Thursday, January 27, 2011

Pre-qualification: The 3 Dimensions of Prequalification

When many Buyers do pre-qualifications, the pre-qualification is focused on the ability of the Suppler to perform the work. Do they have the necessary finances, technology, capacity, quality, design and support structures? Pre-qualification is important to help manage against problems that occur if you select the wrong Supplier for the job. What Buyers miss is the fact that the pre-qualifications, especially pre-qualifications of Suppliers for long term buying relationships, should be three-dimensional. It’s important to make sure that the Supplier is qualified to perform the work or provide the product, but it’s equally important to evaluate the Supplier from a cost perspective and evaluate the Supplier, what the supplier does, and how they do it, for future use in your negotiations.

Here are a number of factors that you would consider from a traditional qualification view, and some examples have been added of how the same item should be looked at from a cost and negotiation perspective:


The traditional view: Do they have the financial resources necessary to perform the work?

The cost view: With their financials, what do we believe is their cost of money? How burdened are they with things like debt and depreciation expenses? Will that impact their ability to reduce costs further? Can they make further capital investments to reduce cost? How competitive are each of the individual elements of their cost structure?

The negotiation view: By looking at their financials, can I see how important things like cash flow and payment are to them, so I can use that in negotiations to get higher value concessions that may reduce my total cost? . Look for critical financial factors that will help negotiate items that are critical to them. For example, if cash is a problem for them, use cash flow issues to get you a better deal. If they have a surplus of cash or low value of money, use that to get them to provide you with low cost financing by extended payment terms, carrying of inventory, etc.

Design Capability and Tools:

The traditional view: Do they have the capability to design what I need today and in the near future?

The cost view: Do they re-use a substantial amount of their designs to reduce their design cost and investment in new products, new equipment, and new tools or tooling? Do they create products of standard building blocks that can reduce design time, costs, and drive materials standardization for lower materials products?  Based on the designs, what type of opportunity is there to reduce cost?

The negotiation view: The degree of standardization will impact their ability to drive further cost reductions. If they don’t have standard approaches that they can use to lower materials costs, how do I get them to reduce cost? Should we be dealing with a different supplier who can provide that? 

The traditional view: Does their design meet our requirement?

The cost view: Does their design use standard or custom parts? Is the design easy to manufacture so costs of production can be reduced. Does the design allow use of automation versus substantial labor assembly? Does the design allow easy service?
The negotiation view:  The more they use custom parts, the greater the exposure
I’ll have in the event of cancellations or engineering changes, so increased attention needs to be given to negotiating those liabilities. Will the design impact my total cost or life cycle cost? If it does, can I use that to leverage a lower purchase price? For example, if the design drives a higher life cycle cost because the product is more difficult to service and maintain because of the design, can I use those higher life cycle costs to negotiate a reduction in the purchase price?

Production equipment:

The traditional view: Is the equipment capable of producing high quality products in the volumes required?

The cost view: Does the production equipment allow for the lowest cost manufacture with a minimal amount of hand assembly work? Are their costs driven into their process because of the type of equipment they use such as additional labor costs because of the operator involvement? The more their equipment creates costs you can’t avoid, the less likely you are to reduce the assembly cost.

The negotiation view:  If there are shortcomings or limitations with their equipment, how can I use that against them in the negotiation? Can I force them to agree to price benchmarks against suppliers with more efficient equipment so they must make reductions in other areas to be competitive?

Production capacity:

The traditional view: Does the supplier have enough capacity to meet our needs?

The cost view: Is the production capacity being managed in a manner where they are running close to full capacity thereby being able to spread their allocations over a broader base?

The negotiation view: What is the level of usage of the equipment and does that provide me with leverage to negotiate a better price if it shows that they have excess capacity?

Quality Management systems:

The traditional view: Are they managing production in a manner that consistently produces quality products?

The cost view: Are they efficient in producing those products or are their costs being burdened with high degrees of checking, re-work, returns etc.? If they have high degrees of checking, re-work, returns, what is the likelihood they can reduce them as they impact cost? Can I build price or yield parameter in that provides me with reductions to cost and forces them to bear the cost of there failure to make any changes needed to improve quality and reduce quality costs?

The negotiation view: Based upon what I see, what do I need to build into my agreement to ensure that all the costs associated with their shortcomings in quality are borne by the supplier and not passed on to the Buyer.



The traditional view: How is the re-work process managed?

The cost view: What is the extent of the amount of re-work being performed and what is the cost impact of that degree of re-work?

The negotiation view: If we see substantial amount of re-work being done which will burden the cost of the product, can we force a price benchmarking requirement so they must compete against suppliers who have little re-work, so they either need to clean up the problem or find other ways to reduce costs in other areas to remain competitive? If there is substantial re-work there is also a higher probability that some quality problems will slip through. What do I need to add to my agreement to ensure that if there are those problems I can recover all my costs associated with them?


Customer Warranty Returns

The traditional view: Do they have an efficient process for managing customer returns?

The cost view: What is the level of the returns and what impact does that have on their costs? Are the returns based on quality problems with production, design problems or reliability problems of the materials? Depending upon the root cause problem, it will impact the ability to reduce the cost and the timing. E.g. design related problems may not get fixed until the next generation.

The negotiation view: With the level of returns seen, what can we include which drives all the cost of those returns back to the supplier so they need to correct the problems? Should we require commitments to performance so depending upon the degree of the problem the supplier assumes increasingly greater costs if the problems increase? Do I need longer warranty periods to alleviate costs of field failures? If they have high warranty returns should we even be considering this supplier as that will impact our warranty costs, the frequency of service calls, and any profit we make for providing post warranty service or maintenance contracts?  There price is low but their life cycle cost is high.


Maintenance and Field Service

The traditional view: Do they have the necessary infrastructure to provide maintenance and field service needs on a cost competitive basis which meets our customers needs?

The cost view: How competitive are their costs to provide these types of services and what impact will that have on both the pricing for any maintenance agreements we may offer and the types of margins we can expect?   

The negotiation view: If we are going to provide long term support and maintenance of these products for our customers, how do I use the leverage I have now to get the best deal I can get for the life cycle of the product?


Materials / Logistics systems / Supply Chain Management

The traditional view: Do they have a materials / logistics / system and supply chain that will provide predictable deliveries and response to our flexibility needs

The cost view: Is there supply chain the most efficient it can be in terms of where operations are performed, inventories are held, etc.

The negotiation view: Is there opportunity to reduce cost within their supply chain and how can I use that to establish price reductions over time which forces them to either make their supply chain more efficient or reduce the cost of the product elsewhere.


Who are their Suppliers?

The traditional view: Is their supply base representative of the type of quality and requirement we want?

The cost view: Is the nature of their supply base cost competitive or do they use many of the higher end suppliers which will impact the cost and the ability to generate cost reductions?

The negotiation view: If they use higher end suppliers, can I work with them to have them qualify more competitive suppliers to reduce the cost? If they use lower end suppliers, do I need to be more concerned about potential quality problems make sure that my total cost isn’t impacted?


Who are their Customers ?

The traditional view: Is their customer base representative of the type of quality, and requirements we will want?

The cost view: Is their customer base driven by the same type of cost pressures and needs as we would require, so they will understand and respond to out needs?
If all their customers are calling for cost reductions, the pressure to reduce cost will be much greater that if you are the only one driving cost. If their customer base doesn’t have the same needs as you to reduce cost, understand that driving cost reductions will be an up hill battle.

The negotiation view: With the customer base they have, will the things we require them to do in the agreement be business as usual versus new. If they want to charge extra for certain requirements, can I use this information to avoid those charges, knowing that they would be performing those activities for their other Customers. If their existing customers have higher level needs and requirements, does that present an opportunity to negotiate a reduce price.


The Supplier Survey


The traditional view:  Use the survey to discover things that will help qualify them


The Cost view: Use the survey to discover things that will impact their cost. Look for things that will potentially add costs to doing business with them or which limit their ability to reduce cost.

The negotiation view: gets key information about them that can be used in the negotiation. For example: Product data sheets or specifications will provide things like Mean Time Between Failure rates or reliability rates that you can use against them in negotiating quality, warranty periods, defects, etc. Key Customers will allow you to check references to identify specific issues you may need to cover or negotiate.

Perform evaluation of Parts/product.

            The traditional view: Understand whether the product meets you requirements

The cost view: Look at the product, how the product is made, the materials used, the processes used to see if there are opportunities to reduce the cost.

The negotiation view: Based on the evaluation, identify any issues with the product that can be used to drive the price down. E.g. lack of features, not an exact match with needs. Especially look at it from a life cycle cost basis where their higher costs in the future should force them to give you a better price today..

Interview the Supplier:

The traditional view: Check to see that they have the necessary capability to do the job.

The cost view: Tour their facility. See what they are doing, how they manage the business, the tools they have. Look at who their customers are. Look at who their suppliers are to see their qualify and character. Understand their process and quality steps. Look at capacity to understand how much they need your business. Look for indicators of problems (high volume in warranty or returns areas, large re-work area for production). It will give you a better understanding of the Company and what is driving their cost.

The negotiation view: Use all the areas where you have identified issues to either negotiate a reduction in the cost, or include contract terms and commitments to make sure that the cost of those problems aren’t passed on to you. I’ve been in a number of negotiations where the supplier wanted to either charge additional costs because of our requirements, or fought against accepting our terms arguing that the terms required them to do something unique. If you tour their plant, you’ll know what their standards are. Many times their standards were exactly the same as what we required or what they were already doing for another customer. If you don't tour their operation you'll never know what the baseline is to measure against in price in the negotiation.

Have them present a representative project.

The traditional view: Check to ensure that the supplier has the ability to perform the work.

The cost view: Look at their approach from a cost perspective to see if they may have steps in their process that aren’t needed, add cost, and can be eliminated. Check their management systems for scheduling, buying of equipment and materials, quality Processes, field service and support capabilities. Understand what you are getting that is included in the cost and what may be extra. Use the information to force them to reduce cost on the basis of a competitive benchmark if others are more efficient.

The negotiation view: Use their response as the standard you will hold them to. If they say they do certain things as standard, include those requirements in your agreement as tasks they must perform. You can always then come back to the looking to reduce cost for something less.

Check references on the Company. Use that information in the negotiation to substantiate contract requirements, demands for reduced pricing, incentive, etc.

The traditional view: Look for any potential problem areas that would disqualify the supplier.

            The cost view: As references about matters that impact cost, cost reductions,
efficiencies, processes, quality performance, delivery performance, changes, cost reduction programs etc. If their experience is good, use that as the standard the must meet for your dealings. If the experience is not as positive, use that to drive either price reductions or contract commitments to better performance and reduced cost.

The negotiation view: Use the knowledge that you gain as a tool to help negotiate what you need from the supplier.

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