today's reality.

Most firms have worked diligently to improve those parts of the supply chain that are under their direct control. In fact, many managers will say they have reached a point of diminishing return as it relates to improving internal performance. If this is the case, where will the next major source for improvement come from? When you understand that at least 60 percent of total revenue often passes directly to suppliers as payment for required inputs, then the source for future cost, quality, delivery, and cycle-time improvements quickly becomes evident.

Pressure to improve is relentless and severe. When combined with other changes and trends, it is not hard to envision the role that suppliers will play in the improvement process. Suppliers that have a cooperative or collaborative relationship with their customers should be willing to participate in a buyer's improvement projects, engage in joint problem solving, participate early in product design, and support other activities that lead to better supply chain performance. Suppliers that do not have a positive relationship with a buyer will presumably be less willing to support meaningful changes. These suppliers may even act in a manner that is counterproductive to the buyer's long-term interests.

2) Reliance on Fewer Suppliers

Throughout the 1990s, more and more companies began to continually—and often dramatically—reduce their number of suppliers.³ As an example, in the late 1990s, 40 percent of Lucent Technologies' company-wide purchase volume was with 2,000 suppliers. Today the company relies on only 60 suppliers for 80 percent of its total purchases.⁴ One report says that over the last several years almost half of the companies surveyed have reduced their supply base by 20 percent, another 15 percent have reduced their supply base between 20 and 60 percent, and fully three-quarters of buying firms now commit 80 percent of their total purchase dollars to fewer than 100 suppliers.⁵

There are some good reasons for wanting to work with a smaller supply base. The cost of maintaining multiple suppliers for each purchased good or service (including duplication of effort and greater opportunity for supply chain variability) usually outweighs any perceived reduction in risk. Perhaps more importantly, maintaining a smaller supply base is a critical prerequisite for leading-edge supply management practices such as supplier involvement during product development, collaborative planning, and cooperative quality and cost-reduction initiatives.

One unintended effect of relying on a reduced supply base is an increase in supplier-switching costs. As buyers reduce their supply base for critical requirements to one or two suppliers, place the remaining suppliers on longer-term agreements, and even begin to use global suppliers to satisfy worldwide operating needs, how much supplier switching flexibility do they really have?

A longer-term reliance on a drastically reduced supply base demands close attention to relationships. Exhibit 2 shows how supply management's role changes when a company moves from a traditional environment that features thousands of component suppliers to a strategic sourcing approach with a drastically reduced set of critical suppliers. These remaining suppliers often receive a larger portion of a buyer's total purchase requirements, further shifting the balance of power toward the seller. Companies that are shifting toward a smaller supply base cannot ignore the role that relationships will play with the remaining suppliers.

3) Importance of Early Involvement

For most firms, the development of innovative new products and services comprises a major part of their competitive business model. A logical question becomes how to gain differential advantage from involving suppliers in the development process.

In their seminal study of Toyota's lean production system, James Womack, Daniel Jones, and Daniel Roos found that automotive original equipment manufacturers (OEMs) in the United States relied on their suppliers for a much lower percentage of their engineering design support during product development than their Japanese counterparts did.⁶ The study concluded that foreign competitors were capturing more value from early supplier involvement than U.S. producers.

U.S. firms now recognize the importance of supplier involvement during new product development. In a number of leading companies, we see an increasing amount of differentiating features and technology in final products and services that originated with suppliers. Consider, for example, the OnStar system in General Motors vehicles, FedEx's tracking technology, and efficient engines and composite materials for Boeing's 787 Dreamliner. These innovations came largely from suppliers that do much more than design a component according to buyer-provided specifications. A company's ability to manage and facilitate supplier involvement early in the product design process can make a difference in whether these innovations become a differentiating part of its product offering or end up as part of its competitor's offering.

Research reveals that executives not only have a high regard for the potential contribution that suppliers can make during development, they also expect suppliers to become involved early on, sometimes during the concept phase. The average performance improvement across a range of categories during product development is 10–20 percent, and sometimes more, when suppliers are early participants.⁷ Capturing these benefits requires having a set of suppliers that are willing to share their expertise and resources as a core component of their relationship as well as having buyers who understand how to manage those relationships.

4) Higher-Level Outsourcing

Even though companies have traditionally outsourced certain requirements, they have been willing only recently to cede direct control over entire portions of their supply chain. This often includes logistics, manufacturing operations, information-technology management, and a wide range of support services.

While activities that are outsourced presumably are not part of a company's internal core capabilities or competencies, they are still essential to success. Can anyone argue that the Asian supplier that produces the iPod does not affect Apple's quality reputation? Is the external supplier that produces Boeing's aircraft fuselages not critical to product performance and customer satisfaction? Is the third-party logistics provider that coordinates GM's worldwide component deliveries not central to the automaker's operating success? Just because an activity is not part of a company's core business strategy does not mean it is unimportant. If it were unimportant it would likely not be performed.

As firms focus on those areas where they add the most value, they will invariably rely on a smaller set of suppliers to fill in gaps across the value chain. As responsibility for entire "chunks" of the value chain is transferred to third parties, anything less than a total commitment to strong relationships with those providers will result in suboptimized performance.

5) Pressure to Become a Full Product-Service Provider

Industrial customers are showing a desire to work with companies that provide a full range of products and services. In order to provide this full range, a company must have capabilities in system design, assembly, test, maintenance, and ancillary services, such as finance or end-of-life disposal. In essence, a full-service supplier performs or coordinates the work of many suppliers.

Becoming a full product-service provider can be a powerful differentiator as more and more customers want to work with a smaller set of suppliers. The problem for many companies is they lack the full range of capabilities that customers demand. Becoming a full product-service provider rather than a niche player forces companies to consider a number of options. They can develop the needed capabilities internally, acquire them through a merger or acquisition, or rely on third-party suppliers to fill in the missing pieces.

Increasingly, we should expect the use of third-party suppliers to be an attractive option. The time and cost required for formal acquisitions or the internal development of a full range of capabilities may simply be too great, at least in the short term. Additionally a company may be reluctant to assume ownership of additional assets from a financial perspective. But in today's hyper-speed environment, a delay in responding to customer needs may open the door just enough to allow a competitor to enter.

Exhibit 3 summarizes how a producer of finished utility trucks now competes as a full product-service provider. In an earlier (and simpler) era, it was enough to satisfy customer demands by delivering a finished product at the right price and quality. Unfortunately, yesterday's order-winning characteristics have become today's order-qualifying characteristics. Customers now demand a wide array of features and services that have little to do with the physical truck. The company is now calling on trusted supply partners to provide much of the added value that wins orders. Can a company that relies on its suppliers to help it compete as a full product-service provider afford not to view relationships as core to its success?

6) Supply Market Constraints

Consider for a moment some recent headlines from a Purchasing magazine report on world supply markets—prices for molybdenum are at historic highs; spot gold predicted to double in coming months; tight cement supply boosts concrete prices; zircon rises as demand exceeds supply; crude oil hits new trading high; copper leaps to record high; and titanium dioxide is about to rise.⁸ Those who follow supply markets know that when demand exceeds supply, the results are often higher prices, allocation of supply, and a power shift from buyers to sellers.

Even if a buying firm does not source raw or semifinished raw materials directly, it is likely doing business with suppliers that are struggling to obtain these increasingly scarce and expensive materials. Companies need to rethink their traditional supplier management practices in the face of these constraints and the related effects on their supply chains. As market changes shift the balance between supply and demand, do suppliers really have to work with customers that treat them poorly? And if these suppliers continue to work with customers who pursue adversarial relationships, should these customers realistically expect preferential treatment?

Most suppliers want to be their customers' supplier of choice (that is, the preferred supplier). Conversely, most buyers should strive to become their suppliers' customer of choice (that is, the preferred customer), especially if these suppliers sell to a variety of customers from different industries. Preferred customers are first in line when a supplier develops new technologies, first in line to receive differentiating ideas that originate within the supply community, and, when supply markets are out of balance, first in line when a supplier's limited output is distributed. To become a preferred customer, a company must focus its attention on supplier relationship management.

7) Competing Supply Chains

If we believe that competition is increasingly between supply chains rather than individual firms, then it makes sense to conclude that effective supply chains feature effective relationships. Descriptors such as aligned, coordinated, and synchronized are all used to describe efficient and effective supply chains. They also imply a cross-organizational perspective featuring a reliance on trusted suppliers. If supply chain management as a philosophy increases in importance over the next several years, we can probably conclude that the relationships between supply chain members will also increase in importance.

An industry that exemplifies competition between supply chains is satellite radio. In their race to be first to market, XM and Sirius each had to work closely with satellite and launch providers, convince an array of electronics companies to produce earth-based transmitting and receiving equipment unique to each company's specifications, organize an extensive radio installation network, and enter into partnerships with automakers to include satellite radio as part of a vehicle's original equipment. A detailed study of this evolving industry shows that it is no longer enough for a single firm to have an innovative idea. Market success increasingly lies in a firm's ability to design a supply chain that can quickly outperform any supply chain assembled by competitors.

8) Fear of Competitive Disadvantage

If the potential advantages of improving supplier relationships are not sufficient incentive to act, then perhaps the competitive disadvantages of not doing so will be.

Nowhere have the competitive aspects of supplier relationships received more attention than in the automotive industry. A recent study reported that U.S. OEMs continue to lag behind Japanese OEMs operating in the United States in managing their relationships with automotive suppliers. An overall conclusion is that Japanese OEMs are applying continuous improvement practices to their supplier relationships just as they have done in their manufacturing processes. As a result, they continue to win the cost-quality-technology race.⁹

Suppliers prefer working with the Japanese OEMs and believe that they have a better opportunity to make an acceptable return from them. As a result, they are shifting resources, particularly capital and R&D expenditures, to the Japanese OEMs while reducing their commitment to the U.S. Big Three. Suppliers also are increasing product quality for their Japanese customers while merely maintaining quality levels for domestic automakers. As the automotive industry example illustrates, it is hard to discount the importance of supplier relationships when competing against companies that have turned their relationships into a competitive advantage.

To create a cooperative or collaborative relationship and gain that competitive advantage, companies need to know what their suppliers expect from a relationship. Exhibit 4 presents a set of expectations that begins to define what suppliers want from their relationship with buyers. These expectations are based on focus group discussions with supply chain professionals.

The desire for longer-term business arrangements, the first item in Exhibit 4, means that suppliers do not want to see their volumes regularly rebid or "shopped around" to other suppliers. This suggests that while standard items with low switching costs should be market tested or rebid on a regular basis, buyers might want to consider a more cooperative approach for managing critical or unique items. Companies that routinely take an adversarial approach with their supply base tend to view reverse Internet auctions and market testing, for example, as approaches that can be applied to almost any requirement. But using reverse auctions to drive prices lower quickly sends a message about the win-lose nature of a short-term relationship.

Protection of intellectual property is another important expectation. Several years ago, an OEM invited suppliers to submit design ideas for the development of a new product. The OEM not only failed to compensate suppliers for their efforts (providing design support is part of the cost of doing business with this buying firm) but also sent the winning design out for bid to other suppliers. The company even included suppliers in China that had not participated in the design phase. Needless to say, any trust that existed between the supplier that created the original design and the OEM disappeared.

A recent survey of European automotive suppliers shows how important understanding supplier expectations can be. This survey noted that suppliers are shifting their business to OEMs that satisfy their expectations. They are also charging more for parts from customers that do not meet expectations. A supplier's willingness to do business with a customer correlates closely with whether the customer fulfills expectations in four main areas—the supplier's return on investment, the customer's support of the supplier, the customer's willingness to reward cost-saving ideas, and the customer's ability to protect proprietary technology.¹⁰ Suppliers also stated a desire to shift business away from customers that have costly and time-consuming negotiating processes.

Suppliers should recognize that the likelihood of meeting each expectation presented in Exhibit 4 is low. However, buying firms should strive, whenever possible, to address these wishes for the sake of longer-term relationships and a smoothly operating supply chain. Satisfying those expectations should, in the long run, strengthen relationships and trust between suppliers and buyers.

Typically we think of customers as being the one pursued rather than the pursuer. But buyers should be proactive in their pursuit of better supply chain relationships. Exhibit 5 presents the actions that buying firms can take to forge stronger relationships with suppliers.

A tangible way to focus on relationships is to make them part of the organizational design. According to a recent study, one of the most widely used SRM practices is to assign individuals to manage specific supplier relationships.¹¹ Who these individuals are will vary as the importance of the relationship changes. For critical relationships, it is increasingly common to find executives responsible for working closely with counterparts at the supplier. Progressive firms also establish buyer-supplier councils to share information at the highest organizational levels.

Especially in a cooperative or collaborative relationship, buyers should pursue activities that promote trust. Perhaps the most critical predictor of a successful relationship, trust refers to a belief in the character, ability, strength, or truth of a party. Buyers demonstrate their trustworthiness through open and frequent communication, following through on promises and commitments, and acting legally and ethically in all dealings. Other actions that indicate a trust-based relationship include basing decisions on the good of the relationship rather than self-interest; publicizing success stories and personal narratives, especially those that enhance the standing of the other party; and treating information and data confidentially. Enhancing trust across the supply chain must be an important objective.

A worthwhile action that few buying firms undertake is a formal assessment of the buyer by suppliers. While suppliers are accustomed to receiving regular reports about their performance, it is much rarer for buyers to receive reports about their performance as a customer. These reverse surveys, conducted by a third party to ensure confidentiality, address how well a buying firm satisfies supplier expectations across a range of areas. The buyer uses this feedback to improve the quality of its supplier management efforts. The fact that so few buying firms take the time to ask their suppliers why they prefer to do business (or not do business) with them is a good, competitive reason to emphasize this activity.

Creating Competitive Advantage

Buyers who still pursue adversarial relationships with their most important suppliers will not meet with success in today's marketplace. They may find their suppliers increasing prices, allocating limited capacity to other firms, or sharing their most innovative ideas with other customers—some of whom may be the buyers' direct competitors.

Committing to better buyer-supplier relationships does not mean trying to satisfy every supplier's expectations. Instead such a commitment recognizes that a cooperative approach with a select group of suppliers offers the potential to better meet the demands of a highly competitive marketplace. The challenge today is to take the set of activities that fall under a broad umbrella called supplier relationship management and turn them into a hard-to-duplicate source of competitive advantage. Put another way, that's why relationships matter.