Late Night Discussions
Number 2

by Dr. Eliyahu M. Goldratt

How to turn an excellent decision into a disaster - a discussion on single-source vendor

We have been sitting quietly for over an hour. I'm on my third drink and Jonah's big cigar is no more than a butt. It's very comfortable and quite relaxing but if I don't stir up some conversation the only outcome of this evening will be a hangover.

"Jonah, you claim that too often industry is using extensive prayers as a shield against the future. Can you give me an example?"

"Purchasing."

I'm waiting for some more but after a short while it's apparent that tonight Jonah is in one of his autistic moods. "Alex," I say to myself, "It seems like you'll have to carry the burden of the conversation on your shoulders. That's life."

"Purchasing," I repeat. "Yes this function is now, more then ever, between the rock and a hard place. If they hold too low levels of purchased parts and material inventories, operations are very likely to run into shortages and everybody will be on purchasing's back. On the other hand, what they have usually done in the past, holding hefty stocks, they can no longer do. The movement to Just-In-Time has put an end to that avenue. Who can hold proper inventory reserves when from all sides you here slogans like: 'inventory is a liability' 'strive to zero inventory'? Jonah it's obvious that purchasing is being forced to use more of that doubtful medicine - extensive prayers. But what is your point? What else can they do?"

"Single source vendor," comes the laconic remark.

"Oh yes, of course," I continue. "Purchasing can start to concentrate on their vendors. Rather than spreading their efforts too thin, they can drastically shrink their vendor base. This will give them the opportunity to reach almost a partnership with the vendors."

Now I'm on a well-beaten path, so cheerfully I fill the room with words. "Purchasing will then be in a position to know the vendor's problems and the vendors can be much more attuned and able to adjust to the company's needs. Not to mention that the shrinking the vendor base gives a company an excellent opportunity to choose just the best vendors and gives the vendors a real incentive to improve. But Jonah, wait a minute. This is exactly what almost all the big and medium companies are doing today. This is currently the big thing in purchasing. Now I really don't understand your claim."

Jonah is absorbed in the ceremony of preparing another cigar to be doomed by fire. "Well," I press on.

"Well what?"

"Why did you choose purchasing as the example for your claim that industry is relying too much on prayers?"

"Alex, don't stop. Continue the analysis." He smiles at me and turns back to his occupation.

"Big help." But since I'm the one who brought it on, it seems that there is no choice but to paddle along.

Not knowing where to turn, "back to basics" I loudly remind myself, and Jonah nods his head in approval. "We pay salaries in order to see the outcome on the bottom line of the company. Actions can improve the bottom line only if they increase Throughput and/or decrease Inventory and/or decrease Operating Expense. Any other action can be regarded, maximum, as an ego trip."

"Fine. Now let's see how the move to a single source can improve the bottom line. All this nice talk about partnerships is very impressive but let's cash them into tangible actions and then see what will actually be on the table."

I'm getting excited, Jonah looks just bored. Never mind.

"One tangible thing that results from the movement to single-source will certainly be less paperwork and less bureaucracy. This is definitely a good outcome, but in what way? What is the impact on Throughput, Inventory and Operating Expense?"

"Less paperwork means less Operating Expense," I continue the dialog basically with myself. What do I mean by less Operating Expense? The savings in the price of the paper itself.? That's ridiculous. The savings are in people's time. But do we actually lay them off. Not necessarily. As a matter of fact these closer relationships with the vendors require much more time to be spent per vendor. It is quite unlikely that anybody in purchasing will be laid off, except maybe one or two low-salary clerks. As long as we do not lay off, we may talk about savings but the truth is that no reduction in Operating Expense is realized. No, the movement to single-source vendor has little, if anything, to do with reduction in Operating Expense."

"The benefits must lie in reduction of Inventory. That must be it! Let's not forget that at the end, single-sourcing is a prime message of Just-In-Time. Yes, forcing the vendor to improve on his frequency of delivery will enable the company to hold lower levels of inventories. If a vendor delivers only once a month we are forced to hold much higher inventories than if he delivers on a daily basis. On top of this," I'm starting to gain real momentum, "on top of this, if we persuade the vendor to improve on his reliability and on quality we can further reduce our stocks. As long as we have reason to believe that a whole shipment could be delayed, or that it might have to be scraped for poor quality, we have to protect operations with much higher inventories. Well Jonah, here's your answer."

He just throws me dirty look. Something significant must be missing, so I hurriedly abandon my euphoria and continue the analysis, trying to be my own devil's advocate.

"All these great reductions in inventory are just for the raw-material and purchased parts. These are the least important sections of inventory to be reduced. The important sections are those that impact the company's response time to it's markets, like work-in-process or finished goods, which purchasing has very little to do with. So, the major impact of the movement to single-source vendor must lie somewhere else, but where?"

"Alex, what about Throughput," says Jonah.

"Yes, of course. Throughput is the most important factor but, like everybody else, I'm too busy looking at savings rather than the bottom line. Throughput is the money generated by the company itself. Given the same selling prices, any dollar the company refrains from paying to the vendor is a dollar added to its Throughput. And what a better opportunity to squeeze lower prices from a vendor then when the vendor base has shrunk. At that time the quantities contracted with the chosen few are naturally significantly increased, and as everybody knows, larger quantities are a legitimate reason for demanding lower prices. Interestingly, almost no one is talking about it, but just look around you. It is definitely the name of the game. Fine Jonah, but I can't see anything bad about it."

"Just continue the analysis, put all the pieces together."

I pour myself another drink to gain some thinking time. Which one is it? The fourth or the fifth? I lost count. In my situation demanding from me to put all pieces together is plain cruelty. I should have chosen a friend which is less of a slave driver!

"Where are we," I courageously continue. "We shrunk the vendor's base, we lowered purchase prices, we induced the vendors to improve (on response time, on frequency of delivery and on quality) and we lowered our own materials inventory. Jonah, I really don't know what you're getting at. Everything from every angle looks positive."

"Alex, will you at least please look into the future. What must be the most plausible outcome of all of these changes?" comes Jonah's impatient response. And then, when he realizes that I'm stuck, "try to look from the vendors' eyes."

"The vendor has significantly improved his performance," I reply.

"Yes Alex, granted. But did he improve his bottom line? Remember, you have forced on him a significant price cut, not to mention the fact that due to your company's continuing pressure, you'll demand a further cut."

"I see what you are alluding to. If the pressure to continue to improve is on going, like it should be, the pressure to further price cuts will continue and the vendor will face one of two alternatives. Either going out of business or using its improved capabilities to get additional orders somewhere else. It doesn't take a crystal ball to predict the more plausible choice. Getting more orders for his operations will increase resources loads, which, considering the current way of running these sections, will very likely give rise to lack of protective capacity. Or even, god forbid, to the emergence of interactive capacity constraints. Yes, it's apparent that before long such vendors will start to slide on their ability to deliver on time."

Jonah is now wide awake. "If the vendor finds himself in a bind, who is the first to suffer?" he asks.

"It's obvious," I answer. "By now we are totally in his hand. He is our single-source. Moreover, now he's the only one that knows how to respond to our operations needs and the technical communications between us are excellent. On the other hand, the other clients are relatively new to him and he still has to gain their confidence. Yes, no doubt, our orders are the ones that would be shipped late. In the long run this will badly hurt the vendor as well, but when it comes to choosing between the short and long term, we all know who has the upper hand."

"And at that time, how well are you protected by material inventory?" Jonah mercilessly turns the dagger.

I just sigh."Yes Jonah, we do tend to use extensive prayers as a shield against the future. But tell me, this single-source vendor has so much appeal, can we enjoy the benefits without ever suffering, from what now seems to be, the direct, long-term devastating outcome?"

"Of course," is Jonah's answer, "and you know what you should do."

"Yes, I know. Go back to the drawing board and check my basic assumptions."

This "Late Night Discussion" is Copyright © 1991 Dr. Eliyahu M. Goldratt