Bloomberg News (Oct 20,2010) reports on a collaboration between Caterpillar and a supplier, Tenneco, to improve the overall manufacturing process, and decrease overall costs by 20 %. The article reports plans by Cat’s CEO to leverage suppliers by decreasing the supply base and increase the level of collaboration and “pull 25 % profit from new dollar sales”. The new Chief Procurement Officer at CAT is Frank Crespo, a veteran in the industry with a background in supply chain collaboration. His goal is to change the culture at CAT to increase collaboration by shrinking the large supply base and improving coordination with the smaller number of key suppliers. Will collaboration create new opportunities for profitability at Cat, like Honda and Toyota ? Or will it create headaches, like Boeing’s recent experience ? Should the goal be set as increasing profits or improving customer service ? Is this article an example of “coordination generated supply chain profits” and is 25 % marginal increase feasible ? Your comments welcome.
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Global Supply Chain Musings 
I have often thought that the biggest potential advantage of having only a few suppliers is that it facilitates collaboration in product/process design. I suspect that this is important for car companies. (and Boeing?). Companies that do all the part designs themselves with little collaboration with supplies have much less potential to gain with respect to reducing supply chain costs.
It seems that, internally, we hear about costs vs. sales (our profitability, or lack thereof), and now our new focus on customers. Your article seems to imply both interests cannot be served @ the same time. The new strategic supplier phenomena is not new @ Cat, and there has been an effort to move in that direction for some time. We also are implementing our PFEP, or Plan for Every Part, implying even a tighter integration within our supply base along with logistics plans for every part, in an effort to optimize our operations. I have been a part of the development team who wrote our new corporate solution for PFEP, which is still in in its infancy, or toddler years. It will be interesting in the years to come to balance our working capital, with reduced inventories, but still servicing unforeseeable swings in demand.
I think that if the products require integration processes for the development, such as an engine and a braking system, it would be a good strategy to select a few customers because the integration process needs a lot of negotiations and a long time for CAT. However, for the commodity products, decreasing the number of the suppliers seems risky because they might lose the chance to get the best prices.
First of all I wanted to point out that Boeing’s issues are not related to supplier base at all, the issue there was more 75% of the dreamliner was outsourced, hence the supply chain even though had less number of supplier for particular parts, the inter-dependencies of these created delays in delivery. In case of caterpillar its quite possible that the administration might be able to save money by making the supply chain more effective, but we should keep in mind that reducing supplier base can cause risk of higher prices. Since CAT itself is removing competition, these fewer supplier might demand premium prices for advance services.
Today, our team went to Caterpillar to communicate our project with Gary Smith, the LEC Supply Chain Manager in Caterpillar corporation. Our project is about the “Rail Intermodal Transportation”. I consider that CAT is trying to develop and explore some area which is strong relate to its manufacture and sales, in order to optimize its operation strategy. The logistics and transportation issues are absolutely important areas in their consideration. As far as I am considered, the Vertical Integration strategy is very important. In some ways, this strategy can secure company’s supply chain flow in an uninterrupted and stable way. For example, if our project works well, it will be an effective way for parts delivery to the facility and an effective way to cut down the cost to Caterpillar.
I believe it is a fair strategy that CAT is developing here: Decreasing the number of suppliers can make sense (lower cost of purchasing through fewer accounts –> decrease in Admin, Headcount, etc. + less complexity). However, decreasing the number of suppliers does not automatically mean that collaboration with the fewer, remaining suppliers goes up without doing anything. Time, money and expertise need to be invested to start/deepen such a collaboration. If CAT manages the collaboration/focus-on-few-strategy wisely then there can be a potential for a cost decrease and consequently a profit increase.
Nevertheless, reaching a profit margin of 25% through this measure seems very optimistic. Currently CAT’s profit margin is at 7%. (Operating Margin 11%, Gross Profit Margin: 28%).
http://ycharts.com/companies/CAT
https://finance.yahoo.com/q/ks?s=CAT
The move of CAT’s “decreasing the supply base and increase the level of collaboration” will only be effective and successful if Caterpillar can actually improve the “Quality” of the supplier base that measured by a clearly defined and well benchmarked KPI(key performance indicator). I agree that it would be good to have a relatively smaller amount of suppliers to save SC management cost but the list of suppliers should not be fixed. There should be always a dynamic flow of suppliers – good suppliers selected into the pool while the ones at the bottom getting ruled out. Thus a well defined KPI and frequent evaluation of suppliers performance is highly important, that would actually be a true game changer instead of simply shirking the suppliers base size.
I believe coordination is key for companies such as Caterpiller because there are two main areas that can generate value. First, once Caterpiller has coordinated with suppliers it can help minimize backlog raw inventory and bullwhip effect issues because of a more efficient supply chain. Second, with coordination, this involves opening the lines of communication with suppliers which could lead to more standardized designs for future product offerings. In the case of Boeing, the relatively low volumes and complexity of design specifications are factors that made coordination a headache. On the other hand, Caterpiller’s volumes are higher which could make coordination a very feasible option.
I was just reading a document on implementing reverse e-auctions for sourcing, and it made me come back to this post to wonder if this would possible/is this what CAT is using currently. If they were to use a e-reverse auction system as opposed to completely reducing the suppliers, maybe it would help them achieve a similar savings? However there is more integration involved with this, and savings are expected to decrease over time. So my stance on this- although it is a good movement towards reducing suppliers, perhaps they can explore other opportunities such as e-auctions for collaboration purposes.
The 25% marginal increase in profit does seem a bit too optimistic and infeasible if reducing the number of suppliers and increasing collaboration with those suppliers is the sole initiative being put in place. While focusing on streamlining their supply chain, Caterpillar must be careful not to let this focus take away from an emphasis on improving the customer experience. A goal of improving the profits through better coordination with select suppliers is a valid pursuit (with a decrease in bullwhip effect, lower ordering costs, and decreased complexity), but if it is not pursued in conjunction with a pursuit of increased sales and customer satisfaction, then this initiative alone will not produce the desired effects.
While collaboration with CAT suppliers has the potential to create opportunities to increase profitability, we need to ask what the magnitude of this collaboration will be/was. Decreasing the supplier base from 9,000 to 6,000 is a huge change which could have negative effects of suppliers demanding higher price premiums. I do not see this option being very likely since Cat has a large supplier base, but it is possible due to potential pushback from now in charge suppliers due to the previous “servant-master” relationship conditions. The suppliers would all have to be working together to demand and receive such premiums. Coordination from supplier to supplier would be very difficult just due to the number of suppliers present. This cut of suppliers could have positive impacts to steady the demand (lessening the bullwhip effect for the upstream suppliers) and increasing ease of design planning. There are so many pieces of this large chain to consider though. Big changes, if not investigated and planned for properly, could just make a mess of the supply chain and only increase confusion and headaches for Cat. Based on the Bloomberb article, I believe that the goal of this large supplier cut was to increase profits and margins. All in all, I think we need to know more information about the extent of this initiative to determine its potential success for Caterpillar. The original article (http://www.bloomberg.com/news/2010-10-20/caterpillar-s-oberhelman-enlists-suppliers-in-targeting-25-profit-margin.html) did make mention of increased coordination with suppliers regarding engineering and quality control, which is a good sign of the thoughtful planning from Cat.
Written a couple of years later, this article may be giving us an idea of the success of the imitative. http://www.chicagobusiness.com/article/20130907/ISSUE01/309079986/is-caterpillar-bullying-its-suppliers
I’m not really sure how Caterpillar plans to pull a 25% increase in profit while also shrinking their supply base. While CAT’s efforts to increase coordination and boost sales for their smaller suppliers are to be applauded, are they risking losing sales just for the sake of cutting costs. While there are certainly costs that can be streamlined, if it’s at the risk of customer service, then it’s not worth it. CAT also needs to make sure they aren’t cutting out quality suppliers.
By decreasing the number of suppliers it has to deal with, Caterpillar could save substantially on negotiation costs and time. If Caterpillar could get all of the components for its engines, machines, and other products from one or just a few suppliers, it could ultimately decrease lead time (and increase customer satisfaction) by reducing the number of companies involved in the production process and solve coordination issues by eliminating some of the middlemen. While a strong relationship with a few suppliers could serve to improve Cat’s coordination and create new opportunities for the company, Cat will have to focus on further developing its relationships with the suppliers it does choose to retain. Without a strong working relationship with suppliers like Tenneco, Cat could be left with even more issues than those it currently faces (such as losing its most important suppliers).
CAT would be able to obtain profit from collaboration with its suppliers if both parties share information about costs to supply and retail prices. As we learned in Supply Chain Management, coordinated supply chain has larger profit than uncoordinated one does. it is uncertain how much profit the coordination earns; however, 25% more profit can be achieved if the supply chain set its priority on customer services. CAT’s profit is shared by the suppliers; thus, if CAT’s profit increases with improved customer services, the suppliers also gains part of the profit. It would give suppliers incentive to improve their supply capability (reduction of cost and lead time, improvement of quality etc.).
The extent of reducing the number of suppliers should be limited to the procurement of products and services that are innovative and proprietary in nature and require extensive collaboration for development. Since coordination is essential for such tasks, CAT can very well invest in developing a long term relationship with a small number of suppliers who are reliable and trustworthy. For mundane activities such as procurement of office supplies, etc., CAT may opt for e-procurement methods as mentioned by Priyanka and others in earlier posts. The fact remains that a higher degree of skilled work needs better partnership with the suppliers whilst commodity purchase does not require long-term partnerships and can be purely based on price and minimum performance benchmarks.
The margins proposed by CAT seem too high, however, in the long run there may be certain investments in time and coordination that may pay off, perhaps a new technology that is jointly developed by CAT with able support from a small gamut of its suppliers which the competitors may take a long time to catch up due to non-disclosure agreements that CAT has in place with its closely coordinated long term suppliers.
By increasing the level of collaboration and reducing the number of suppliers may result in some saving within CAT’s supply chain and procurement, and it sounds like a viable strategy aiming at increase profit. However, collaboration with fewer suppliers will reduce the flexibility compare to larger suppliers based; hypothetically, if the relationship between CAT and its supplier(s) go south, finding new supplier(s) or rebuild the relationship will take both time and money, otherwise the suppliers will become a big bottleneck for CAT’s regular manufacturing process. In order for CAT to successfully pull this plan off, CAT should not just end the relationship with some of the non-key suppliers, but to form periodically evaluation profess for all suppliers; in other words, whoever perform well will remain as the key suppliers; those cannot satisfied CAT, no matter it is quality issue or long lead time or higher price compare to others, will be eliminated for the next period.
In addition, even if CAT can successfully implement the strategy and eliminate the potential negative effects and achieve their original goal- increase profit, 25% sounds way to optimistic.
Definitely coordination wise, this will result in a more efficient negotiation with suppliers, since there will be less people to talk to, and more time dedicated to each so each party knows each other’s needs. Also, if CAT is planning to manage standardize products only, there shouldn’t be any problem having less suppliers, I think small suppliers may be the ones who can actually to specific kind of products, and that what CAT would be losing, but if they do only similar products, then there is no problem, they will have cost savings. Of course it will create headaches at first, every change in processes or management requires adaptation and they will face obstacles, but in a long run, this will benefit everyone.
The 25% increase in profit is fairly possible by performing coordination with suppliers but in that case CAT has to invest in building small suppliers capabilities and CAT team has to prepare a strong long term contracts with these small suppliers that they will not switch after earning a stable growth. Also CAT has to identify suitable number of suppliers so that their capacity cannot become a bottleneck for CAT products and services. CAT can encourage these suppliers by signing Take-or-Pay Contracts in which CAT can pay some salvage value for left over unused raw material. ITC in India has done a tremendous job by initiating e-choupal with farmers to procure quality wheat and grain directly from them. This was ITC is able to keep better control of the sourcing and by paying fair price to farmers establishing a good long term relationship with them.
To reduce a supplier base is sometimes a double-edged sword. It can truly reduce the costs of operation and generate profits by increasing the collaboration with specific key suppliers. And also the long-term and deep partner relationship can let the whole supply chain run more smoothly. However, the stability and quality of the suppliers must be taken into account, a smaller supplier base means CAT might not have so much space and time to deal with an emergency problem, if a quality problem of the suppliers’ products really happens and the CAT cannot find the alternative supplier in time due to the limited supplier base, that will be a great loss of profit and reputation.
I always think collaboration will help companies to achieve more goals (both money-wise and social effect-wise). Use Caterpillar and Subaru as examples, they are both implementing JIT (just-in-time) for their supplies. The advantage of implementing JIT are few storage space required, less hold inventory and less warehouse management administration costs. Being able to implement JIT, companies have to work closely with their suppliers to arrange the schedule and amount to co-response to their production plan. The bigger company is, the larger potential opportunities but also more difficulties to overcome. Such as for Subaru, many of supplies are coming from Japan so the lead time and supplies damages could be unpredictable variations. Sometime, those variations are out-of control no matter how closely companies are working with their suppliers. Let us the Caterpillar facility around campus as an example, Caterpillar outsource its warehouse to a local logistics company and in the Caterpillar facility you only can find the parts or supplies for today’s production. Caterpillar works very closely with this logistics company (the logistics company even has Caterpillar logo on their building but they are actually different companies) and Caterpillar is the company’s only customer. After outsourcing the warehouse, local Caterpillar actually saved a fortune but too bad I don’t know if that local Caterpillar increased 25% of sales margins.