Suppliers finding footing in price negotiations.

The results of the latest IRN biennial survey, The Dynamics of Price Reduction Requests, have been published, and there may be cause for faint optimism among suppliers that the interaction with their customers is changing. The automakers are still setting a high bar for the savings that they expect out of their purchasing function, but some suppliers seem to be gaining a foothold in representing their position. Some of the survey results support a cautiously optimistic view that a transition phase is coming.

The average reduction requested by most customers, with the exception of GM, decreased this year.

The overall average price reduction request went from 6.3% in the 2003 survey to 6.2%. While this is not much of a drop, it is the first time that the overall average declined since we started conducting the survey in 1997. If we take the GM responses out of the calculation, the average amount requested by other customers was 5.5%.

The customer asking for the most rigorous concessions has varied in each of the years that we have done the survey. DaimlerChrysler, Ford (twice), the Tier Ones taken collectively, and now GM have each had a turn at the top of the list. The 2005 results stand out in that there is a greater spread between GM's average request and that of its colleagues (1.1 percentage points between GM and the next highest, DaimlerChrysler, compared to just 0.1 between the top two in the previous survey). What's more, there is a larger range from the lowest request to the highest this time around--a difference of 3.9 percentage points between the high and low requests, compared to 2.2 percentage points in 2003 and just 1.3 in 2001. When companies get into trouble, their behavior often starts to change. More aggressive treatment of suppliers is a hallmark of this situation, so it is no surprise to see GM with the heaviest hand at this point. Even in this situation, however, there are suppliers that have gained business at GM without completely acquiescing to its demands.

The average amount given by suppliers has modestly declined to 3% from the 3.6% reported in IRN's 2003 survey.

Suppliers were hit with a double-whammy during this survey period--the usual pressure from customers on prices, but also the pressure of the marketplace through steep hikes in raw material costs. Fifty-Five percent of the respondents were not able to pass through any of their increased material costs to customers. Many survey respondents mentioned that the increase in inputs had an impact on what they were able to do for customers in the price negotiations. Some customers took into consideration these higher costs in reforming their expectations for pricedowns, but they did not consider this a reason to give anyone a complete bye on a reduction.

On the positive side, a three percent level of annual improvement is doable, at least, for those suppliers that are truly lean. It is also consistent with the Japanese product development belief that, while incremental cost improvement is possible after product launch, anything over that level can only come through process and product design.

Sometimes the sacrifice is worth it.

The customers seem to be embracing the concept that a supplier's willingness to support annual price reduction targets should be rewarded by an increase in business. The percentage of suppliers reporting that they gained more business with their customer as a result of their being willing to make a price concession rose to one-third of the respondents in 2005, from one-quarter in the 2003 survey. This data supports IRN's anecdotal observation that successful suppliers continue to get lots of opportunity to grow, while many others are struggling to maintain both revenue and profit. The supply base is becoming a world of haves and have-nots.

It is still true that the most common immediate result of a supplier's concession was simply to maintain the same level of business with this customer. For 57% of the respondents, that was the immediate outcome of their negotiations. Almost half (47%) of the companies responding to the survey expected to gain more business in the future, however. A pricing decision that yields an offsetting increase in new business is not an unreasonable course to take.

Penalties for refusal are not a sure thing

Among the survey respondents who declined to yield any ground in their pricing, 10% immediately lost business, but 72% maintained what they had. Since there are costs to shifting business between suppliers, this is not surprising. Fifteen percent actually gained business, their refusal notwithstanding. Looking further out, the percentage that expected to lose was about the same, and many (19%) did not know what to expect in the way of repercussions. Almost 40% expect to maintain their business with this customer in the future, and 29% anticipate getting additional business from the customer, in spite of this unfavorable round of negotiations. Whether a company feels that it can take a chance in choosing this stance has a lot to do with the availability of substitutes.

There is some level of cost reduction that accrues from hard work and creativity on the part of the participants in a supply chain. This can result in a win-win scenario for both customers and suppliers when it is a matter of driving cost out of the system entirely. Much of what we have seen over the past few years is more in the nature of cost-shifting from one party to the next. New supplier relations programs, such as Ford's Aligned Business Framework, are being positioned as a collaborative approach to the problem, and that is a trend that we hope will continue. In the meantime, suppliers who have some competence that yields a competitive advantage appear to be finding firmer footing on the slanted playing field that the auto industry has become.

By Melissa Anderson, Vice President, IRN, Inc. [e-mail]