Rethinking the supply market for complex mechanical parts

Leopoldo Romagnoli- 2016 Final-1

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Forget Goliath, says Leopoldo Romagnoli. It’s David you need to worry about.

One of the biggest procurement challenges engineering companies face is the ability to re-tender the sourcing of complex mechanical parts. Essential to the business, the technical specifications for these components is commonly managed by external suppliers and rarely shared with the client. They can be the smallest parts of the largest machines. Sometimes design drawings are outdated, of poor quality and, even worse, the intellectual property of the vendors. In many cases they are bespoke to the job and not of a common specification.

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When a large share of the overall procurement spend goes towards these engineered to order (ETO) parts developed exclusively for the client, it is very difficult for the company to address this cost and attempt to reduce it. They are also at a disadvantage when attempting to cut costs for these direct components. Often finding themselves little fish in a large pond with very limited bargaining power when they are dealing with large multinational parts manufacturers who hold a monopoly in their particular market.

A further complication is because drawings and specifications have been developed by one vendor over time it is likely that these specifications and the level of design complexity has risen making it virtually impossible to replicate in the open market.

A new way of thinking is needed, one which circumvents a potentially incestuous supply market. The constant movement of engineers and sales reps from one vendor to the other can negatively impact negotiations due to the high risk of collusion between suppliers, as well as a risk suppliers are themselves not willing to participate in competitive events. So what can be done?

It is critical to gain the buy-in of your engineers and sales and marketing department from the outset. Get them on side early on, and the implementation of a new way of working will be much smoother. Once this is done, select the most relevant parts in terms of spend and reverse-engineer specifications and operating conditions to be able to send them out to market for quote. This is the most engineering intensive element of the project.

Once the component has been decided on, create an internal design specification for the particular part by bringing together your in-house engineers and at least two small original engineering manufacturers (OEMs) with strong engineering capabilities. Run meetings between these in-house engineers and supplier engineers to align the demand with the technical proposal/design response given by the suppliers.

This brings ownership and control of the final design back in-house and bypasses the difficultly of creating a competitive scenario because only one vendor has the design. Also, having a small OEM producing the part implies the possibility of capturing the aftermarket business, an attractive proposition for vendors who earn most of their profit from retrofitting (repair kits and spare parts). This is the famous “Gillette” business model, where the first part is sold at break-even (razor handle and blade) while the following parts (pack of replacement razors) are sold at a large margin.

Finally involve large manufacturers (mostly incumbents) and invite them to bid on the client-proprietary specifications, thus allowing them to demonstrate their willingness to manufacture the parts in-house.

The implementation of parts from the small OEM will require significant validation and testing. Therefore, it is worth employing a short-term strategy where the large incumbent supplier is kept as the ‘preferred’ supplier and slowly include the small OEM in the mix as soon as their parts are tested and approved.

The strategy outlined above can be used to stimulate negotiations with all key manufacturers and achieve significant savings. This is a two part saving, as there will also be significant cost reductions on the parts manufactured by the small OEM. If the company decides to add the proprietary sales, for example those made from the small OEM into their product offering over the long term, then these savings can be built on over the medium to long term and result in an increase in revenue. By taking care of David, Goliath is much easier to bring into line.

 Leopoldo Romagnoli is a senior consultant with business management consultancy Efficio