Development of the Business Relation LARGE SCALE CUSTOMER : small scale supplier

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1 Development of the Business Relation LARGE SCALE CUSTOMER : small scale supplier what can Swedish forestry learn? Anna Furness-Lindén Engineering Logistics Department of Industrial Management and Logistics Faculty of Engineering, LTH Lund University, Sweden This paper is an abstract and a short version of a master thesis written in fall 2005/spring 2006 at the University of Lund, Sweden. Swedish forestry need to upgrade the productivity and efficiency of logging operations. Today, logging is performed by a vast number of small entrepreneurs working for a couple of large scale timber organisations. The purpose of the study is to identify key elements for efficiency and production improvement in the business relation of the large scale customer and the small scale supplier at companies outside of the forestry sector. The study has been carried out on commission by Skogforsk, the Forestry Research Institute of Sweden. The full text version of the thesis is to find at Skogforsk and at the Division of Engineering Logistics, Faculty of Engineering, LTH. Introduction There are several companies and lines of business where there for decades has been a focus on disciplines of business development and strategic purchasing. In general, the forestry sector needs to make better use of this and try to learn from those business experiences already made, regardless of branch. To show that this can be done is also an underlying purpose of the study approach. The explicit purpose of the study however, is to gather and evaluate successful business concepts and strategies that large scale, non-forestry related customers use when managing their smaller suppliers. Over a relatively short period of time, the forestry in Sweden has transformed structurally. Most people that used to be on the permanent staff of logging are now entrepreneurs, offering logging services to their former employers. Measures for development and continuously improved productivity are therefore now depending on individually operating entrepreneurs. Logging costs of Swedish forestry amount to 6 billions SEK on a yearly base and logging is the one dominant expense when round wood reach processing industry. Furthermore, the fact that the large scale forestry companies are dominant compared to the small scale entrepreneurs lead to a situation where the customers to a larger extent can dictate the rules of the market and the way to undertake business on the same. Above described situation pared with a more intense overall competition addresses the need to carefully evaluate if - and how - large scale customers of logging services can act to create incentive for continuous improvement of the single entrepreneur. And - thereby stimulate to a more efficient market of logging. 1

2 Mode of Procedure The four large scale customer companies chosen for the study - IKEA, Skanska, Scania and Toyota all have an explicit focus on supplier development and efficient business relations and are also known as leading in the field. Moreover they represent several different lines of business and production practice. Each company is represented of a person with good insights, experience and understanding of strategies for supplier handling. Data is also gathered in order to describe and fully understand the specific features and characteristics of the forestry of Sweden by interviewing several supplier and customer representatives. The empirical work is carried out in qualitative interviews. Theory With every business transaction comes a business relation. A business transaction is built up of a couple of characteristic elements such as a product, a market and two or more transaction actors. Together, the features of these components roughly define the conditions for the business relation. Therefore, it might be a good idea to take some time to reflect over these basics before mapping out a business relation strategy. The product, the basic component around which the transaction is carried out, is usually defined as a goods or a service or, which is the most common case, as a combination of these. A product also varies in complexity as the model of the extended product below illustrates. Extended Product Expected Product Basic Product Basic Utility Figure 1 The Model of the Extended Product 12 1 Jakobsson, P., Bättre affärer, bättre kommunikation, Cowboy Communications AB, Västerås Extended product A place to stay Basic utility rest Basic product a bed Expected product sheets, a lamp, a shower, a towel Extended product cable-tv, swimming pool, sauna, pool hall, a bar, laundry service Figure 2 The Extended Product an example 3 It is important that the two actors have the same idea of what the product looks like, and on what conditions it should be priced (is the product a bed in a hostel or a luxury, all inclusive overnight stay?). The features of the market are often discussed in relation to a point zero called the perfect market 4. In that scenario all actors have the same information, nobody can set a price, neither the buyers nor the sellers, and every single one actor can enter or leave the market without noticeable hindering transaction costs. Even though the perfect market doesn t exist, it functions as a model to bench mark against and the closer to the perfect market, the more actors can rely on the market forces to set the rules of the transaction. As mentioned, the characteristics of the product and the market set important prerequisites for the business relation. Historically, the business relations were, if at all reflected upon, considered irrelevant output that naturally occurs when a transaction is carried out. However, as Peter Kraljic and many people after him argue, good and well managed supplier relationships are valuable and customers ought to strategically optimize a "supplier relationship portfolio" the same way they handle other valuable assets of the company 5. To be able to do so, the 2 Personal comment, Lennstrand, Personal comment, Lennstrand, Mankiw, N.G., Principles of macroeconomics. The Dryden Press, USA 5 Kraljic, P., Purchasing Must Become Supply Management, Harvard Business Review nr , s

3 business relations need to be evaluated and categorized in systematic ways. Furthermore, they need to be chosen and handled in a way that optimizes the overall relationship portfolio and hence the purpose of the business. Some suggests three categories of relationships, below named A, B and C. A B C Figure 3 Kraljic and others argue that the customers need to strategically handle and optimize a "supplier relationship portfolio" the same way they already handle other valuable assets of the company. Some suggests three types of relations, here named A, B and C. The relationships of type A are far reaching, long term partnerships where the customer and the supplier work closely together and share a large amount of information and strategic tasks like product development. The product is very much an extended product and a competitive price is only one of several factors that together set the value of the final product. The C-type relations on the other hand are impersonal, discrete "catalogue" purchasing decisions with no or little factors to consider and evaluate other than a standardized product and a competitive price. Regarding and analysing the business relation a bit further, and doing it from the customers point of view, two main ways of handling suppliers can be sketched out. The first one, the classical way to handle small scale suppliers is characterized by: Customer and supplier competition. Competition is about the margin of profit of the supply chain. A relation based on a felt win-lose situation; one will win on expense of the other. Each part respectively tries to minimize the others' strengths. The overall risk of this approach is that the large scale, more dominant customer will impoverish the market of suppliers 6. The small scale suppliers are put under continuous price pressure leading to diminishing margins of profit and truncated investments in development. This type of relation creates a minimum of incentives for efficiency and efforts of continuous improvement 7 8. During the eighties, influenced by the Japanese production philosophy, another way of considering the business relation between supplier and customer was formed 9. This "new" approach is in short summarized below 10 : Customer and supplier are involved in a more or less tight partnership relation. The relation is based on a win-win situation; both parts need to benefit from the arrangement. The business actors together try to strengthen the competitiveness of the supply chain as a whole, maximize the overall profit and thereby create better margins for both. The latter approach makes it obvious that it is in the interest of the customer to contribute to the competitiveness of the supplier and vice versa. The approach is to some extent the very key to the ideas of cooperation, process optimization and supply chain management Mattsson, S-A Logistik i försörjningskedjor, 7 Ibid. 8 Burt, D., Managing Suppliers Up to Speed, Harvard 9 Ibid. 10 Mattsson, S-A Logistik i försörjningskedjor, 11 Grönroos, C., Service management och marknadsföring, en CRM-ansats, Liber AB, Stockholm 12 Mattsson, S-A Logistik i försörjningskedjor, 13 Burt, D., Managing Suppliers Up to Speed, Harvard 3

4 Empirical findings Three of the four companies have experienced a situation similar to the one that Swedish forestry is facing; too high production costs, lack of flexibility, poor profitability of the entrepreneurs and generally bad use of skills and expertise represented. There was a unanimous opinion that the traditional way to do business just wasn t efficient enough and there was also a similar way to look at the solution to the problem; all four today use concepts of process optimization, cooperation and put a focus on the business relation itself. By doing so, they all claim to improve the traded product, sometimes to a level that maybe could be defined as "the Potential Product". Potential product? Figure 4 The Potential Product This "potential product" goes beyond any level of the Extended Product and the very definition is that it cannot be created without the cooperation and communication of the two market actors. The Potential Product could therefore be said to be the "key" to the hidden and captured efficiency potentials that are clearly spotted and identified, but hard to reach in the traditional business relation between large scale customer and small scale supplier. The companies studied all have acknowledged the portfolio theory and the idea of strategic handling of business relations first presented by Kraljic. They all distinguish carefully between different types of relationships and supplier categories and hence manage them differently in thought through manners. Their work with strategic purchasing is overall highly professional. Summing up, a couple of common features and underlying beliefs can be defined; drive Strategic and professional purchasing Understanding of the proper "tools" to handle and make use of the market forces and features End consumer perspective throughout the whole supply chain what is the end consumer actually paying for? A proper understanding of the traded product and its full value Honest belief in improved efficiency by close relations and cooperation with suppliers Clearly formulated business contracts and stated areas of responsibility of the involved business actors Belief in satisfying pay back on investments in supplier support and development When it comes to the latter, the "hands on" support and creation of supplier incentives for efficiency improvement, David Burt (1989) concludes the basic reasoning of the new approach that follows the path of process optimization and cooperation 14 ; "Big companies have no choice but to make supplier partnerships work. The cost of maintaining suppliers' profits and technological progress are a burden. But if big companies inadvertently beat their suppliers into submission, they will have to face the much bigger burden of managing their suppliers themselves." There are several measures to undertake when supporting the suppliers. Generally, they depend on above described supplier classification and engagement costs and are carefully selected and adjusted according to this. The support vary from pure development support teams assisting the supplier, competitions and study visits, to training and business education offers and complex joint ventures. 14 Burt, D., Managing Suppliers Up to Speed, Harvard 4

5 Today, the business method of tendering is being introduced in Swedish forestry. Tendering is a business method that clearly needs to rely on functioning market forces and healthy and fair market competition. In other words, tendering is to a large extent a method to handle the "C-type" business relations. Some reasons for the new tendering approach are good and serving a purpose but one should keep in mind the characteristics of the market and the product. There might be a risk involved with this new practice. As mentioned, the customer is in most cases a very dominant business partner, setting most of the rules of the transaction. The entrepreneurs are most often small and very locally oriented and have close, not seldom personal relations with the local customer representatives and the rest of the business network in the area. A great deal of the value of the product is hence good local knowledge of the logging conditions and the logging sites combined with a web of valuable contacts. Moreover, the investment costs are high; a harvester and a forwarder, the basic machinery needed to log, costs around 5-7 million SEK. Conditions like these might indicate that the market forces are not totally capable of setting optimal rules for the transaction. The small entrepreneurs might need to be sent signals of relations where the customer is willing to invest time and energy into a more long term relationship. These relationships are preferably built on mutual communication and optimization and efficiency as a common task. To sum up, the customers might need to signal an intention to create A- and B-type of business relations. Else, the situation that the small scale supplier faces might appear too risky. This will possibly lead to diminishing resource allocation and failing focus for overall development. Figure 5 The customers might need to signal willingness to involve and invest in more sophisticated relations (A- and B-types) in order to attract the "right clientele" of suppliers. Summing up Swedish forestry needs to work intensively with productivity and efficiency improvements throughout the whole supply chain. Logging is a dominant element of this chain and is today performed entirely by small scale entrepreneurs. The problems of the entrepreneurs are also the problems of the customer and vice versa. It seems to be more important than ever before to carefully evaluate, correctly price and finally choose the right logging entrepreneurs and also to pamper, not totally cut out, the forestry tradition of close relations. By doing so, there should be a good chance to short cut the counterproductive development experienced by the studied companies. However, by not doing so, there is a virtual risk that the branch at this very moment is losing the entrepreneurs that Swedish forestry of tomorrow are the most dependent on; the ones that are interested in business and development in professional settings and hence if they are not paid for their products and their work of development will leave the business. A B C 5