By Anand Raman

      In China's Guandong province, one of the world's biggest manufacturing hubs, over 62,000 companies shut down in the last six months of 2008—or, roughly, 340 units a day. As demand from the US and Europe fell, leaving factory owners with large inventories of raw materials and finished products, many of those entrepreneurs locked the gates of their factories and quietly vanished into the night. Much of the world's attention has focused on the Chinese workers who lost their jobs and, in many cases, several weeks of pay as well.

The workers will find other jobs, but the relationship between suppliers and buyers may never be the same. Imagine the plight of the hapless Wal-Mart buyer trying to locate the vendors who agreed to fulfill a sudden surge in demand for, say, air purifiers or Adam Lambert replicas—and finding that supplier had simply vanished.

Is the buyer likely to trust any vendor again? Not surprisingly, when HBR surveyed readers in January 2009, we found that more than one-fifth of 1,024 respondents admitted that their trust in suppliers had been shaken over the past 12 months. That relationship isn't the only casualty; the June issue of HBR, online next week, will spotlight trust. As the articles will show, trust has drained away in almost every facet of business.

It'll take as much time for suppliers to regain trust as it will for commercial banks to convince people that they're healthy, and trustworthy, again.

Both manufacturers and suppliers benefit by forging long-term relationships with each other, but it isn't easy to do so. In fact, as Jeffrey Liker and Tom Choi argued (Building Deep Supplier Relationships, HBR, December 2004), one of the key reasons for the failure of the U.S. automobile companies is their inability to trust suppliers the way that their Japanese rivals do.

More, not less, trust may be in order on the road to recovery.

Provided by Harvard Business—Where Leaders Get Their Edge

Building Deep Supplier Relationships

by Jeffrey K. Liker and Thomas Y. Choi

      Two Japanese automakers have had stunning success building relationships with North American suppliers—often the same companies that have had contentious dealings with Detroit’s Big Three. What are Toyota and Honda doing right?

“The Big Three [U.S. automakers] set annual cost-reduction targets [for the parts they purchase]. To realize those targets, they’ll do anything. [They’ve unleashed] a reign of terror, and it gets worse every year. You can’t trust anyone [in those companies].” —Director, interior systems supplier to Ford, GM, and Chrysler, October 1999
“Honda is a demanding customer, but it is loyal to us. [American] automakers have us work on drawings, ask other suppliers to bid on them, and give the job to the lowest bidder. Honda never does that.” —CEO, industrial fasteners supplier to Ford, GM, Chrysler, and Honda, April 2002

“In my opinion, [Ford] seems to send its people to ‘hate school’ so that they learn how to hate suppliers. The company is extremely confrontational. After dealing with Ford, I decided not to buy its cars.” —Senior executive, supplier to Ford, October 2002

“Toyota helped us dramatically improve our production system. We started by making one component, and as we improved, [Toyota] rewarded us with orders for more components. Toyota is our best customer.” —Senior executive, supplier to Ford, GM, Chrysler, and Toyota, July 2001

       No corporation needs to be convinced that in today’s scale-driven, technology-intensive global economy, partnerships are the supply chain’s lifeblood. Companies, especially in developed economies, buy more components and services from suppliers than they used to. The 100 biggest U.S. manufacturers spent 48 cents out of every dollar of sales in 2002 to buy materials, compared with 43 cents in 1996, according to Purchasing magazine’s estimates. Businesses are increasingly relying on their suppliers to reduce costs, improve quality, and develop new processes and products faster than their rivals’ vendors can. In fact, some organizations have started to evaluate whether they must continue to assemble products themselves or whether they can outsource production entirely. The issue isn’t whether companies should turn their arms-length relationships with suppliers into close partnerships, but how. Happily, the advice on that score is quite consistent: Experts agree that American corporations, like their Japanese rivals, should build supplier keiretsu: close-knit networks of vendors that continuously learn, improve, and prosper along with their parent companies. (Incidentally, we don’t mean that companies should create complex cross holdings of shares between themselves and their suppliers, the way Japanese firms do.)

     For corporations intimidated by the prospect of building familial ties with the suppliers they’ve traditionally bullied, our research offers some bad news and some good news. First, the bad news: It’s tougher to build relationships with suppliers than companies imagine. For more than 20 years, many American businesses have unsuccessfully tried to build bonds with suppliers. As part of the quality movement of the 1980s, these companies ostensibly adopted the Japanese partnering model. They slashed the number of suppliers they did business with, awarded the survivors long-term contracts, and encouraged top-tier vendors to manage the lower tiers. They also got top-tier suppliers to produce subsystems instead of components, to take responsibility for quality and costs, and to deliver just in time. In 2001, the Malcolm Baldrige National Quality Award Committee made “key supplier and customer partnering and communication mechanisms” a separate category on which it would judge the best companies in the United States. 

      However, while these American companies created supply chains that superficially resembled those of their Japanese competitors, they didn’t alter the fundamental nature of their relationships with suppliers. It wasn’t long into the partnering movement before manufacturers and suppliers were fighting bitterly over the implementation of best practices like continuous quality improvement and annual price reductions. By the turn of the millennium, two additional factors made cost, again, the main criterion in supplier selection. First, companies were more easily able to source globally, notably from China. They jumped to the conclusion that the immediate benefits of low wage costs outweighed the long-term benefits of investing in relationships. Second, the development and spread of Internet-based technologies allowed companies to get suppliers to compete on cost more efficiently—and more brutally—than they used to. Consequently, manufacturer-supplier relations in America have deteriorated so much that they’re worse now than before the quality revolution began. In the U.S. automobile industry, for instance, Ford uses online reverse auctions to get the lowest prices for components. GM writes contracts that allow it to shift to a less expensive supplier at a moment’s notice. Chrysler tried to build a keiretsu, but the process unraveled after Daimler took over the company in 1998. Not surprisingly, the Big Three have been more or less at war with their suppliers. Having witnessed the American automakers’ abject failure to create keiretsu, most Western companies doubt they can replicate the model outside the culture and society of Japan.

     Time, perhaps, for the good news. Contrary to the cynics’ beliefs, the reports of the keiretsu’s demise are greatly exaggerated. The Japanese supplier-partnering model is alive, well, and flourishing—not just in Japan but also in North America. During the past decade, $160 billion Toyota and $75 billion Honda have struck remarkable partnerships with some of the same suppliers that are at loggerheads with the Big Three and have created latter-day keiretsu across Canada, the United States, and Mexico. The two Japanese companies work closely with their suppliers in those areas. Of the 2.1 million Toyota/Lexus vehicles and the 1.6 million Honda/Acura vehicles sold in North America in 2003, Toyota manufactured 60% and Honda produced 80% in North America. Moreover, the two companies source about 70% to 80% of the costs of making each automobile from North American suppliers. Despite the odds, Toyota and Honda have managed to replicate in an alien Western culture the same kind of supplier webs they built in Japan. Consequently, they enjoy the best supplier relations in the U.S. automobile industry, have the fastest product development processes, and reduce costs and improve quality year after year.

Consider the evidence:

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