The subcontracting or outsourcing of non-core activities has become popular in recent times. In practice most subcontracting or outsourcing arrangements are based on the potential to save costs, suppliers are likely to have lower overheads and variable costs, and may benefit from economies of scale if serving other firms.
Resource dependence and agency theory are more commonly used to explain vertical relationships and are concerned with the need to control key technologies in the value chain. Perceptions of the practices of Japanese manufacturers have led many firms to form closer relationships with suppliers. Indeed, closer links between firms, their suppliers and customers may help to reduce the cost of composers through specialization and sharing information on costs. However, factors such as the selection of suppliers and users, timing and mode of their involvement, and the novelty and complexity of the system being developed may reduce or negate the benefit of close supplier-user links.
The quality of the relationship with suppliers and the timing of their involvement in development are critical factors. Traditionally such relationships have been short-term, contractual, arm’s length agreements focusing on the issue of the cost, with little supplier input into design or engineering. In contrast the Japanese or partnership model is based on long term relationships and suppliers make a significant contribution of the development of new products. The latter approach increases the visibility of cost performance trade-offs reduces the time to market and improves the integration of component technologies. In certain sectors, particularly machine tools and scientific equipment there is a long tradition of collaboration between manufacturers and lead users in the development of new products. Different types of relationships are appropriate in different circumstances segmenting supply needs and suppliers.
I have objectives ranging from cost reduction, quality improvement, lead time reduction through to product and process innovation. I distinguish between three types of supply market:
- Homogeneous – all potential suppliers have very similar performance
- Differentiated – suppliers differ greatly and one is clearly superior.
- Indeterminate – supplies differ greatly under different conditions.
In the case of homogenous supply conditions and a primary objective to reduce costs, we would argue that a traditional market / contractual relationship are the ideal arrangement. In its most recent form this might be achieved by means of a business to business intranet exchange or club, whereby potential suppliers to a specific customer or sector pool their price and other data, or bid for specific contracts. Examples include Covisint in the automobile industry, established by Ford, General Motors and DaimlerChrysler and Metal Site formed by a group of the largest steel producers in the USA. Such developments are not confined to manufacturing and British Airways, American, United, Delta and Continental have established an electronic procurement hub for routine supplies with an annual turnover of few billions. With other applications of Internet technology the most significant savings are in transaction costs rather than the goods purchased. Estimates and efficiencies vary, but reports suggest transaction costs can be just 10% of conventional supply chains. Such developments attempt to exploit buyer power, and make supplier prices more transparent. They are the closest thing in the real world to the market of perfect information found in economic textbooks. Nonetheless, there are still some concerns that these might evolve into cartels controlled by the existing dominant companies, and thereby restrict new entrants and potential competition.
Some form of partnership or lean relationship is often advocated based on the quality and development lead time benefits experienced by Japanese manufacturers of consumer durables, specifically cars and electronics. We can identify a number of defining characteristics of such partnership or lean supply relations:
- Fewer suppliers, longer term relations;
- Greater equity – real cost transparency;
- Focus on value flows – the relationship, not the contract
- Vendor assessment, plus development,
- Two way or third party assessment
- Mutual learning: share experience, expertise, knowledge and investment.
These principles are based on a distillation of the features of the best Japanese manufacturers in the automobile and electronics sectors, and more recent experiments in other contexts, such as aerospace in the UK and USA, and as such may represent best practice under certain conditions. Comparing supplier relations in Japan and the UK, partnership approaches had significant advantages over market relations, including more supportive customers and less erratic trade. This resulted in measurable differences in operational performance, such as a reduction in inventory held by customers, tool development, substantial time reduction. In the lean relationships customers were rated by suppliers as being significantly more demanding than in the market relationships and involved a much higher degree of monitoring by customers. The suppliers sales were dominated by a few key customers, and asset specificity a measure of how much a suppliers’ plant and equipment are dedicated to a particular customer was much higher. These factors make suppliers in lean relations very vulnerable to the fortunes of their key customers. Nevertheless, partnership models have fast become the norm in both the private and public sectors, irrespective of the supply market conditions or objectives of the relationship.