Deep supplier relationships drive automakers' success

Building deep supplier relationships is a key facet of success for Japanese automakers Honda and Toyota. Through a supplier-partnering hierarchy, the two companies work with suppliers to reduce costs, increase efficiencies, and maximize market share. One ASU professor has spent his career studying the auto giants, and reveals what's behind their revolutionary practices. He found that the Japanese take care to cultivate relationships with their suppliers, integrating a "tough love" approach of high standards and demanding requirements. Driving this philosophy is their belief that the suppliers' success is absolutely crucial to their own.

In a field known for contentious manufacturer/supplier relationships, automotive giants Toyota and Honda have bucked the trend, leading the way in championing supplier relationships that go beyond just price. The Japanese concept of keiretsu, a close-knit network of vendors that continuously learn, improve, and prosper along with their parent companies, is the underlying strategy behind Honda and Toyota's supplier relationships.

Other auto manufacturers — including the American heavyweights in Detroit — have failed miserably at attempts to establish similar practices. What's the secret to Toyota and Honda's success?

Thomas Choi, professor of supply chain management at the W. P. Carey School of Business at ASU, has spent the last two decades finding out. The simple answer is Honda and Toyota have turned arms-length relationships with suppliers into close partnerships, bringing increased efficiencies to both parties, says Choi. The complex part is making that happen.

"Relationship-building is often overlooked as too mushy. Companies say, 'Why are you holding the supplier's hand? Why are you being so benevolent?'" says Choi. "But having a strong relationship with your suppliers actually has good, hard, solid business results." For Toyota and Honda, those results include faster production times than the majority of their U.S. competitors — they design new cars in just 12 to 18 months compared to the industry norm of two to three years. The automakers also reduced manufacturing costs on the Camry and the Accord, respectively — two of the three top-selling cars in the U.S. — by 25 percent in the 1990s, while still scoring top spots on the JD Powers customer satisfaction surveys.

The supplier revolution

This, of course, is key; Dr. Phil fans aside, C-title executives are usually more interested in return on investment than relationships ­— which is often the reason they are using suppliers in the first place. During the last 10 to 15 years, the increased downsizing trend coupled with the spread of a truly global economy has led more and more companies to lean on suppliers to gain competitive edge. Outsourcing manufacturing operations to suppliers — when done successfully — can help businesses increase profit, time-to-market, and customer satisfaction, while decreasing costs and keeping up with consumer demand.

For Honda and Toyota, in particular, suppliers have been key to their innovation and success. Indeed, the two companies source about 70 to 80 percent of their manufacturing costs from outside suppliers. And suppliers return the favor: For example, many of the cost-cutting ideas that made Accord and Camry so successful came from suppliers, reports Choi.

Of course, with such great reliance on suppliers comes a great need to manage and build relationships with those suppliers and that is where the two Japanese automakers far outpace their American rivals. Though keiretsu was briefly in vogue with American business in the 1980s, its prominence was short-lived. "American companies decided the immediate benefits of low-wage costs outweighed the benefits of investing in relationships," says Choi.

It might be fair to assume the "cheaper, faster, better" American culture makes the concept of building deep supplier relationships alien to our way of conducting business. But Choi is quick to challenge that. Company culture, he says, is far more important.

One need only look to the New United Motor Manufacturing Inc. (NUMMI) facility in Freemont, Calif., as an example, he says. The former GM facility suffered from labor management problems that threatened its existence when Toyota executives offered to revive the plant. Using the same facilities, equipment, and workers, Toyota implemented a keiretsu system with American managers and workers, with astounding success. Today, NUMMI is a Toyota/GM joint venture, and the manufacturing site for successful vehicles such as Toyota Corolla, Chevrolet Geo Prizm, and Toyota Takoma.

"Toyota proved that company culture matters," says Choi. "A lot of Honda and Toyota's good supplier-relationship practices can be transferred to American companies."

It's all about diligence

That is the good news for companies seeking to improve supplier relationships. The bad news? "If I were to summarize the key to building deep supplier relationships in one word, it would be 'diligence,'" says Choi. A quick fix it is not.

Choi's findings — gleaned from interviews with more than 50 Toyota and Honda managers in Japan and the United States, as well as more than 40 of Honda and Toyota's North American automotive suppliers — show six best practices the two companies utilize to develop deep supplier relationships. Toyota and Honda succeed by combining these elements together to form a supplier-partnering hierarchy.

• Conduct joint improvement activities
• Share information intensively, but selectively
• Develop suppliers' technical capabilities
• Supervise suppliers
• Turn supplier rivalry into opportunity
• Understand how suppliers work

Theirs is a "tough love" approach, with high standards and demanding requirements. It is tempered, however, by their belief that the supplier's success is absolutely crucial to their own.

Toyota and Honda's supply base cuts across different tiers — first-tier suppliers work with smaller, lower-tier suppliers to manufacture components according to Honda's specifications. Having multiple layers protects the automakers from supply chain exceptions, and provides depth and stability. American manufacturers often have more flexibility since they typically use dozens of suppliers, but they are burdened with higher administrative costs, and no time to devote to relationship building, explains Choi.

A closer look at the practices in the supplier-partnering hierarchy shows Toyota and Honda's dedication to forming deep supplier relationships — and the diligence it takes to manage them. Exchanging best practices, sharing information, honing innovation, and learning how suppliers work are all crucial parts of their process.

Target pricing, for example, is a constant gripe between manufacturers and suppliers, who often feel overburdened trying to meet manufacturers' constant cost reductions. Not so with Toyota and Honda. "When it comes to target pricing, Honda and Toyota do their homework," explains Choi.

"They know what price the market can bear and they work backward, breaking down the cost one piece at a time. They also have a good idea about the suppliers' capability — can they meet this cost and still make money?" For worthy suppliers who cannot meet target prices, the automakers set up pricing schedules, giving suppliers three years, for example, to reduce the price of an item from $15 to $10.

Suppliers agree to this because they have faith the automakers will help them achieve the target prices, while making their own manufacturing prices leaner and more competitive.

When working with suppliers to develop technology, Toyota creates a guest engineer program — suppliers send engineers to Toyota's facilities to work alongside its own engineers for two or three years. This extensive training allows suppliers to fully integrate with the manufacturers' processes, and eventually, develop design ideas of their own. In addition, the experience makes the suppliers more technologically advanced, and increases their value to Toyota.

Toyota doesn't seem worried about the intellectual property these engineers carry with them after they leave. The company views its supplier relationship practices as "a competitive advantage that cannot easily be replicated in the marketplace," says Choi.

And the office swapping goes both ways. Honda, reports Choi, often sends its engineers — and occasionally its senior executives — to suppliers' facilities to study their operations and cultures.

Extensive measuring systems — a common best practice among world-class supply chains — keep Honda's suppliers in check. Monthly reports measuring quality, delivery, and incident reports communicate performance to suppliers. When issues do arise, Honda expects senior management to be involved in resolution, says Choi. Staying on top of supplier performance protects Honda's long-term investment in the supplier, and helps suppliers benchmark their quality and develop new capabilities.

There are, of course, some downsides to developing such deep supplier relationships. Investing vast amounts of time and money in supplier development makes switching suppliers somewhat prohibitive. Honda for example, worked with one supplier for three years to help them perfect the technology for a specific wood grain console before cutting the supplier loose when it couldn't get it right.

"Clearly, switching costs go up with these types of supplier relationships, and there is a risk involved. You have to live with that," says Choi. But suppliers control more in terms of cost, quality, and delivering goods to the marketplace than ever before, and the payoff for manufacturers is worth it, he believes. "You may loose some flexibility as a company, but what you gain in return is far greater," he says.

By helping suppliers better themselves in the process of meeting their exacting standards, Toyota and Honda create mutually beneficial relationships that allow them to get what they need from suppliers without "beating them with a big stick," says Choi. While American auto manufacturers have yet to find a way to do the same, Toyota and Honda's remarkable success with keiretsu has piqued much interest in the manufacturing world. And Choi expects the trend to continue.

"Having a good relationship with suppliers pays the rent," he explains. What executive can argue with that?