12/1/2001 | 4 MINUTE READ

Saving the Second Tier

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Tier-two manufacturers are becoming an endangered species, and are especially vulnerable in the current industry downturn.


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Tier-two manufacturers are becoming an endangered species, and are especially vulnerable in the current industry downturn. Often mom-and-pop enterprises, the tier-two firms make the majority of components that go into vehicles. At the same time, they have little clout over their typically much larger, tier-one customers. Making life miserable for many of them are inaccurate forecasts from their tier-one buyers. Bad information here drives up not only tier-two costs, it multiplicatively raises the prices of tier-one/system integrators and OEMs, alike.

In response, many are heralding new eBusiness solutions for tier-twos as the industry fix. Unfortunately, most of these eBusiness champions do not fully understand life in the tier-two trenches. In particular, they greatly overestimate the available resources of tier-two firms. Furthermore, few realize that many of the core problems are not the tier-two’s doing.

Any high-tech solution must be accompanied by greater tier-one understanding of how their practices impact cost and quality at the tier-two level. Specifically, tier-one firms must synchronize their business practices more to their sub-suppliers and vice versa. Only in this way can tier-two firms permanently cut costs out of their operations and begin to operate a more continuous-flow style of operations. If this is done then new eBusiness initiatives such as supplier-managed inventory, electronic auctions, electronic catalogs, and the like can truly add greater efficiencies. Any eBusiness proposal, even then, must recognize the hard constraints faced by tier-two firms. These are significant financial, staffing, and training limitations.

The auto industry has traditionally competed by hammering away at material costs. After demanding price giveback after price giveback, many firms are discovering they are still not price competitive. Tier-two firms are almost doomed from the start to fix this cost problem. Many of tier-two firms are continuously blindsided by customers who successively hit them with rush orders and canceled orders, over and over again. The process begins with forecasts from customers that bear no resemblance to what tier-two firms will be asked to actually ship on any particular day. With tier-two raw-material lead times measured in weeks, such unpredictability rains havoc on tier-two operations. This uncertainty:

  • Pushes up tier-two inventories
  • Raises premium freight charges
  • Requires unscheduled overtime
  • Forces unanticipated tooling changes
  • Leads to high administrative costs.

For instance, Dajaco Industries had dreaded late Friday phone calls from their customers; it often meant adding unscheduled weekend overtime shifts. Handling these contingencies raises the cost of doing business and must be manifest in more expensive part prices. Tier-one and OEM prices go up even more, as a result, since their profit margins must reflect their own, higher material costs.

Meanwhile, tier-two firms are shouldering more of the industry’s manufacturing burden. Tier-one firms such as Dana Corp. are outsourcing more manufacturing as they view design, engineering and assembly as their core competencies, and not parts fabrication.

Industry misperceptions about the tier-two segment abound. Many in the auto industry, for instance, believe tier-two firms are merely smaller versions of their far more sophisticated cousins. In fact, most tier-two plants have no programmable logic controllers (PLCs), local area networks (LANs), or other high-tech equipment typically found in OEM and tier-one plants. The typical tier-two firm also does not have any full-time, information-systems (I.S.) staff. Instead each non-hourly employee often wears many hats. For instance, the president/owner is often the firm’s only salesman, designer, and engineer.

Their readiness and eagerness to adopt eBusiness practices is often hampered by the harsh realities of the availability of capital. Lenders are reticent to loan money to an industry that rarely shows substantial profits, even in boom years, noted Gretchen Perkins, vp at IRN, Inc., when she spoke at the last U of M/CAR Management Briefing Seminars.

Yet their tier-one customers expect these sub-suppliers to support and communicate via a flurry of electronic exchanges. These include:

  • Electronic data interchange (EDI) based communication
  • Supplier performance reporting
  • Vendor-managed inventory
  • E-settlement
  • Freight authorizations, etc.

Acquiring such capabilities would not be a problem for a $300-million/year firm. However, the vast majority of tier-two firms have revenues far less than $30-million/year; they generally operate with fewer than 100 employees.

Especially problematic in some cases is a tier-one customer that demands its sub-supplier comply with unique eBusiness practices and protocols. This could be tight integration over the tier-one’s supplier portal, for instance. Some tier-one companies want their sub-supplier’s order management, scheduling, and shipping practices to function as if that tier-one firm was its only customer. That tier-one customer, however, may barely account for $50,000 of the tier-two’s profits per year. The tier-two firm, consequently, may not be able to reorganize its entire business to the whims of each of its customers.

The most powerful agents for improving the efficiencies of tier-two manufacturers are their tier-one customers. Today’s slow down in tier-one businesses should free up additional tier-one employees to concentrate on their supply chains. Some of these employees could be reassigned to understand their sub-suppliers and learn how to operate with them better.

Likewise, each eBusiness vendor must stop pretending that the whole tier-two universe will swirl around only its products and services. Each eBusiness vendor (including Covisint) cannot price its products and services assuming that all the tier-twos’ business will flow through its exclusively. Such economies of scale are not there yet. Similarly, both eBusiness vendors and tier-one firms must offer the tier-twos user interfaces that are easy to understand and use. Browser-based interfaces that generally require no more than one screen are best for tier-two users.