Large firms have been trying hard to balance their operation strategy and cost reduction for material purchase ever since the free trade era was introduced. As noted by Robert Kaplan in his Strategy Maps, long-established firms with large market share tend to opt productivity improvement strategy to protect their products from low-priced products sold by new competitors.
One way to implement productivity strategy is by reducing operation costs. For large manufacturers, material purchase is undoubtedly the biggest burden in their operation cost’s structure, ranging between 55% – 75%. Another way is to improve productivity, that is by reducing fixed costs and overhead (ranging between 15% – 25% of their costs structure), can be less significant if it is not followed by reducing the costs for material purchase.
Another reason why reducing the costs for material purchase is preferred by many large manufacturers is because it can generate quick savings. Meanwhile, efforts to reduce fixed costs and overhead through improving productivity on production floor requires more resources, time and persistence, and sometimes productivity consulting service is needed for a long period of time, which is of course costly.
The problem is that reducing costs for material purchase does not necessarily lead to strong and sustainable competitiveness if not followed by cross-cutting strategy design such as using e-sourcing that can help reduce the time from order taking to goods delivery. E-sourcing can save a lot of time taken for identifying new suppliers, negotiating with them, and comparing prices the quoted. Reducing the costs for purchase material is likely to be difficult if the company still wants to buy from its old suppliers.
Another strategic advantage of using e-sourcing is that it may reveal the true or base price of the material. This once happened to one of the largest HVAC companies, York Air Conditioning and Refrigeration (Thailand) Co., Ltd., which indirectly revealed the true price for a capacitor for refrigerating industry. The e-sourcing concept with e-bidding facility (online buy auction) could attract many suppliers to submit their quotation for the same product item and in the same time. This forces them to lower their price to the lowest point which still can give them some margin.
In HVAC case, the price for electric capacitor of various types dropped to 20% – 30% from the market price. This shows that there has been unrealistic pricing for quite long period of time for those parts. Thus, HVAC could take advantage of the system and leave behind its competitors who still suffer from unrealistic pricing set by their suppliers.
In addition to implementing e-bidding, HVAC company also had an interesting experience in interacting with its suppliers. Their old suppliers, that are enlisted in the system, withdrew themselves from the bidding once they knew they had tight price competition, but then they came back with revised quotation, which was lower than the one they submitted the previous year. This created lucrative savings for the company.
Such practice was made by their existing suppliers in the US for e-bidding for electric capacitor and their current suppliers in Thailand for e-bidding for brass valve. Although it is illegal for HVAC company to cancel e-bidding, the experience really shows that there is one way to alter “the game complexity” with long existing suppliers.
It is often the case that after maintaining a long relationship with a number of suppliers, a company is reluctant to find other suppliers with better price. This may be true when managers of the company have “special relationship” with their long existing suppliers.
Another case involved freemarkets.com in 2002 when it facilitated online buy auction for elevator company Orleans company. This company deliberately give a second chance for their existing suppliers, American companies, to renegotiate their quotation that was submitted in e-bidding against supplier from Mexico.
E-sourcing as a strategic instrument to test existing suppliers’ willingness to modify their price of previous year must be used wisely. E-bidding, which could generate new prices and suppliers, had better not be cancelled (including not canceling the current e-bidding). If the company does this, it will lose its credibility quickly among suppliers.
How to avoid doing this? The company may reveal some materials it purchases from its old suppliers in the e-bidding and let the rest of the materials remain supplied by the old suppliers to give them chance to modify their price through conventional negotiation. If implemented appropriately, this strategy can help a company to have better prices for materials from different suppliers, both old and new, without putting risks on old suppliers of losing everything they have built and maintained thus far. As noted by experts, it is more advantageous to maintain relationship with old suppliers than selecting new suppliers just on low price consideration only.
This opinion article was first published in SWA and then Warta Ekonomi in 2006, written by Hery Kameswara when he was an Industry Advisor at USAID SENADA-Indonesia Competitiveness Program. Currently, he serves in the Board of Management, Mars Digital Indonesia, as Senior Advisor –
