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PURCHASING AND COST MANAGEMENT IN THE SUPPLY CHAIN

Towards an integrative framework

Work in Progress

First Draft

Johan Peeters*

Lieven Quintens

ABSTRACT

In recent years, it has been acknowledged by literature that thoroughly coordinated

purchasing efforts can become a strategic weapon in the current market environment. The

cost management literature, on the other hand, has given many concepts to interpret these

efforts. However, this is hardly done. This paper contributes to this by presenting an

integrative framework between the purchasing function process and the concepts that are

developed in cost management in supply chains, i.e. supply chain costing, proactive cost

management, lean management accounting, inter-organisational cost management and

organisational settings. Pilot case study research is conducted in order to explore this

framework and its application to the first and second tier automotive suppliers from a Belgian

OEM.

JEL-code: L22, M00

Keywords: cost management, purchasing, supply chain management

*: Corresponding author: Johan Peeters

Corresponding addresses: Lessius Hogeschool , Korte Nieuwsstraat 33, 2000 Antwerpen; tel. +32 (0)3 201 18

14; fax. +32 (0)3 201 18 99; email: johan.peeters@lessius-ho.be and Limburgs Universitair Centrum,

Universitaire Campus Gebouw D, 3590 Diepenbeek

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INTRODUCTION

In recent years, it has been acknowledged by literature that purchasing can play a key role in a

firms policy. While purchasing activities traditionally have been considered as part of the

operational activities of a company, nowadays they are presented as strategic weapons facing

the threat of the current market environment (Trent & Monczka, 1998; Gadde & Hkansson,

2001). With the reduction of many trade barriers, global purchasing has indeed become a

reality. This globalisation of the market implies for suppliers that they should be aware of

competitors on a worldwide scale.

A thorough coordination and control of purchasing related actions, such as adopting shorter

delivery times and reducing on-hand inventory (Das & Handfield, 1997), is not only a way to

generate short-term solutions, it is essential to create competitive advantages. These

advantages include more flexibility, faster introduction of ever more innovative products and

lower total cost of ownership. The advantages can be found both at the level of an individual

company as well as at the level of the supply chain.

Cost related issues have always been important in purchasing. The belief that purchasing was

a mainly operational activity put heavy pressure on the cost of goods and services that were

purchased. Nowadays, the situation has become more complex. Supplier relationships, quality

and innovativeness are all becoming much more important, while cost aspects remained one

of the key elements of purchasing.

However the importance attached to costs in purchasing, literature on supply chain

management and purchasing does not deal explicitly with cost management (Ellram, 2002).

Most literature on these topics discusses how the interfaces between buyers and suppliers can

be made more efficient. Only recently questions have been raised in literature about the role

and integration of modern management accounting techniques In supply chains on the one

hand and supply chain management on the other hand (Wouters, 1999; Ellram, 2002).

This paper aims at filling in this gap. The concept of cost management in supply chains is

seen from a holistic perspective with a strong emphasis supplier involvement and purchasing.

A careful consideration of cost aspects in the supply chain during the early stages has already

been proven beneficial for a company (Wynstra & Ten Pierick, 2000). Although looking at

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the intersection of both disciplines, supply chain management and cost management, does not

lead to a single, clear concept. Therefore, this paper focuses on the concepts for cost

management in supply chain management and the implications on purchasing.We start this

discussion with the trade-off between local versus global purchasing decisions in the supply

chain. Therefore, the first part of the paper will give an overview of local versus global

purchasing and its relation to cost management. The second part of the literature review deals

with supply chain management and the intersection of this discipline with cost management

and new product development. This section provides insights on how cost management in

supply chains can be conceptualised. Furthermore, the paper empirically tries to validate these

findings through the investigation of several first and second tier suppliers of an Original

Equipment Manufacturer (OEM) plant in Belgium. These pilot case studies describe the use

of concepts and techniques for cost management in supply chains in relation to purchasing

and new product development and how this is passed on through the supply chain.

PURCHASING AND COSTS

Local versus global purchasing: why purchasing abroad?

The purchasing literature has given many reasons why companies purchase abroad (Rexha &

Miyamoto, 2000; Birou & Fawcett, 1993). Generally spoken, however, four main reasons for

buying internationally can be distinguished. The first reason is the availability of the product

that is sourced. Some products can only be found at very specific places in the world (e.g., a

number of raw materials). Moreover, some companies add international suppliers to their

portfolio in order to be able to respond to a future or unexpected increase in demand.

Secondly, quality related issues have become important. This is closely related with the

uniqueness of a product and is particularly important in high-tech industries. Components

from different manufacturers can only differ on some minor characteristics, but this could

make it incompatible with other components. The number of companies that become possible

suppliers is therefore limited, but this phenomenon increases the need of purchasing abroad.

Moreover, when quality is considered, thorough supplier selection criteria will limit the range

of possible suppliers that can offer acceptable solutions to a few, not necessarily the local

ones.

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The third reason is the strategic vision of the company. Companies realise that the world is

globalising, and action should be undertaken in order to deal with the fierce competition.

International purchasing can be a tool to tackle this competition. As a consequence, world-

class suppliers are sought, foreign business cultures are better understood, and even brand

awareness is pursued, all contributing to a better competitive position for the company.

However the abovementioned three reasons has been indicated as very important, the cost

aspect cannot be neglected as an important reason for going internationally. The ultimate aim

is to find the supplier who produces or delivers the desired product (in terms of quality, time

aspects,) at the cheapest price. Because of some typical characteristics of global trade

(different cultures/languages, large distance), risk will be increased and the purchasing

process will face increased complexity than when only dealing with local suppliers.

This cost aspect is difficult to comprise, because both direct and indirect costs should be

detected and evaluated. While cost-related aspects can be the main drivers for engaging in

international activities, most of the barriers are also related with cost aspects. This is in line

with Carter and Narasimhan (1990) who defined 14 cost elements that should be taken into

consideration especially when engaging in global purchasing.

The drivers are related to the cheaper costs of the products or services. Foreign countries often

have cheaper labour and benign tax policies, which makes it possible for companies

(especially in new developing economies) to produce high quality goods at a lower price than

in most developed countries. While the cost of the goods is only one aspect, other costs may

not be clear at first sight. These costs are mostly seen as barriers, because they generally are

higher for activities abroad. The most obvious example is the transportation cost, which can

become even more than 25 % of their purchasing budget (Murphy & Daley, 1994). Besides an

increase of transportation costs, international purchasing is hindered by an increase in

communication and coordination costs, travel costs and inventory costs. These costs are

difficult to determine, for example how to calculate the cost of language problem or how to

preview the long-term effects of exchange rates on the cost of purchased goods or services.

It is clear that all the pros and cons of local and global purchasing have to be taken into

consideration, not only the directly allocated cost aspects in order to make a balanced

decision. While local purchasing can be financial beneficial for a company, because of low

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transportation costs and the absence of tariffs (Murray, Wildt & Kotabe, 1995), global

purchasing can in his turn offer lower product costs due to the abovementioned reasons.

The purchasing view on costs

Cost has always been a major issue in purchasing, whereby elements such as cost reduction

were important. This does not mean, however, that cost minimisation is always the best

solution while striving to achieve more profit (Dunning, 1993). Increasing costs is therefore

not necessarily considered as problematic, as long as the associated revenues grow faster

(Dobilas & McPherson, 1997).

Let us take a closer look now on how costs are perceived throughout the purchasing process.

Cost related aspects are found in every part of the purchasing function. A model that is

frequently used in the purchasing literature is the model of Van Weele (2002; see figure 1).

He defines purchasing as a six staged process. To every step in this model, specific costs can

be defined that should be considered in the decision to source and supply local or global.

Figure 1: The purchasing function process (Van Weele, 2002)

The price of a product is the most obvious component of the total amount of money a

company has to foresee in order to obtain the product. Management accounting learns that

this price include the material costs, the cost of direct labor and a number of indirect costs in

order to manufacture the product. These cost elements imply that foreign sources are seen as a

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valuable alternative for local purchasing. Price levels of the material and indirect costs are not

equal throughout the world. Moreover the regions where these costs are lowest are

characterized by lower wages. This makes foreign product prices competitive with local ones.

However, when a product is purchased, additional costs should also be taken into

consideration. The previously mentioned model of Van Weele (2002) is used to determine the

costs associated in each of the purchasing stages, as shown in table 1. It should be noted

however, that these costs do not always occur, and if so, their impact on the total cost is often

negligible. Examples of these costs are risk of obsolescence or damage during transport.

Travel costs when selecting a supplier will take place when for instance a new supplier has to

be found for an important product. While a less important product has to be bought and five

well-known suppliers in the supplier portfolio offer that type of product, it is likely that no

plant visit will be organized before selecting the supplier.

The different costs associated to a particular stage are interconnected. The case of the

specifications is a clear example of this. In this stage, specifications (e.g. quality, logistics and

maintenance) are defined that imply costs later on in the purchasing process in the contracting

and expediting stages (Van Weele, 2002).

Stage Associated costs

Determining specification R&D costsInternal coordination costs

Selecting supplierTravel costs

Information gathering costs

Contracting

Legal costs

Negotiation costs

Communication costs

Ordering -

Expediting and evaluation

Transportation costs

Communication costs

Import/Export duties

Insurance costsQuality control costs

Follow-up and evaluation

Quality control costs

Inventory costs

External coordination costs

Administrationandorganization

alcosts

Table 1: stages in purchasing and their associated costs

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Internal coordination costs are the costs associated with bringing together different

departments such as production and marketing that need to be contacted to give their opinion.

External coordination costs are the costs that make the buyer-supplier relationships work well.

One type of costs is present in all stages of the purchasing process: the administration and

organizational costs. These costs ensure the fluent transition from one stage to another.

The costs mentioned in table 1 assume that the product is actually purchased from an outside

firm. However, to find the optimal solution, a make-or-buy decision has to be undertaken.

SUPPLY CHAIN MANAGEMENT AND COST MANAGEMENT

The supply chain view on costs

While the importance of purchasing is often discussed from the perspective of a single

company, this scope can be broadened to evaluate the impact of purchasing through supply

chain management.

Within the new market environment customers desire shorter delivery times, more flexibility

and faster introduction of ever more innovative products (Kaplan & Cooper, 1999). This new

market situation and the decreasing level of vertical integration have led to the need of supply

chain management in practice.Hereby the flow of products, services and information is pro-

actively planned and coordinated from procurement of raw materials to delivery of finished

products in order to increase the efficiency of the process (Scannell, 2000; Matthyssens et al.,

1998). A better cooperation between functional areas and links within the supply chain is not

only desired within a single organisation but also between all the members of the supply

chain. Supply chain management, from the operational management perspective, attempts to

improve this coordination as a whole. Although there is no comprehensive definition, supply

chain management is often described as a collaborative cross-enterprise operating strategy

(Cooper & Ellram, 1993; Smith & Lockamy, 2000). In this respect, supply chain management

aims at cost reduction and the improvement of services in general through improved supply

chain relationships and cooperation. This is in line with the current trend of closer buyer-

supplier relationships. It is obvious that supply chain management brings together two major

issues: the management of material and information flows and the management of

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relationships. In this respect supply chain management can be seen as a platform of methods,

concepts and techniques.

This platform of supply chain management intersects with the discipline of management

accounting and cost management. Like supply chain management and all other disciplines,

management accounting and cost management have also changed because of the

developments in the business environment during the last two decades (Kaplan & Cooper,

1999). Not only the changes in the market place and the technology but also new

manufacturing methods, organizational structures and new management styles have led to the

arising of new management accounting techniques. The use of traditional management

accounting systems in this new business environment led to shortcomings as distorted product

costs, irrelevant and dysfunctional operational control information and ineffective

performance measurement (Siau, 1999). Instead of using one accounting system, different

separate systems are needed for valuations of inventories, cost measurement of products and

operational control and performance measurement.

During the 80s new and more accurate cost systems were being developed that calculated the

cost of activities and allocated the activity costs to the cost object that consumed the activities.

Many of these new techniques, like activity-based costing, share a strong focus on activities

or processes and a horizontal view of the company. Other important features of the new

techniques are the increased interest in non-financial measurements, the inclusion of both

historical and future events as well as the fact that they are process-oriented and go beyond

the boundaries of the firm. Manufacturing companies have after all limited freedom in cost

management in the product development stage and therefore highly dependent on other

members of the supply chain, mainly for two reasons. First, because product life cycles are

becoming increasingly shorter and the high level of designed-in costs, cost management

became more and more focused on the products planning and design phase (Blanchard,

1978). Beside this, manufacturing enterprises are increasingly outsourcing the value added of

their products and most of the associated design tasks (Cooper & Slagmulder, 1997).

Therefore, in addition to the activity based cost innovation, the discipline of management

accounting initiated cost reduction and control techniques that crossed the borders and

boundaries of the company. With the application of these cost management techniques in

supply chains, the company is seeking closer ties involving cost information sharing and

R&D collaboration with suppliers (Seal et al., 1999; McIvor, 2001).

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To a certain level, cost management is connected to purchasing and supply chain

management, as cost reduction and containment are crucial for gaining competitive

advantage. Looking at the intersection of both disciplines does however not lead to a single

clear concept as mentioned before. This paper focuses on how cost management in supply

chains can be conceptualised and applied in the purchasing process. We therefore describe

five concepts that illustrate that costs are not only created by means of material and

information flows along the supply chain, but also by the supply chain itself.

In order to effectively reduce costs in a supply chain, cost management instruments or

techniques are used. Two of those instruments, activity-based costing and target costing form

a unifying topic throughout the concepts. These two instruments will be explained in the next

section.

Activity-based costing and activity-based supply chain costing

Activity-based costing (ABC) systems refine cost systems by focusing on individual activities

as the fundamental cost objects. Because direct cost can be traced easily to jobs and products,

ABC-systems focus only on indirect costs. Activity-based costing is based on the idea that

costs are caused by different activities. Hereby the system calculates the costs of individual

activities and assigns costs to cost objects such as products and services on the basis of the

activities undertaken to produce each product or service (Figure 2). This assignment is made

through the use of cost drivers, i.e. the causal factors that cause cost of an activity to change.

The aim of ABC is not only to implement a more accurate cost calculation. ABC can also be

used for a wide range of cost management applications, such as cost reduction and activity-

based budgeting (Kaplan & Cooper, 1999; Horngren et al., 1997).

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Fundamental Cost Objects Assignments to other Cost Objects

Activities Costs of Activities

Cost drivers

Figure 2: The concept of Activity-Based Costing (Kaplan & Cooper, 1999, adapted)

Although the concept of ABC is traditionally applied within a single company, its application

can be broadened to the entire supply chain. Hereby ABC aims at optimising total overhead

costs in chain-wide perspective. This implies that not only overhead cost on firm level should

be analysed, but also the transaction costs on supply chain level. In this respect transaction

costs are analysed through the transactions linked to them (Seuring, 2002).

Target costing and supply chain target costing

Besides the introduction of the activity-based costing technique (cfr. supra) that enabled the

transparency costs, the discipline of management accounting initiated cost reduction and

control techniques that crossed the borders of the company. In this respect target costing is

often mentioned as the main tool for cost management in supply chains (Cooper &

Slagmulder, 1997). The role and nature of this system of chained target costing in relation

with supply chain management is related in literature to the concepts discussed in the next

section of this paper. One important characteristic of target costing is that it is not a cost

accounting system like activity-based costing. The emphasis in the target costing process does

not lie on the accurate cost calculation, but on the cost reduction in the development of new

products (Everaert & Bruggeman, 1996; Monden & Hamada, 1991; Kaplan & Cooper, 1999).

Those new products have to be profitable when launched. Therefore, target cost is based upon

the selling price for the good or service:

Target Cost = Estimated Selling Price Desired Profit

Cost of :

Product Service Customer

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The application of target costing in supply chain management focuses on the integration of

suppliers on the one hand and on-going cost reduction and re-design on the other hand during

the process of new product development (McIvor, 2001). Value engineering is often used in

this respect to describe the cost reduction process, as a systematic evaluation of all aspects of

the value-chain business functions, with the objective of reducing costs while satisfying

customers needs. Value engineering can result in improvements in product design, changes in

materials specifications, or modifications in process methods. (Horngren et al., 1997, p. 438)

A first important characteristic of target costing is its market focus. Fundamentally, the target

costing process is based on customer requirements, whereas the cost associated with the

product can be viewed as a result of those customer requirements translated in specified

functionality, quality and sales price. Because target costing has an eye on the market the

technique allows firms to respond quickly to fast changing market conditions and ever-

decreasing product lifecycles (McMann & Nanni, 1995). Secondly, target costing is often

used in a lean production environment. Hereby, the lean company will try to transform

innovation in products and processes to high quality, low production costs, returns to scale,

flexibility and differentiation by use of target costing (Debackere & De Backer, 1999).

Thirdly, product and process technology are so much integrated, that 80-95 % of a new

products cost are determined by its design and therefore are committed before the product

enters the manufacturing stage (Blanchard, 1978; Cooper & Slagmulder, 1997). This justifies

the importance of cost management in product design and the importance of the use of target

costing, which both try to reduce product costs in the design stage. The utmost opportunities

to reduce these costs are situated in this stage of the product lifecycle. A last important

characteristic of target costing concerns the product development cycle, whereas more

traditional systems of product development are characterised by a predetermined sequential

process of functions and departments.

Through the application of target costing, design teams became cross-functional. The product

design team with members of marketing, industrial design, product engineering,

manufacturing and purchasing integrates views of all key constituencies to make the tradeoffs

during the design stage (Hertenstein & Platt, 1998). Through the interaction of members of

the design team and management accountants, not only the cost can be controlled but also

quality and functionality. This cross-functional team approach, which crosses the borders of

the company, is also important with respect to the long-term buyer-supplier relationships

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(Ellram, 2002). This trend of partnership sourcing also reduces the number of suppliers

(McIvor, 1997). Another advantage of the system of cross-functional design teams is the

reduced cycle time and time-to-market which allows to lean competitors to respond to

technological changes and shorter product life cycles. When the overall target is established,

the cost is allocated to the products various functions and components (Cooper & Chew,

1996). By means of this component level target costing, companies try to pass the cost

pressure onto its suppliers (Cooper & Slagmulder, 2001). Hereby supply chain management

plays a substantial role throughout this process (Ellram, 2002). The component level target

costing is necessary because manufacturing companies are limited in cost management in the

product development stage and they are therefore highly dependent on other members of the

supply chain.

As stated above, activity-based costing and target costing form a unifying topic throughout

the concepts of cost management in supply chains. Table 2 gives an overview of the concepts

and their main characteristics.

Author Concept Characteristics

Seuring Supply Chain Costing Three cost levels need to be analysed: direct,

activity-based, and transaction costs to account for

all costs in a supply chain and find the right

partner to control them.

Kajter Proactive Cost Management Proactive cost management is a market-oriented,

anticipatory system.

Hines,

Silvi,

Bartolini,

Raschi

Lean Management Accounting Linking strategic and operational levels to

understand customers and processes, and thus

enhance customer value.

Slagmulder Inter-Organisational Cost Management Managing supplier and customer costs in

coordinated cost reduction programs are carried

out during product design and manufacturing.

Goldbach Organisational Settings Cost management has a functional and an

institutional dimension. Principal-agent-relationships are important in the application of

cost management in a supply chain.

Table 2: Concepts for cost management in supply chain management (Seuring & Goldbach,

2002)

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The contribution of this literature review lies in the fact that we try to couple the different

stages of purchasing of the model of Van Weele (2002) to the concepts of cost management in

supply chains (Figure 3). In this respect we examine to what extent purchasing associated

tasks are being dealt with and can be related to the five different concepts and their associated

techniques. The next section of the paper will explain the main characteristics of the different

concepts and their link with the model of Van Weele.

Supply Chain Management Cost Management

Figure 3: Linking concepts for cost management with purchasing associated costs

Supply Chain Costing

Three dimensions - product, relationships and costs - form the first conceptual framework of

supply chain costing (Seuring & Goldbach, 2002). In this framework three cost levels are

Stages of purchasing

Determining specification

Selecting supplier

Contracting

Ordering

Expediting and evaluation

Follow-up and evaluation

Techniques

Target Costing

Activity-Based Costing

Concepts

Supply Chain Costing

Strategic Cost Management

Lean Management Accounting

Inter-Organisational Cost Management

Organisational Settings

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analysed: direct, activity-based, and transaction costs to account for all costs in a supply chain

and find the right partner to control them. Hereby direct costs can be influenced within a

single company, and transaction costs within the supply chain. An increase of costs on one

level, especially the transaction cost, will often reduce other costs. The view on transaction

costs and activity-based costs, is in line with the purchasing view on costs (Dunning, 1993;

(Dobilas & McPherson, 1997) and the model of Van Weele. Both literatures on purchasing

and the concept of Supply Chain Costing state that the relative importance of the three cost

levels, however, is highly dependent on the nature of the product. Transaction costs and

activity-based costs are higher for products with a very short production cycle, which is often

shorter than the product development time. This increased risk of investments that do not pay

off, emphasises the importance of transaction costs and activity-based costs. As a

consequence, those costs will be much lower for products with a longer life cycle. So far,

companies within the supply chain often focused only on costs within the borders of their

company. Through the integration of transaction costs in the concept of supply chain costing,

cost management is integrated in supply chain management on all stages of the supply chain.

The model of Van Weele is well suited in this respect to focus on the transaction costs related

to purchasing.

Proactive Cost Management

Although some conceptual work has been done in the field of cost management, only few of

them also deal with the management of costs in supply chains. Some approaches that gained

much attention are Strategic Cost Management, Inter-Organisational Cost Management and

Supply Chain Costing. The latter two are separately discussed in this section of the paper. The

framework of Kajter for proactive cost management, however, is a comprehensive

conceptual framework enabling the integration of numerous cost management parameters and

putting them in a broader context (Seuring & Goldbach, 2002). In order to be effective in a

highly competitive environment proactive cost management should be market-oriented and

holistic in the sense that it looks at the entire supply chain and product life cycle. Cost

management should also start in the design phase and should be anticipatory in order to

influence the future cost position. Effective cost management is also a continuous, cross-

functional improvement process, which requires involvement of every employee within the

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company. This involvement can be seen over the complete purchasing process, especially in

the buyer-supplier relationship.

Lean Management Accounting

In this framework for extending lean accounting into a supply chain, Hines et al. (Seuring &

Goldbach, 2002) integrate lean management and strategic cost management. The concept of

lean management accounting has two basic ideas. Firstly, through the lean transformation of

the supply chain, waste is reduced both within and between companies and the supply chain is

aligned to the actual needs of the final customer. In this respect, strategic and operational

levels are linked to understand customers and processes, and thus enhance customer value.

Secondly, the framework deals with the development of an information and cost system able

to support the lean transformation of the supply chain. The framework forms an integrative

approach from different management research areas. The purchasing function process of Van

Weele (2002), can be seen as an important part of this lean transformation of the supply chain.

Inter-Organisational Cost Management

The fourth concept of inter-organisational cost management systems coordinate the cost

management systems between the firm and its clients and suppliers and increase the

efficiency of the interface between the buyers and the suppliers (Slagmulder in Seuring &

Goldbach, 2002). With the application of inter-organisational cost management (IOCM), the

company is seeking closer ties involving cost information sharing and R&D collaboration

with suppliers leading eventually to supplier involvement in customer design and joint buyer-

supplier cost reductions (Seal et al., 1999; McIvor, 2001). Inter-organisational cost

management manages supplier and customer costs by means of coordinated cost reduction

programs, carried out during product design and manufacturing (Cooper & Yoshikawa, 1994).

The concept of IOCM can be coupled to the first and the last stage of the model of Van

Weele, determining specification and expediting and evaluation. The stages of selecting

supplier, contracting and ordering are of relative less importance considering the more long-

term buyer-supplier relationships (Ellram, 2002).

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Organisational Settings

In literature, cost management in supply chains mostly focuses on the management of

activities and transaction causing costs. Apart from this functional level, cost management has

also an institutional dimension, in which management is responsible for cost-related

decisions. So, principal-agent-relationships are important in the application of cost

management in a supply chain. Table 3 gives an overview of the analysis criteria that will

serve as a basis for the analysis of the agency relationship. The presented criteria describe two

extremes. Constellations between the two extremes remain however posible.

Analysis Criteria

Cooperative Confrontative strategy

Trust/incentives Control as coordination mechanisms

Trust-based Power-based relationships

Win-win solutions Win-lose solutions

Table 3: Analysis criteria related to the agency problem (Seuring and Goldbach, 2002)

Goldbach (Seuring and Goldbach, 2002) applied the analysis criteria on the two instruments

target costing and activity-based costing, described earlier in the paper. He described activity-

based costing as cooperative, using incentives and trust as coordination mechanisms, and

relying on trust. In target costing however, both a cooperative and confrontation strategy

exist.

RESEARCH METHOD

Clearly, no individual or function within the organization will have the ability to address all of

the abovementioned issues. To empirically validate the findings and suggestions made in

literature by means of open-ended interviews, a snowball case study method was used, in

which the initial contact point in the organization helps to identify those parties in the

organization that have the knowledge required to address the issues presented above. In this

stage of the research we interviewed the managing directors of 8 automotive companies as a

pilot case study to conduct a large case study and a large-scale survey based on these findings.

Apart from first and second tier suppliers we interviewed also a supplier of maintenance,

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repair and operating materials and a Flemish coordinating organisation for automotive

suppliers.

The semi-structured interviews are conducted and analysed, based on the guidelines as

described by Eisenhardt (1989), Miles and Huberman (1994) and Yin (1994), amongst others.

Respondents were provided with a full text transcript to corroborate its accuracy.

Confidentiality is guaranteed and the participant names are disguised.

The research is focused on the Belgian automotive industry. Four major production plants are

situated in Belgium: Ford, General Motors, Volkswagen and Volvo, and another 11 assembly

plants are located within 300 km. As a consequence, for the total of 260 automotive suppliers

that are based in Flanders, 8.400.000 vehicles are within reach. As global competition grows

fiercer, those companies continue to look for new ways to increase their competitive edge

without jeopardizing their profit margins. The product prices are currently on that level that

improvements without rise for quality and continuation are no longer recommended.

Therefore, the car manufacturers are looking for new techniques whereby all segments of car

production and associated material handling and logistics must be permanently under

investigation for improvements to keep car-manufacturing cost at a minimum.

In the Belgian automotive sector, manufacturers have launched programs to decrease their

level of vertical integration. Externally purchased materials account for 60 % to 70 % of these

manufacturers cost. Car manufacturers are increasingly outsourcing non-core activities while

relying on upstream suppliers in order to achieve competitive advantages. This strategic

outsourcing reduces the number of suppliers and moves companies towards publicly declared

strategic partnerships. The case companies of this paper are first and second-tier suppliers of

an OEM plant in Belgium.

An outline is given with respect to the use and development of techniques described in

literature, related to local and global purchasing, supply chain management, cost management

in supply chains and new product development. Furthermore, the integration of the supply

base and the supplier relationships is highlighted, in particular, how techniques and principles

are passed on through the supply chain and what effects they have on new product

development.

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RESEARCH FINDINGS

The most striking finding was the importance all parties of the supply chain attached to price

and cost, regardless of the position of the company in the supply chain, and regardless the

recent literature on purchasing, supply chain management and cost management that suggests

that other criteria have gained importance over price. Those criteria such as quality, delivery,

reliability, relationship, flexibility and service, are considered crucial throughout the entire

supply chain and are regarded as essential to survive in the automotive sector, but cost issues

definitely remain the most important.

The suppliers try to use the same principles for target costing for their customers as the OEM

imposes to them. However, three reasons are mentioned why this is not always possible. The

first one concerns the size of the second and third-tier suppliers. These suppliers are mostly

very small, which easily leads to liquidity and payment term difficulties, when first-tier

suppliers try to pass on payment terms set by the OEM. Certainly in the case of new product

development, liquidity problems can occur because first-tier suppliers of an OEM are often

paid-on-production. A second obstacle is the staff of the first-tier supplier. The number of

purchasers is mostly limited, leaving no opportunities to follow-up their suppliers in a way the

OEM does. The third reason is the product specificity. While first-tier products are very

specific and complex, second and third tier suppliers often produce standardised goods and

sell these to many customers. These findings are consistent with literature on purchasing and

the concept of supply chain costing and with the classifications of buyer-supplier relationships

based upon the nature of the product and the degree of interaction of the firms in the new

product development cycle (Cooper & Slagmulder, 1997; Cooper et al., 1997; Tyndall &

Gopal, 1998; Seuring & Goldbach, 2002).

The use of multifunctional teams is considered to be of great importance in the product

specification stage. Concretely, these teams aim at finding a balance between functionality,

quality, safety and the cost target. Besides these teams, the OEM is involved in the

specification phase, by setting the targets, but also by recalculating suggestions made by the

first-tier supplier. These calculations have to be made, because small changes can have large

implications. This phenomenon is more likely when dealing with complex and high-tech

products.

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During the interviews it was clear that administration costs play a key role. There is a fixed

price for an order, independent of the quantity or price of the product. On the other hand,

inventory costs can be quite high. While the just-in-time principle aims at reducing inventory,

a shift is noticeable. Indeed, the inventory of the OEM is reduced, but now the inventory is to

a large extent kept by the first-tier supplier. However the just-in-time principle is used and

efforts are made to implement the concept throughout the entire supply chain, real just-in-time

only occurs between the OEM and first-tier suppliers. Because there is a shift in inventory,

there are still possibilities for inventory cost reductions if the principle could be used down

the supply chain.

These cost reductions are extremely important for the first-tier suppliers, as the OEM expects

that every year, productivity can be enhanced. Excess expenditures will be reduced to a

minimum. However, not all efforts will be effective. One company mentioned the necessity to

have a plant in the near surroundings of the OEM plant, because just-in-time requirements are

easier to comply and moreover, it reduces their costs, which benefits both the supplier and the

OEM. This is in line with the appearance of full system suppliers. Their parts are suited to be

transported over a conveyor belt. Another company indicated that the cost of hiring a plant in

the near surroundings of the OEM plant would not worth the effort, because the value does

not outweigh the needed investment. The same vision maintains when OEMs ask their

suppliersto follow them abroad. It will definitely be considered if when it is socio-economic

profitable.

Throughout the interviews we have noted little evidence that R&D collaboration with

suppliers eventually leads to supplier involvement in customer design and joint buyer-supplier

cost reductions. Collaboration focuses mostly on possible short-term contributions in terms of

reduction in lead-time or costs. As mentioned above, often suppliers are given all technical

and functional specifications, as CAD-information. As a consequence, opportunities for cost

reduction remain limited even though 80-95 % of a products cost is determined by its design.

Therefore OEMs costs are committed before the product enters the manufacturing stage. The

inter-organisational cost management focuses more on cost information sharing and annual

cost reduction targets set by the OEM. The research provides evidence that those cost

reductions are attained on direct product cost, acquisition cost and operations cost, however

this is only done within the organisation. In order to achieve these annual cost reduction

targets, the OEM asks for an open accounting system, whereby cost transparency forces the

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supplier to reveal cost breakdowns. It is obvious that suppliers prefer not to share all the

information, although respondents acknowledged that shared information could also be

useful. This counts especially for new product development, where involvement up to five

years before the launch of a new product is no exception. The cases indicate that the more

complex and the more expensive a part is, the more willingness exists to cooperate and to get

involved early. Early involvement is not a guarantee for a contract, although this is rather the

exception. Some respondents mentioned though that they were actively involved in pre-

production phases, but the production contracts were passed on to a competing firm. Product

lifetime contracts exist, but a slight modification of a specification means the cancellation of

the contract.

CONCLUSIONS AND FURTHER RESEARCH

The research findings of this pilot case study revealed important insights in the needs for

effective cost management in supply chains with respect to purchasing. Generally spoken,

themes referred to by literature are confirmed. Targets, set by the OEM are pushed through

the supply chain. The further away from the OEM, the more difficult it becomes to impose

cost targets to suppliers. The consequence is that first-tier suppliers become sandwiched

between the OEM, who focuses on targets, and second-tier suppliers, unable to comply with

the same targets. In this situation, the first tier-supplier is forced to cut down its own profit

margins to the absolute minimum. This implies a certain business risk, because it has been

contractually laid out, that changes in input prices are on the account of the first-tier supplier.

The results however, must be nuanced. Every cost calculation is based on case-specific

information. The more critical and specific a product is, the more attention is given to cost

calculations and target costing. Not only quality and pricing, but also the place seems to be

important. Suppliers of smaller and less complex parts have an advantage when they are not

situated on the green field of a car manufacturer. Lower transportation and packaging cost do

not always outweigh the additional cost of being part of a conveyor system.

The findings of this pilot case study revealed some insights in the needs for effective cost

management related to supply chain management. This will serve as guidance for future

research on the abovementioned topics by means of a large-scale case study and a survey.

This study is only based on a limited number of interviews. Although acknowledging that no

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generalisations can be made, the trend appears to be that in the case of complex products,

more attention is given to cost management in supply chains and early supplier involvement

in new product development.

For future research on this topic, we suggest a longitudinal approach. Various respondents

indicated that concentration of OEMs will become eminent, while overcapacity becomes a

major issue. Many of the first-tier suppliers are part of international group production plants

worldwide. Few competitors remain here as well. The mergers of OEMs and the possible

closure of production plants will probably increase competition amongst suppliers of similar

products. The evolution of cost management in supply chains in this perspective will become

an interesting future research topic.

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