Today, to stay commercially competitive, companies are forced to outsource commodities and focus on their core competency and creative ways to increase product value. Traditionally, most buying organizations use a competitive bidding process to find a supplier for the selected commodities to outsource, whereas they will send out Request for Quotation (RFQs) to get bids from suppliers for the business. To get the lowest cost possible, typically, buying organizations will use several rounds of the competitive bidding process. However, the data seems to indicate several iterations of the competitive bidding process does not get you the lowest price. Why?
In many industries, more so in automotive, medical device, and consumer electronics, suppliers pad their beginning quotes from the beginning because they know most organizations play this game and they will need room to lower their cost in follow-on rounds. Contrary to the conventional wisdom, data indicates that the most effective way to get the lowest bid is to tell suppliers that they will only have one chance to bid/quote on the business. If suppliers truly believe this, then they will deliver their best quote the first time around, because it is the only time.
Beyond the amount of time and energy required to conduct multiple competitive bidding rounds, it can result in increased risk and a weak supply base in the long term. To quantify this, with competitive bidding in many cases you are simply trying to get suppliers to low ball each other to win your business. But the negative flip side of that is that, you are directly reducing their profit margin. If you have a current supplier that charges $1.00 per part, and it costs them $.90 to make it, they have about a 10% margin. If you force them to continuously rebid the business, and they ultimately agree to $.93 per part you have reduced the supplier’s margin down to nothing. In the end, this cost reduction strategy will generate short term cost savings but will weaken or destroy your supply base long term.
A more viable option and true strategic supply chain approach, beyond the cost reduction approach, would be taking a supply partner development approach. Whereas, in true partnership, it is required that you, as a buying organization, sit down with your supply partners to leverage your experiences to help them reduce their direct costs (e.g., labor and material). What if you could help cut their direct costs by 30% which would enable them to keep their 10% margin? Likely, that supplier would say thank you because their margins would not change (potentially they would increase), they would become more operationally efficient and cost competitive resulting in earning more business because of it, and you would likely pay 20-25% less for your commodity. In the end, this approach can create a Win for all parties.
Many companies have moved beyond just outsourcing commodities to outsourcing core/strategic part and modules. In the past, many thought this strategy could not be done effectively, but it can, and Chrysler has mastered it. Chrysler leverages tools such as co-location, long-term contracts, and establish joint legal ownership of all design and manufacturing capabilities developed. However, when outsourcing core modules there typically are far fewer supply partners that can fulfill your need, in some cases there might only be 1 or 2 suppliers to choose from. Also, if it is core, chances are you need to go with one supply partner because using more than one might be too complicated and sensitive. For example, Chrysler outsources interior seating systems to one supplier (JCI). JCI does not want to do business with Chrysler if they also use their competitor (Lear). Ford will use Lear though not JCI. I am embellishing here a little to make a point.
Keep in mind companies do not use competitive bidding when they outsource core parts. Why? One, how do you use competitive bidding if there are only 1 or 2 suppliers to choose from? You cannot. Have you heard about the government awarding multibillion dollar contracts to suppliers with no bids? People often ask why doesn’t the government use competitive bidding to get the same price.
Some people think it is because large defense contractors are well connected. Politics aside, a major contributor to the limited number of firms that compete for government contracts is because there are often only 1 or 2 suppliers that can fulfill the governments magnitude of requirements, needs and wants. Leading firms analyze a multitude of criteria for strategic core parts, and price often is not the most important. Of course, all supply chain professionals care about price. Typically, in these cases, supply chain professionals will establish cost target goals for complex modules, collaborate with a supply partner to jointly craft solutions to reach the goals, reward the supply partner if they exceed the goal, and source selection is determined by overall forecasted performance (e.g., quality, service, and flexibility).
In summary, enhance your firms short and long term future by establishing a single round of competitive bidding and then partnering with your supply partners to drive cost out of your supply chain.