Watching Your Back (Not Looking Ahead)

Anand Ramand noted in a blog recently that one far-reaching consequence of the current economic disaster is the erosion of trust in supplier relationships. A single PO gone awry can easily damage trust that has built up over many successful transactions. Costs and trust are inversely proportional. This doesn't bode well for supply chains, and ultimately the consumers and economies dependent on the value created by them.

Years ago, a consultant from Ford's quality management team shared a story that speaks to the relationship between cost and trust. Ford and Mazda, new to their partnership at the time, were benchmarking their business processes. One obvious difference in their organizations was Accounts Payable: it appeared to be missing at Mazda. Ford, probably assuming a translation problem, asked again: how many people do you have reconciling invoices and entering vouchers and claims? Mazda replied that they didn't receive invoices and so didn't have a need to reconcile them. So how did they ensure that they didn't over-pay suppliers? Mazda gave as example a windshield supplier: every car has one windshield. We know how many cars leave the assembly line. Each one of them has to have an acceptable windshield. We just pay the supplier for as many windshields as cars that were produced; we send the payment electronically, so there's no handling.

That solution perfectly illustrates the cost benefits of trust in the supply chain. The supplier has to trust that Mazda is going to pay for every windshield that was used in the finished product and is going to report production accurately. Mazda receives a benefit from accurate reporting too, since the supplier must have accurate demand information in order to provide the right amount of windshields to keep the production line running. Both parties' costs are driven up if there is too much or too little raw material at the production line. The supplier has to eat the cost of every windshield that didn't leave in a finished car, even if the customer damaged the part during installation. (Realistically, this is no different from the more traditional process of invoicing and claims, however both parties save themselves the cost of personnel to handle the claims.) Mazda also has to trust that the supplier is providing the raw materials at a competitive cost, since the windshields are single sourced.

Fast-forward to 2009. Many if not most companies have made significant progress in creating tighter supply chain relationships built on trust. Inventories are much leaner, and companies are more vulnerable to cancellations or delays in purchase orders. Fearing a supplier's unreliability, companies start thinking they should diversify their sources. Decisions based on fear can unravel relationships and initiatives that previously enabled lowered costs and increased production.

The immediate reaction to fear is necessarily short-sighted: you become focused on overcoming a threat in the here-and-now. Caught up in the moment, it is easy to make decisions unmindful of long-term consequences. There's no question that managers have to make decisions to address current business objectives. But before taking an action that could substantially jeopardize the trust foundation of a relationship, it is equally important to consider what outcomes you want, and what is acceptable, for the business' long-term value and prosperity. Businesses need to remember that everything happens in the context of a relationship. Everything.