Small Suppliers Are in Peril (and It's Not Getting Any Easier)

I read two articles recently that lay out in bleak terms the challenges that America’s small- and medium-sized supplier/manufacturers are facing, especially in view of the coronavirus pandemic. I will cite some points from each that I hope will pique your interest enough that you’ll want to read the articles in their entirety—they are worth the read.

The first—Aerospace Suppliers Should Brace for Headwinds—laid out the issues aircraft manufacturers are facing in the light of slower orders for aircraft as well what suppliers should expect as a result. This was happening, by the way, even before the effects of the coronavirus effects on the economy and air travel took hold. That virus will likely increase dramatically the negative impacts detailed in the article. Here are a few of lines from the article with my commentary following them in italics:

1. “Although a great deal has been written about the 737 Max and the massive cash and profit pressures on Boeing, the predictable result is Boeing’s cost squeeze on suppliers.”

My 22 November article laid out the issues that Boeing suppliers will be facing as their customer’s new price-reduction tsar—Stanley Deal—takes charge. Mr. Deal, if you remember, primarily built his reputation on squeezing supplier margins.

2. Cost targets “will be part of an imminent pricing correction in the parts market over the next 12 to 24 months as OEMs are driven to reduce costs through supplier rationalization, vertical integration and continuous improvement through continuous improvement programs through the supply chain.”

Pardon me for being a skeptic, but over the years supplier development has been my bread-and-butter and, in my work with OEMs and their suppliers, I haven’t seen much in the way of available supplier development resources and/or infrastructure. In other words, OEMs are not positioned to provide much to help to assist suppliers in cost reduction. Or for that matter, for suppliers to assist OEMs in cost reduction efforts through processes such as design reviews.

3. “Where should aerospace suppliers focus their attention? Simple: the lifeblood known as the OEM’s long-term agreement.”

Really?

I once was engaged by an airline manufacturer to help them redesign their supplier development function, which, in my mind, was virtually non-existent and certainly had minimal impact on their supplier chain.

One of the steps in this process was to conduct a proof-of-concept pilot with a select group of supplier participants. We kicked off this pilot with one supplier and were about a month into the project—and making good progress—when a purchasing team from the same OEM I was working for came in and demanded an immediate 15% price reduction. Both the supplier and I were shocked. This supplier had two years left on a contract with this customer, but the customer basically laid out the reality of such contracts. Specifically,” we have more and better lawyers than you do, so we’ll be able to drag this out in the courts long enough that it will likely drive you out of business.” So my advice to suppliers is not to place too much stock in long-term agreements unless you are positioned to take a customer on in an extended legal battle. Long-term agreements are pretty much put together to protect the OEM

The second article is a March 11 report from the law firm of King and Spalding called “The Impact of COVID-19 on Supply Chain Finance.” The article is a good primer on what small- and medium-sized manufacturers go through to get either (or both) working capital and a line-of-credit.

One point laid out in the article especially helps one understand why suppliers rely on bank financing: it’s the lag time between delivering parts to their customers and when customers pay them for that delivery. An article I wrote a couple of years ago discussed this issue in detail. Back in the day, weeks or a month of lag time could perhaps be justifiable, since collecting, verifying and processing paper invoices can take a lot of time. Today, however, with most invoicing and payments occurring electronically, this lag time is unnecessary.

A second point laid out is that an OEM’s credit profile is usually more favorable than that of most members of their supply chain. That should be no surprise to anyone. Over my career, I’ve met with hundreds of small- and medium-sized suppliers, and most weren’t prepared to sustain operations for more than a few weeks or months in the event of a dramatic downturn in business. And guess what? When such downturns negatively impact supplier financials, their line-of-credits often are “called” by their banks or, at a minimum, are reduced.

Most OEMs look to their supply chain for cost reductions, not because their own businesses are in dire straits. Rather, they are looking to maintain their own financials, so that the price of the stock doesn’t drop. After all, you can’t have the primary driver of executive-level bonuses take a hit when there are suppliers to pound on.

Anyway, when OEMs do this, it’s akin to sailors on a sinking ship standing on the shoulders of others in an attempt to save themselves.

What many OEMs that rely primarily on beating down piece-prices in working with suppliers aren’t driving their suppliers to become more lean. Rather, they are driving them to become anorexic to the point where it threatens their ongoing viability.

At some point, these same OEM customers will probably go to the well once too often and not have an effective fallback strategy for getting more value out of their supply chain.

Paul Ericksen is IndustryWeek’s supply chain advisor. He has 40 years of experience in industry, primarily in supply management at two large original equipment manufacturers.