Ranica Arrowsmith, Associate Editor10.16.13
Socialism vs. capitalism: That’s how Tony Mulone, vice president and general manager of custom product solutions at Covidien, described the battle between the business philosophies of open-book pricing and traditional closed book during a panel session on the topic at a symposium in 2010 sponsored by Medical Product Outsourcing (MPO).
Open-book pricing (OBP), which is often called open-book accounting (OBA), is simply the practice of a seller showing all its costs to a customer. Put in terms of the medical device industry, this practice shows an original equipment manufacturer (OEM) customer exactly how much a contract manufacturer (CM) is spending on raw materials, labor and myriad other expenditure points, and exactly what its profit margin is. This, of course, opens a CM up to negotiation on what, perhaps, an OEM customer thinks an acceptable profit margin should be.
Once a company opens its books, Mulone contended, they lose the value proposition assigned to whatever their product is, whether it’s a process, a technology or otherwise. Its competitive edge is lost.
It is a sensitive area, and while the practice is not common in the medtech world, it is standard practice in markets such as consumer electronics and automotive.
Giant retailer Walmart, for instance, is known for pushing back on price with their products suppliers. Steve Agran, managing director of Chicago, IIl.-based financial and operational consulting firm Morris Anderson, explained that the mega-store’s logic is that the longer a supplier of goods or services has been doing a job, the more efficient it should become at its processes. Therefore, its costs should go down, and when its costs go down, the price Walmart pays should decrease as well. Of course, anyone capable of basic math can see that this model is not sustainable. Costs and prices cannot diminish infinitely, and economic factors can cause cost fluctuation in both directions.
“Very large consumer products companies … really heavily control the whole process because they’re so large, and they have very high quality control units,” Agran told MPO. “That’s a situation where [suppliers] don’t have a whole lot of choice. If you want the business, they require you to be open book with them.”
The automotive industry is perhaps the most well known industry for the practice of transparent pricing.
“If you take automotive manufacturers in Europe, you could buy gears from Germany and people would know the cost of those gears to four decimal places,” said Stephen Ashcroft, a business consultant with British procurement and supply chain consultancy Brian Farrington Ltd.
A 2011 report titled “Cost Transparency in Supply Chains: Demystification of the Cooperation Tenet,” which appeared in the German business journal Schmalenbach Business Review, found from interviews that the automotive industry has some of the highest levels of cost transparency.
“Some automotive purchasing experts even state that they have cost transparency for their total purchasing volume,” according to the report. “Purchasing experts who use OBA often require their suppliers to provide cost information through so-called supplier cost breakdown forms that differ in structure and in level of detail, but usually provide cost information for every component of the bill for materials, including both materials and production costs and the cost of items that comprise them. Moreover, overhead costs and profits are usually explicitly mentioned.”
This prevalence of OBA in technical industries such as automotive does not translate to the medical device industry, even though the industry is highly technical and competitive. The reasons for this do not go beyond simply that suppliers are extremely dubious about sharing what they see as “secrets” with buyers. This is not about tricking OEM customers; rather, it is about the lack of trust that OEMs will fully understand the whys and wherefores of CMs’ cost structures. And similarly, the reason OEMs would love OBA from their suppliers is due to an underlying lack of trust that the supplier is giving them the best deal possible.
However, the buying and selling of medical devices and medical device components is not about getting “the best deal possible,” as Norm L. Rodriques, president and self-titled “chief of fun and inspiration” at Springfield Spring Corporation based in Longmeadow, Mass., iterates:
“Imagine this scenario. You or a loved one are just about to be wheeled into the O.R. The surgeon greets you and says: ‘Okay, you have one more decision to make. I need to use a special device for this delicate operation. One is made by a well-known U.S.-based medical device manufacturer and will cost you $119.99. Here is another one made by a lower-cost manufacturer in Asia, and it will cost you only $29.99. The one by the U.S.-based device manufacturer is tested and validated for performance. The less-expensive one is, well, just that—less expensive. Which would you prefer I use and you pay for?’”
Point made. But the Medtronics and Johnsons & Johnsons of the world—any medical device company worth its salt—would not be so naïve as to chase down ridiculously low prices just for the sake of it. As Ashcroft explains, the desire for OBA is the desire for a trusting relationship and a fair deal for both parties.
“The starting point [for establishing an OBA relationship] is the need to engender trust between the buyer and contractor,” Ashcroft said. “The way we do that is ask for the price from the contractor and say we’re going to ‘ring fence’ your profit. So regardless of how the constituent elements of the cost change, you will still get that profit regardless of what price is charged to us. And then what we do is look at all the additional cost items. We see that as being advantageous because we keep being told by the contractors that they want to protect their profit. So, very early on we ensure that they may be making a relatively small margin in the profit, but when the cost goes down, although the profit stays the same, as a percentage of the total price it certainly becomes a larger figure. And the second advantage to the contractor who agrees to OBA is a competitive advantage, because so many contractors say no. So for you to be the one that says ‘yes,’ you’ve differentiated yourself in the supply market.”
Sell-Side vs. Buy-Side
Despite the advantages that Ashcroft outlines, CMs are still very reluctant to acquiesce to requests to open their books. Tom Black, vice president of OEM sales and marketing at Bethlehem, Pa.-based B. Braun Medical Inc., contends that there is no need to beg for trust at the feet of customers when a CM can show OEM customers via its processes and experience that it is, in fact, as efficient as possible.
“I’ve asked what the advantages are to our OEM customers that have requested OBA because I want to know,” Black said. “At B. Braun we’re open to improving our relationship with all of our customers and improving the process. We’re very Lean focused throughout the organization, so I’d like to better understand how the OBA process improves a relationship. I haven’t gotten a good response to that other than an OEM stating that knowing what the cost would be, they would be able to assist us with looking to drive cost out of the system. And yet, we’ve been manufacturing for over 50 years here in the United States, so we’re pretty well polished with regards to our manufacturing process on our own floor.”
Springfield Spring’s Rodriques has, for the past decade, practiced what is known as open-book management at his company. He bought the company in 1986 as a minority shareholder and became the majority shareholder in 2000 with his partner, Tina Malley. It was after the events of Sept. 11, 2001, that he realized the company was in “dire straits,” as he called it. The bleak outlook for the economy following Sept. 11 was exceeded only by the credit crunch, housing market bubble burst and the Wall Street implosion of 2008. OEM business decreased dramatically and the economy was suffering. The problem was, he said, that he was effectively financially illiterate. Both Rodriques and Malley knew how to run a business with traditional accounting reports but the reports were generated after the activity. When it came down to getting the company out of the debt it had sunken into, he needed help. So he set about educating himself, and that experience convinced him that everyone at the company needed a solid understanding of exactly how the company worked. If every employee from the ground up was armed with education and information, they could all drive the ship together for a more successful, happier, profitable and competitively efficient company.
Rodriques turned to The Great Game of Business Inc., the educational arm of SRC Holdings Corporation, a manufacturing company also based in Springfield, for his education on open-book management. The “great game” business philosophy of open-book management was developed by SRC’s President and CEO Jack Stack. At the core of the “great game” is this tenet: “The best, most efficient, most profitable way to operate a business is to give everybody in the company a voice in saying how the company is run and a stake in the financial outcome, good or bad.”
Open-book management is actually mother to the practice of OBA, but that does not mean Rodriques bares his accounting soul with abandon to customers.
“In terms of transparency, I don’t send my customers my financial statements carte blanche,” Rodriques explained. “If someone does, though, say, ‘Hey we want to verify the solvency of your company financially, because if we’re going to make an investment in Springfield Spring, and you’re going to supply critical components that go into our medical devices, we want to make sure that there’s never a line stoppage. We want to make sure that you can buy material. We want to make sure that you are investing in new technologies, and so on.’ It’s hard to do that if you’re in financial trouble; if you have employees leaving; if you’re not paying your payroll tax; if you’re so heavily in debt that you can’t invest in new technologies or new equipment; or if your financial health is not in order. That would be financial transparency. That is different than transparent pricing.”
In fact, customers regularly send audit teams to Springfield Spring.
“During the audit process, customers are encouraged to interview our employees,” Rodriques said. “We want customers to openly ask questions about the best-practice tools and Lean Six Sigma activities our employees use each day to drive efficiency and eliminate non-valued added waste. These activities are the catalyst behind Springfield Spring’s component cost models. If we run our company lean and our financial ratios are clearly defined, measured and openly managed by everyone, this becomes the key ingredient to offering our customers fairly priced components—absent of costs required to cover waste and mismanagement.”
Though Rodriques is reluctant to hand over Springfield Spring’s actual costs and pricing structures, he is prepared to show financials to show where Springfield Spring adds value in global supply chains.
The problem with OBA is that even if a CM opens its books to a customer, there are numerous ways it could present a price or cost structure that is not entirely honest. Numbers can always be manipulated, and if there is not enough trust in the first place between an OEM and its supplier, who is to say that the cost structure presented is the whole story. Because pricing can be manipulated, Brian Farrington’s Ashcroft noted that it is important for companies on the buy-side to have a person or team assigned and willing to take the time to examine a CM’s cost and pricing structure, whether it’s presented openly or just partially.
Noting the difference between “cost” and “price,” Ashcroft outlined several ways in which open-book pricing can be manipulated:
Price skimming, which is the practice of artificially setting a price high in order to lower it over time, creating the illusion of increased efficiency;
• Penetration pricing, which is the practicing of “lowballing” just to win OEM business. Most experts interviewed by MPO agreed that penetration pricing only led to a lack of trust down the road when the CM is eventually forced to admit they make a “mistake” and have to raise the price of the component;
• Promotional pricing, or pricing that is dependent on non-cost related factors. For instance, pricing could be based on a CM sales team reaching the end of their quarter, or the end of a fiscal year. The scramble to win business or boost numbers can lead to CMs artificially raising or lowering desired profit margins;
• Prestige pricing, or pricing based on brand recognition and perceived desirability. “We’re not paying because it’s Saville Row suits or a Rolls Royce motor car,” Ashcroft said;
• Diversionary pricing. “What we’re finding is that part of a full set kit is provided at a very low price in order to give an opportunity for higher prices once we’re locked into that provider,” Ashcroft said;
• Target pricing. Suppliers do seek out the decision-making team on the buy-side organization, and if the supplier finds out what the customer perceives as a “correct” price, they will try and match that—which of course is not authentic pricing.
“Which is why,” Ashcroft concluded, “we’re interested in cost analysis.”
According to Rodriques, he and his team don’t practice any manipulative price presentation because it’s simply not worth it.
“If someone’s looking for me to be lowest price, I’m probably never your best supplier,” he said, explaining why he doesn’t cater to lowball requests and customers chasing rock-bottom pricing. “Let’s say a prospective client asks me if I’ll fill out this form and it’s 100,000 pieces of something that will go into a medical device; it’s a one-year contract, and I come in at 10 cents each. The next guy comes in at 8.5 cents. The next guy comes in at 13 cents, and someone comes in at 4 cents. They call me and say ‘Hey I got one at 4 cents.’ Well, enjoy. I’m not interested. At the end of the day, I believe that the value proposition of Springfield Spring is so much more than pricing.”
And this is where we circle back to the notion of socialism vs. capitalism. Even if a company is open book, the tenets of capitalism can still be in play, because customers (hopefully) seek more than just a low cost or the lowest-cost device or component. Companies such as B. Braun work diligently to provide value-added services that help attract and retain customers.
“We have an operational excellence program,” B. Braun’s Black said. “The real focus of that is continuous improvement from a quality standpoint, cost standpoint and process standpoint with regard to value. We want to eliminate all non-value added procedures or anything that just doesn’t add value to the product. We eliminate that with tools provided by our Lean program, so we’re continuously driving costs out and keeping our costs down for our customers, and passing that along to them as much as possible.”
The socialism vs. capitalism argument is relevant, Ashcroft allowed, when the buyer tries to dictate what the supplier’s profit margins should be.
“But in the Farrington approach to OBA, we say if that’s your profit, that’s your profit,” Ashcroft said. “It’s not for us to dictate what profit margin you should be making. We’re interested in looking at the costs. You may find that a contractor is brilliant with IP (intellectual property) in house but when they themselves are engaging with third parties down their supply chain, frankly they’re very bad buyers because they might think that they’re just passing on the cost to the end user. So we’re interested in learning how to get those costs down.”
Building Trust
Ashcroft noted that procurement teams on buy-side organizations, though oft-forgotten, are extremely valuable in making sure their companies actively promote their own agenda on how they want to engage with suppliers, and also making sure they don’t fall victim to the “vendor-side agenda.” CMs in the medical device sector, however, largely have been successful in convincing their customers that they have their best interests at heart. For instance, though B. Braun does not always buckle under pressure to open its books, it has succeeded in retaining customers who demand it nonetheless.
“We have been successful at projects where we did not give our pricing out but we were able to provide them with enough information to meet their objective,” Black said. “We’re up-front with them as we always are. We want to know what is it that they’re trying to accomplish, what information they need, and how the information they’re requesting is going to help the long termrelationship between B. Braun and the OEM. We want to get a feel from the beginning as we always do with any relationship on what the outcome needs to be for the customer to be successful with their project. If you get all the information up-front then you can figure out what it is you’re able to provide them in order to make the project a success.”
And when books are open, it is vital to treat cost and pricing information with as much discretion as IP.
“Ultimately, it is this issue of trust,” Ashcroft said “If we are going to decide to trust each other there need to be non-disclosure agreements in place so that very sensitive commercial information is not shared with third parties. Our view is that when it comes to pricing and cost models, they are treated as carefully as IP. In that regard it is not sustainable is somebody shares the supplier’s competitive edge, which includes the pricing. And hence the embedded relationship. It’s fair to say that the spot purchase—a one-off purchase of one machine, for example—is not going to lead to that level of that relationship. It’s definitely something that has to be long term. And in the medical device sectors, that’s about right, isn’t it? Because a lot of the OEMs have long-term relationships with their end users.”
And trust woks both ways. Morris Anderson’s Agran recently worked with a medical device CM client that regularly practices open-book accounting with its OEM customers.
“In one instance, [the company] opened up the books and said, ‘Listen guys, we’re losing money on your account. We need help,’” Agran recalled. “And the customer helped. The customer knew the pricing of where the CM needed to be, so they sat down and worked with my client to come up with areas for the company to concentrate on to know where they needed to improve. Whether it was in labor, component parts, whatever it was, they were able focus. So the CM sat down with their customer and said, ‘Listen, if we can’t do what you’re saying, we’ll stop doing business. But if you show us where we’re missing, we will work to correct that area. As long as we can correct it per our discussion, we should go produce it at the price that you think it should cost.’ They were willing to do that—and it gave them a focus.”
The Future of Open-Book Accounting
“I don’t see OBA becoming the norm,” Black said. “I think OEMs understand that suppliers need to be healthy. They always say from initial discussions on a project that they understand that the suppliers need to make acceptable margins. You just trust each other that you’re trying to provide them with the best products at the best quality at the best price and go from there. If it’s good for them then you proceed. If it isn’t, then you try to work out other options to get to the end objective that the OEM wants to accomplish.”
Unlike Black, Ashcroft is based in the United Kingdom and firmly believes in the opposite happening.
“The reason I say [open-book accounting will become the norm] is because when I was a boy they used to have people in corporations called estimators,” Ashcroft, who is in his late forties, said. “But what we’ve got now is the global economy where if I actually wanted to benchmark costs anywhere, I personally could do it online. If I had the wherewithal, I could do benchmarking activities myself. Here in the United Kingdom, we’ve got the benchmarking index, the European benchmarking network, corporate partnership program, price track, service track—there is so much data available to the buy-side that I really can’t see it continuing any longer. We know the bill of materials for the iPhone. We have such transparency access by the Internet that it really isn’t just going to carry on. The buy-side firms and organizations are just going to bring in a third party and say, ‘We’ve done some benchmarking and we believe that your price should be this matched against your current corporate profit rate.’ So it’s frankly inevitable that relationship-selling will decrease over time and it will become more of a commoditized process. I don’t mean that as a visionary—it’s not like I have some special insight. It’s just the way things are going to go.”
Open-book pricing (OBP), which is often called open-book accounting (OBA), is simply the practice of a seller showing all its costs to a customer. Put in terms of the medical device industry, this practice shows an original equipment manufacturer (OEM) customer exactly how much a contract manufacturer (CM) is spending on raw materials, labor and myriad other expenditure points, and exactly what its profit margin is. This, of course, opens a CM up to negotiation on what, perhaps, an OEM customer thinks an acceptable profit margin should be.
Once a company opens its books, Mulone contended, they lose the value proposition assigned to whatever their product is, whether it’s a process, a technology or otherwise. Its competitive edge is lost.
It is a sensitive area, and while the practice is not common in the medtech world, it is standard practice in markets such as consumer electronics and automotive.
Giant retailer Walmart, for instance, is known for pushing back on price with their products suppliers. Steve Agran, managing director of Chicago, IIl.-based financial and operational consulting firm Morris Anderson, explained that the mega-store’s logic is that the longer a supplier of goods or services has been doing a job, the more efficient it should become at its processes. Therefore, its costs should go down, and when its costs go down, the price Walmart pays should decrease as well. Of course, anyone capable of basic math can see that this model is not sustainable. Costs and prices cannot diminish infinitely, and economic factors can cause cost fluctuation in both directions.
“Very large consumer products companies … really heavily control the whole process because they’re so large, and they have very high quality control units,” Agran told MPO. “That’s a situation where [suppliers] don’t have a whole lot of choice. If you want the business, they require you to be open book with them.”
The automotive industry is perhaps the most well known industry for the practice of transparent pricing.
“If you take automotive manufacturers in Europe, you could buy gears from Germany and people would know the cost of those gears to four decimal places,” said Stephen Ashcroft, a business consultant with British procurement and supply chain consultancy Brian Farrington Ltd.
A 2011 report titled “Cost Transparency in Supply Chains: Demystification of the Cooperation Tenet,” which appeared in the German business journal Schmalenbach Business Review, found from interviews that the automotive industry has some of the highest levels of cost transparency.
“Some automotive purchasing experts even state that they have cost transparency for their total purchasing volume,” according to the report. “Purchasing experts who use OBA often require their suppliers to provide cost information through so-called supplier cost breakdown forms that differ in structure and in level of detail, but usually provide cost information for every component of the bill for materials, including both materials and production costs and the cost of items that comprise them. Moreover, overhead costs and profits are usually explicitly mentioned.”
This prevalence of OBA in technical industries such as automotive does not translate to the medical device industry, even though the industry is highly technical and competitive. The reasons for this do not go beyond simply that suppliers are extremely dubious about sharing what they see as “secrets” with buyers. This is not about tricking OEM customers; rather, it is about the lack of trust that OEMs will fully understand the whys and wherefores of CMs’ cost structures. And similarly, the reason OEMs would love OBA from their suppliers is due to an underlying lack of trust that the supplier is giving them the best deal possible.
However, the buying and selling of medical devices and medical device components is not about getting “the best deal possible,” as Norm L. Rodriques, president and self-titled “chief of fun and inspiration” at Springfield Spring Corporation based in Longmeadow, Mass., iterates:
“Imagine this scenario. You or a loved one are just about to be wheeled into the O.R. The surgeon greets you and says: ‘Okay, you have one more decision to make. I need to use a special device for this delicate operation. One is made by a well-known U.S.-based medical device manufacturer and will cost you $119.99. Here is another one made by a lower-cost manufacturer in Asia, and it will cost you only $29.99. The one by the U.S.-based device manufacturer is tested and validated for performance. The less-expensive one is, well, just that—less expensive. Which would you prefer I use and you pay for?’”
Point made. But the Medtronics and Johnsons & Johnsons of the world—any medical device company worth its salt—would not be so naïve as to chase down ridiculously low prices just for the sake of it. As Ashcroft explains, the desire for OBA is the desire for a trusting relationship and a fair deal for both parties.
“The starting point [for establishing an OBA relationship] is the need to engender trust between the buyer and contractor,” Ashcroft said. “The way we do that is ask for the price from the contractor and say we’re going to ‘ring fence’ your profit. So regardless of how the constituent elements of the cost change, you will still get that profit regardless of what price is charged to us. And then what we do is look at all the additional cost items. We see that as being advantageous because we keep being told by the contractors that they want to protect their profit. So, very early on we ensure that they may be making a relatively small margin in the profit, but when the cost goes down, although the profit stays the same, as a percentage of the total price it certainly becomes a larger figure. And the second advantage to the contractor who agrees to OBA is a competitive advantage, because so many contractors say no. So for you to be the one that says ‘yes,’ you’ve differentiated yourself in the supply market.”
Sell-Side vs. Buy-Side
Despite the advantages that Ashcroft outlines, CMs are still very reluctant to acquiesce to requests to open their books. Tom Black, vice president of OEM sales and marketing at Bethlehem, Pa.-based B. Braun Medical Inc., contends that there is no need to beg for trust at the feet of customers when a CM can show OEM customers via its processes and experience that it is, in fact, as efficient as possible.
“I’ve asked what the advantages are to our OEM customers that have requested OBA because I want to know,” Black said. “At B. Braun we’re open to improving our relationship with all of our customers and improving the process. We’re very Lean focused throughout the organization, so I’d like to better understand how the OBA process improves a relationship. I haven’t gotten a good response to that other than an OEM stating that knowing what the cost would be, they would be able to assist us with looking to drive cost out of the system. And yet, we’ve been manufacturing for over 50 years here in the United States, so we’re pretty well polished with regards to our manufacturing process on our own floor.”
Springfield Spring’s Rodriques has, for the past decade, practiced what is known as open-book management at his company. He bought the company in 1986 as a minority shareholder and became the majority shareholder in 2000 with his partner, Tina Malley. It was after the events of Sept. 11, 2001, that he realized the company was in “dire straits,” as he called it. The bleak outlook for the economy following Sept. 11 was exceeded only by the credit crunch, housing market bubble burst and the Wall Street implosion of 2008. OEM business decreased dramatically and the economy was suffering. The problem was, he said, that he was effectively financially illiterate. Both Rodriques and Malley knew how to run a business with traditional accounting reports but the reports were generated after the activity. When it came down to getting the company out of the debt it had sunken into, he needed help. So he set about educating himself, and that experience convinced him that everyone at the company needed a solid understanding of exactly how the company worked. If every employee from the ground up was armed with education and information, they could all drive the ship together for a more successful, happier, profitable and competitively efficient company.
Rodriques turned to The Great Game of Business Inc., the educational arm of SRC Holdings Corporation, a manufacturing company also based in Springfield, for his education on open-book management. The “great game” business philosophy of open-book management was developed by SRC’s President and CEO Jack Stack. At the core of the “great game” is this tenet: “The best, most efficient, most profitable way to operate a business is to give everybody in the company a voice in saying how the company is run and a stake in the financial outcome, good or bad.”
Open-book management is actually mother to the practice of OBA, but that does not mean Rodriques bares his accounting soul with abandon to customers.
“In terms of transparency, I don’t send my customers my financial statements carte blanche,” Rodriques explained. “If someone does, though, say, ‘Hey we want to verify the solvency of your company financially, because if we’re going to make an investment in Springfield Spring, and you’re going to supply critical components that go into our medical devices, we want to make sure that there’s never a line stoppage. We want to make sure that you can buy material. We want to make sure that you are investing in new technologies, and so on.’ It’s hard to do that if you’re in financial trouble; if you have employees leaving; if you’re not paying your payroll tax; if you’re so heavily in debt that you can’t invest in new technologies or new equipment; or if your financial health is not in order. That would be financial transparency. That is different than transparent pricing.”
In fact, customers regularly send audit teams to Springfield Spring.
“During the audit process, customers are encouraged to interview our employees,” Rodriques said. “We want customers to openly ask questions about the best-practice tools and Lean Six Sigma activities our employees use each day to drive efficiency and eliminate non-valued added waste. These activities are the catalyst behind Springfield Spring’s component cost models. If we run our company lean and our financial ratios are clearly defined, measured and openly managed by everyone, this becomes the key ingredient to offering our customers fairly priced components—absent of costs required to cover waste and mismanagement.”
Though Rodriques is reluctant to hand over Springfield Spring’s actual costs and pricing structures, he is prepared to show financials to show where Springfield Spring adds value in global supply chains.
The problem with OBA is that even if a CM opens its books to a customer, there are numerous ways it could present a price or cost structure that is not entirely honest. Numbers can always be manipulated, and if there is not enough trust in the first place between an OEM and its supplier, who is to say that the cost structure presented is the whole story. Because pricing can be manipulated, Brian Farrington’s Ashcroft noted that it is important for companies on the buy-side to have a person or team assigned and willing to take the time to examine a CM’s cost and pricing structure, whether it’s presented openly or just partially.
Noting the difference between “cost” and “price,” Ashcroft outlined several ways in which open-book pricing can be manipulated:
Price skimming, which is the practice of artificially setting a price high in order to lower it over time, creating the illusion of increased efficiency;
• Penetration pricing, which is the practicing of “lowballing” just to win OEM business. Most experts interviewed by MPO agreed that penetration pricing only led to a lack of trust down the road when the CM is eventually forced to admit they make a “mistake” and have to raise the price of the component;
• Promotional pricing, or pricing that is dependent on non-cost related factors. For instance, pricing could be based on a CM sales team reaching the end of their quarter, or the end of a fiscal year. The scramble to win business or boost numbers can lead to CMs artificially raising or lowering desired profit margins;
• Prestige pricing, or pricing based on brand recognition and perceived desirability. “We’re not paying because it’s Saville Row suits or a Rolls Royce motor car,” Ashcroft said;
• Diversionary pricing. “What we’re finding is that part of a full set kit is provided at a very low price in order to give an opportunity for higher prices once we’re locked into that provider,” Ashcroft said;
• Target pricing. Suppliers do seek out the decision-making team on the buy-side organization, and if the supplier finds out what the customer perceives as a “correct” price, they will try and match that—which of course is not authentic pricing.
“Which is why,” Ashcroft concluded, “we’re interested in cost analysis.”
According to Rodriques, he and his team don’t practice any manipulative price presentation because it’s simply not worth it.
“If someone’s looking for me to be lowest price, I’m probably never your best supplier,” he said, explaining why he doesn’t cater to lowball requests and customers chasing rock-bottom pricing. “Let’s say a prospective client asks me if I’ll fill out this form and it’s 100,000 pieces of something that will go into a medical device; it’s a one-year contract, and I come in at 10 cents each. The next guy comes in at 8.5 cents. The next guy comes in at 13 cents, and someone comes in at 4 cents. They call me and say ‘Hey I got one at 4 cents.’ Well, enjoy. I’m not interested. At the end of the day, I believe that the value proposition of Springfield Spring is so much more than pricing.”
And this is where we circle back to the notion of socialism vs. capitalism. Even if a company is open book, the tenets of capitalism can still be in play, because customers (hopefully) seek more than just a low cost or the lowest-cost device or component. Companies such as B. Braun work diligently to provide value-added services that help attract and retain customers.
“We have an operational excellence program,” B. Braun’s Black said. “The real focus of that is continuous improvement from a quality standpoint, cost standpoint and process standpoint with regard to value. We want to eliminate all non-value added procedures or anything that just doesn’t add value to the product. We eliminate that with tools provided by our Lean program, so we’re continuously driving costs out and keeping our costs down for our customers, and passing that along to them as much as possible.”
The socialism vs. capitalism argument is relevant, Ashcroft allowed, when the buyer tries to dictate what the supplier’s profit margins should be.
“But in the Farrington approach to OBA, we say if that’s your profit, that’s your profit,” Ashcroft said. “It’s not for us to dictate what profit margin you should be making. We’re interested in looking at the costs. You may find that a contractor is brilliant with IP (intellectual property) in house but when they themselves are engaging with third parties down their supply chain, frankly they’re very bad buyers because they might think that they’re just passing on the cost to the end user. So we’re interested in learning how to get those costs down.”
Building Trust
Ashcroft noted that procurement teams on buy-side organizations, though oft-forgotten, are extremely valuable in making sure their companies actively promote their own agenda on how they want to engage with suppliers, and also making sure they don’t fall victim to the “vendor-side agenda.” CMs in the medical device sector, however, largely have been successful in convincing their customers that they have their best interests at heart. For instance, though B. Braun does not always buckle under pressure to open its books, it has succeeded in retaining customers who demand it nonetheless.
“We have been successful at projects where we did not give our pricing out but we were able to provide them with enough information to meet their objective,” Black said. “We’re up-front with them as we always are. We want to know what is it that they’re trying to accomplish, what information they need, and how the information they’re requesting is going to help the long termrelationship between B. Braun and the OEM. We want to get a feel from the beginning as we always do with any relationship on what the outcome needs to be for the customer to be successful with their project. If you get all the information up-front then you can figure out what it is you’re able to provide them in order to make the project a success.”
And when books are open, it is vital to treat cost and pricing information with as much discretion as IP.
“Ultimately, it is this issue of trust,” Ashcroft said “If we are going to decide to trust each other there need to be non-disclosure agreements in place so that very sensitive commercial information is not shared with third parties. Our view is that when it comes to pricing and cost models, they are treated as carefully as IP. In that regard it is not sustainable is somebody shares the supplier’s competitive edge, which includes the pricing. And hence the embedded relationship. It’s fair to say that the spot purchase—a one-off purchase of one machine, for example—is not going to lead to that level of that relationship. It’s definitely something that has to be long term. And in the medical device sectors, that’s about right, isn’t it? Because a lot of the OEMs have long-term relationships with their end users.”
And trust woks both ways. Morris Anderson’s Agran recently worked with a medical device CM client that regularly practices open-book accounting with its OEM customers.
“In one instance, [the company] opened up the books and said, ‘Listen guys, we’re losing money on your account. We need help,’” Agran recalled. “And the customer helped. The customer knew the pricing of where the CM needed to be, so they sat down and worked with my client to come up with areas for the company to concentrate on to know where they needed to improve. Whether it was in labor, component parts, whatever it was, they were able focus. So the CM sat down with their customer and said, ‘Listen, if we can’t do what you’re saying, we’ll stop doing business. But if you show us where we’re missing, we will work to correct that area. As long as we can correct it per our discussion, we should go produce it at the price that you think it should cost.’ They were willing to do that—and it gave them a focus.”
The Future of Open-Book Accounting
“I don’t see OBA becoming the norm,” Black said. “I think OEMs understand that suppliers need to be healthy. They always say from initial discussions on a project that they understand that the suppliers need to make acceptable margins. You just trust each other that you’re trying to provide them with the best products at the best quality at the best price and go from there. If it’s good for them then you proceed. If it isn’t, then you try to work out other options to get to the end objective that the OEM wants to accomplish.”
Unlike Black, Ashcroft is based in the United Kingdom and firmly believes in the opposite happening.
“The reason I say [open-book accounting will become the norm] is because when I was a boy they used to have people in corporations called estimators,” Ashcroft, who is in his late forties, said. “But what we’ve got now is the global economy where if I actually wanted to benchmark costs anywhere, I personally could do it online. If I had the wherewithal, I could do benchmarking activities myself. Here in the United Kingdom, we’ve got the benchmarking index, the European benchmarking network, corporate partnership program, price track, service track—there is so much data available to the buy-side that I really can’t see it continuing any longer. We know the bill of materials for the iPhone. We have such transparency access by the Internet that it really isn’t just going to carry on. The buy-side firms and organizations are just going to bring in a third party and say, ‘We’ve done some benchmarking and we believe that your price should be this matched against your current corporate profit rate.’ So it’s frankly inevitable that relationship-selling will decrease over time and it will become more of a commoditized process. I don’t mean that as a visionary—it’s not like I have some special insight. It’s just the way things are going to go.”