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Mutual manufacturing

Why do some manufacturers end up as commodity suppliers of cheap products while others become sought after business partners? Professor Colin Coulson-Thomas reveals the winners and the 'laggards' in modern manufacturing

Whether companies move up or down the value chain is not inevitable but a matter of choice on the part of their boards and management teams. In the manufacturing sector, companies which stand still tend to be those simply kept alive by dominant customers that are securing cheap sources of supply. Others seem to be locked into a spiral of descent towards commodity supplier status. Then there are those companies which break free and grow towards mutually beneficial partnering relationships.

Research by the Centre for Competitiveness at the University of Luton suggests it depends upon the company's attitudes, approaches and behaviours. Manufacturers in similar situations can succeed or fail according to how they set about basic activities such as pricing and working with customers and suppliers.

Not everyone's a winner, baby

Recent research reveals that 'losers' tend to have a limited and short-term vision and are obsessed with ratios and cost-cutting. Their focus is internal and they adopt a win-lose approach to negotiations. They often work hard, but they also cut corners and stay too close to what they know. They find their margins squeezed and their profitability falling.

Commodity suppliers can usually be recognised by their behaviour (see figure 1). They are risk averse, cautious, legalistic and protective of their own interests. They engage in damage limitation exercises and put safeguards in place. They do not like to be challenged. They play it safe and avoid uncertainty by only undertaking what they feel they are technically able to deliver. Winners are more adventurous. They formulate broader, longer-term and more ambitious visions. Their obsession is with customers, and creating and adding greater value. Their orientation is external, and when negotiating they seek win-win outcomes. They build capability and develop relationships. They work smarter and experience rising margins and improving profitability. Individuals in winning organisations recognise that risk and return are related (figure 1). To obtain higher margins they are prepared to share risks and the visions of others, accept challenges and adopt new approaches. They are flexible and innovative and like to be at the frontiers of opportunity where little may be known. They explore, pioneer and discover. They stress the business relevance of their attitudes and approaches.

Figure 1. Commodity supplier or business partner?
Figure 1: Commodity supplier or business partner?
Source: Colin Coulton-Thomas, The Future of the Organisation, Kogan Page 1997 & 1998

Make sure the price is right

These differences of approach are apparent in many research reports published by the Centre for Competitiveness. The report 'Pricing for profit' demonstrates how revealing pricing decisions are in showing whether a company is likely to move up or down a value chain. They also impact directly on sales revenues and profitability. Charging too much means orders are lost, while charging too little erodes margins and may give the impression that products are of a low quality. Obtaining and sustaining higher prices ought to be a top priority of manufacturers. Yet often they agonise over perfecting what is sold and then take quick pricing decisions based largely on guesswork.

So how should prices be set? Companies tend to be protective of their methods for setting prices; however, the Centre for Competitiveness research team managed to persuade 73 companies to describe their pricing strategies, tactics and practices. The firms surveyed provided data on 127 factors that could affect pricing decisions. The findings, summarised in the report, reveal that more effective pricing could boost the profitability of many companies. Comparing the companies that are most successful (the leaders) at using pricing to achieve business objectives, with the least successful (the laggards) reveals stark differences between the two groups.

Leading the way or dragging your heels?

Leaders understand the strategic importance of pricing and are more attuned to factors which affect price sensitivity. Sales management, marketing, sales force personnel and finance are the groups most involved in pricing. However, leaders involve a wider range of departments in their pricing decisions and specifically, members of the sales team play a more significant role.

Marketing and sales departments should contribute to pricing because they are close to the customers. But left to themselves they may be tempted to 'buy' orders. Offering discounts may be regarded as a softer option than differentiating, tailoring and delivering extra value to justify a higher price. Excessive discounting can significantly reduce profitability.

The most successful companies rely on concrete evidence rather than a hunch when it comes to pricing decisions. For instance, before pricing products as a line (rather than individually) smart companies calculate whether an increase in profit overall would exceed the costs of implementation and any reductions in profit on individual products that might occur.

Leaders sell on value not on price. They are more likely to segment a marketplace and take a long-term view, for example using 'penetration pricing' (an initial low price to quickly secure market share) to enter a new market. When laggards look ahead it is often for defensive reasons, for example cutting prices to hold onto market share.

The cost drivers of leaders and laggards are very different. Leaders are five times more likely to increase volume to achieve economies of scale. In contrast, laggards are more likely to reduce product volume to allow price cuts or special discounts. Leaders are more realistic when allocating costs and more likely to understand the direct and indirect costs attributable to a particular product or service.

Overall, leaders adopt a very different approach to building their businesses. They focus on each market segment, differentiate their product or service, and look for ways of increasing quality and delivering improved customer service. Investing in these areas allows them to build sales volumes, reduce unit costs and become more competitive.

Pricing tactics should support business development strategy. Too often pricing is handled in an ad hoc and uncoordinated way. It is important to strike a balance between the centralised response demanded by major customers and the decentralised approach needed to respond to local market conditions.

Automating the more routine aspects of pricing can reduce the risk of errors and free up time for creating bespoke responses. Smart firms monitor trends and developments that may impact on prices. For example, they tend to be more alert to possible price hot spots that might trigger consumer militancy.

Catching on to collaboration

As part of their pricing strategy, winners agree mutual objectives with companies that have compatible aspirations, and form partnerships with them. This involves practicing open book accounting and sharing any benefits or savings achieved.

Research by the Centre for Competitiveness in the book Transforming the Company suggests that successful and unsuccessful companies use very different approaches in handling confrontation and encouraging collaboration. Losers are cautious collaborators. They stress the effort and expense required to establish and build relationships, and often conclude that the likely results do not somehow justify the investment required.

Many losers act as though working with others is an option rather than a necessity. At heart they are reluctant to share and would prefer to operate alone. They keep to themselves to avoid becoming entangled in rivalries and drawn into disputes. When negotiating they pursue divisive strategies and often seek to benefit at the expense of other parties.

Avoiding partnerships can mean passing up development opportunities. Smart companies know this and actively search for potential business partners for joint initiatives. They do not mind the confrontation and argument that may precede mutual respect and a meeting of minds. They endeavour to find common ground, resolve conflicts and promote shared interests and joint goals.

As companies outsource and focus upon core competencies, it may be beneficial to transfer some activities to specialist suppliers. As a consequence, combinations of complementary organisations work together in supply chains, to deliver value to cus- tomers. This way each company concentrates on what it does best. In contrast, a company that endeavours to do everything itself may become a 'jack of all trades and master of none'.

The dos and don'ts of collaboration

It helps if aspiring collaborators are compatible and complementary. However, losers tend to seek potential collaborators with similar characteristics to themselves. Consequently, they sometimes find the whole is not necessarily greater than the sum of its parts.

If the parties endeavouring to cooperate are very different they may not have enough in common to cement a relationship. On the other hand, if they are so alike as to add little to each other's capabilities, collaboration is unlikely to add value. Winners understand that lasting relationships often involve dissimilar but complementary partners that allocate roles and responsibilities according to comparative advantage.

It is useful to review collaborative processes and practices. For example, putting arrangements in place to clarify the ownership of customers, prevent poaching and protect intellectual property. Research undertaken for The knowledge entrepreneur suggests companies also equip their people and business partners with the job support tools needed to understand and promote each other's offerings.

Discussion, informed debate and a willingness to challenge can prevent complacency, spur innovation and lead to higher performance. Differences are usually better kept out in the open, where efforts can be made to resolve them, than hidden where they can fester. Ultimately winners become good business partners by thinking and behaving like them. They collaborate as well as compete. They strive for and achieve beneficial outcomes for all members of the more intimate networks they build. They integrate processes and systems. They work with their supply chain partners to produce differentiated and bespoke products that deliver more value to their customers and, because of this, earn a price premium.

Biography

Colin Coulson-Thomas is Professor of competitiveness at the University of Luton. He advises, coaches and consults on the management of change. Following marketing and general management roles he became Professor of corporate transformation and more recently process vision holder of major transformation projects. He can be contacted on t: 01733 361 149 or e: colinct@tiscali.co.uk