Since I conducted research on manufacturing in the US Midwest in the early aughts, I’ve kept in contact with a few of my informants. One of them, Paul D. Ericksen, has 38 years of experience working in procurement and supply management, primarily in two household-name, multinational manufacturing corporations. Ericksen has been writing a blog on Next Generation Supply Management at IndustryWeek since April 2014, and I’ve been keenly following it.
The Ericksen blog is an object lesson in how wide the gulf is between the everyday problems facing manufacturing managers in the real world and the way academics represent management within mainstream management theory. By mainstream management theory, I have in mind the economistic literature based on assumptions that individuals are rational maximizers and markets are inherently efficient (as opposed to the sociological literature, which emphasizes how cultural institutions and power relations in the real world systematically undermine the maximization of efficiency).
Ericksen worked with many hundreds, perhaps thousands of factories that supplied parts and subassemblies to the Fortune 500 companies he worked for. Based on this experience, he highlights a number of ways in which deeply embedded forms of culture and power, in both the multinational corporate brands (prime contractors) and their suppliers (subcontractors), generate and sustain systematic inefficiencies in their organizations. (For academic studies that document and triangulate such outcomes with the views of other informants, see my colleague Josh Whitford’s book on the decentralization of American manufacturing, as well as my own study of routine inefficiency in factories.)
Supply chain management is now big business. Academics celebrate long-term relations between prime contractors and their subs as network ties that increase efficiency over traditional forms of vertical integration or arm’s length subcontracting. Yet, according to Ericksen, attempts to develop long-term forms of relational contracting – ongoing network-style relations rather than arm’s length contracting – are routinely undermined by clashes of power and culture within organizations.
Ericksen discusses a number of ways in which such power clashes and cultural forces within prime contractors systematically generate inefficient outcomes, and he offers a proposed solution for each case. While his solutions are sound – and I encourage industry leaders and manufacturing managers to read them carefully – I want to emphasize here the systematic nature of the problems, with a view to highlighting how far away the pristine free markets and simple maximizing principles of economics are from the real world of operations management.
Erickson highlights power struggles over the appropriate authority hierarchy within multinational prime contractors. The worst situation for supply management is when the procurement department reports to the finance department, where an obsessive focus on piece-price reduction (in the guise of material variance analysis) undermines supplier management concerns with quality, delivery and overall supplier capability (more on this below).
Alternatively, in some multinational prime contractors, procurement reports to engineering. Although the latter will be concerned with product quality, they typically will not share other supplier management considerations, such as whether a given supplier picked based on criteria important to engineering is “financially viable? Further, does it have the manufacturing wherewithal to transition its prototyping capability to a production basis in support of forecast order fulfilment needs?” Similarly, procurement might report to manufacturing, but the latter will focus on internal constraints, without regard for supplier capability.
Ericksen’s solution is for procurement to be given equal status to the other departments, and for supply management to have control over the entire value stream because it “has the best visibility to all bottlenecks—whether internal or external—and, correspondingly, can put together a schedule that can both maximize alignment with demand and minimize waste.” Yet, in most multinational prime contractors, procurement continues to play a traditional, subordinate role in the overall firm hierarchy, due the entrenched positions of the more powerful departments.
In another post, Ericksen tells a story of what happened when he was a supply chain manager reporting to engineering. During a peak production period, he received and rejected a design change request (and scheduled it for a later slow production period) because it would risk disrupting production. Yet, he was forced by engineering to accept the change, which saved $13,000 over the period. In order to facilitate this, Ericksen had to send in his own engineers to assist supervising a third shift that a supplier required to immediately make the newly designed product in order to ensure continuity of production. The out-of-pocket costs to the procurement department (airline tickets, car rentals and lodging) to solve the problem were $20,000, while additional costs of pulling these engineers off their existing projects were estimated to be another $30,000. Engineering made some profit, but the corporation as whole lost out.
In some cases such intra-organizational struggles are purely about protecting turf and maintaining positions of power, but in many cases they are rooted in deeper, cultural divisions. Sociologists have emphasized there is no single logic of economic rationality, but many competing institutional logics – ways of thinking about the world and associated strategies for action. Competing logics become embedded in professional socialization (e.g. engineering vs accounting), as we have seen above. Additionally, competing logics may be dominant in particular institutional periods within the evolution of an economy (e.g. from a corporate focus on vertical integration to product differentiation to shareholder value).
Thus, traditional procurement metrics of cost, quality and delivery are a form of cultural logic that continues to be widespread, despite the fact that they systematically undermine the upgrading of supplier capability, because these metrics don’t address internal suppler performance. As Ericksen explains, suppliers can easily game these metrics by intensively sorting to ensure quality (rather than building quality in through lean manufacturing), build stocks of inventory to ensure on-time delivery (rather than being lean) and cut their own margins in order to “buy the business.”
Similarly, a traditional approach (a cultural logic) which is still widely practiced is for prime contractors to demand annual price reductions of all suppliers, across-the-board. Yet, this approach fails to take into account the fact that some suppliers are far leaner than others, meaning that they have less “available waste” to eliminate. This means that demanding annual price reductions of the leanest suppliers may, counterproductively, make them cut their own margins in order to maintain the business, making them less able to make future investments in process and product improvement.
Finally, returning to where we began, Ericksen laments the ongoing struggle within multinational prime contractors over whether the emphasis should be on demanding piece price reductions by any means versus providing direct supplier development to improve supplier process. He discusses a case where he was able to run a supplier development project to lean up a supplier by offering direct assistance, teaching it how to reduce its product lead times. The outcome was that the supplier “was able to reduce need for $890 million in finished goods inventory yet maintain targeted customer fill rates,” resulting in “an annual recurring savings of $107 million!” This amount was orders of magnitude higher than the costs reduced through traditional piece-price reduction, yet the accounting “attitude,” or cultural logic, that “the role of purchasing is simply to ‘go shopping’ for the lowest price,” continues to dominate corporate America.
As a result, supplier development programs by American multinational prime contractors are few and far between, meanwhile, Japanese multinational primes have a long history of providing their suppliers with direct assistance.
The upshot is that “profit maximization” does not necessarily translate into “efficiency maximization.” In particular, maximizing short-term profit often generates mid-term inefficiencies. And it’s not just a matter of eliminating perverse incentives – as the mainstream analysis would have it – but of competing cultural logics and power positions. Ericksen offers a number of promising ways to address the issues he raises – for those who are willing to listen. Unfortunately, given entrenched cultural understandings and power relations, reason and evidence are not always going to win the day.