Price vs Cost

PRICE VS COST: A DEGREE IN STUPIDITY

“It was a dark and stormy night…” which is the way that most horror stories begin. But this was a horror story that would have long-term inpact and would affect basically thousands of people.

I was sitting in my office late one night in beautiful downtown Bangkok, Thailand. Being one of the senior managers of a computer disk drive company in Bangkok, I usually stayed late to catch up on some work in make sure that everything was ready for the next day. Now to put things into perspective, I had been in the computer industry for almost 30 years in in the areas of design and manufacturing. So, I think that I had a pretty good idea of how manufacturing works and what it would take to turn out a good product.

Now to be fair, this company that I was working for (name withheld to protect the “guilty”), was known for developing one of the highest quality products in the industry. In fact, one of its big selling points was the extremely long mean time between failure (MTBF). So, we had a good product and we were proud of what we had done. The company had started a program of quality improvement that had been taught by a follower of Dr. Deming’s principles. We had all looked at ways of reducing waste, improving processes, working with our suppliers and generally getting all of the workforce involved in some very “proactive” programs. The company had been operating for about three years in Thailand, and I thought that the future was looking bright. Unfortunately, the lessons we were learning on the plant floor, had not made it to corporate back in the United States.

Then the phone rang. You have to understand, that by now it is close to 10 PM in Bangkok which means that it’s about 8 AM in Southern California, the corporate headquarters of our company. I was curious about who might be calling at this time of night so, I answered: “hello?”. Much to my surprise, the Chairman of our company was on the phone. “Oh, I’m glad that I caught you. I didn’t think that you would be working this late.” As I wanted to impress the big boss, I said, “no problem, I was just finishing up some work before going home. What can I do for you?” (Even at 10 a clock at night I want to sound enthusiastic and helpful). He said, “I’m calling to tell you that we’ve added a new member to our corporate staff. He is our new Finance VP. He’s coming on board and he’s got some very good ideas about how we can reduce our expenses, increase our revenue, and make the company much more competitive. I’m sure that you’ll enjoy working with him.” Well, now I’m impressed. We finally have somebody at corporate who knows how to juggle numbers and it looks like that things are going to get better in the future. “That’s terrific! I’m looking forward to working with him. Tell me, what experience does he have?” There was a long pause on the long-distance connection. Finally the answer came back,” Oh, he comes to us with a lot of credentials. He has an MBA from (again, name withheld to protect the unknowing)”. “That’s nice”, I said, “but, tell me what experience does he have?”. Once again there was a long pause which I don’t think was because of the long-distance telephone line. “I don’t think you understand, he comes highly recommended, and has come to us with a lot of cost-saving ideas!”. I’m beginning to sense that the chairman is getting a little bit upset by this time. “Well, fine, put him on and let’s talk”.

A fairly young sounded individual got on the line. “Well, Paul, I’m glad to meet you. I’ve heard a lot about you.” (I think he’s trying to make me feel good) “I have a lot of ideas about how we can reduce our costs and with all of your experience, I’m sure that I can rely on you to help us do this. I see that you been spending a lot of time on quality training with staff, which is good. But I want to try to reduce some of that training so that we can put our efforts in some other areas. One of the first things that I need your help with is working with our suppliers. As you know we have a lot of suppliers there in Bangkok, and they’re all very competitive. So I want you to go out for competitive bid and let select those with the lowest price so that we can increase our profit margin”.

As I said at the very beginning, “it was a dark and stormy night…”. Now, my momma didn’t raise any fools, and I had spent a lot of time trying to understand much of what Dr. Deming had said. Certainly, the idea of “Not selecting suppliers based on price alone” certainly made a lot of sense to me. And being in all parts of the manufacturing business I knew, how many problems we had with our suppliers. I knew, that we were constantly having to do 100% inspection on incoming parts because, we had problems with our suppliers. I decided to confirm my understanding of what our new MBA VP meant with his request.

“So, let me make sure I understand. You want me to go out and select the lowest priced supplier for our parts that were going to use in manufacturing. Is that correct?” Finally, the words came through the phone that I was fearing the most, “yes, you’ve got the idea. Now I’m sure that you’re going to help us meet our cost reduction goals”.

“I just want to make sure, you do understand the difference between ‘price’ and ‘cost’? They did cover that in your MBA course didn’t they!!” (I didn’t really say that, but I wanted to) “of course I do”, he said. So I told him that I would get back to him and let him know what I could do to help.

I did what any intelligent, hard-working, production oriented guy would do. I went out, had a couple of beers, and then returned back to my office. By now, it’s almost midnight in Bangkok and 10 o’clock in the morning in Southern California. I called corporate headquarters, and the office of the Chairman. Sure enough our new MBA financial VP was in his office charting out the future course of our company. I called. “Well, I just want to get back to you to let you know how much I appreciate all of your ideas, and how much your experiences are going to help our company toward a brighter financial future. And, I’m certainly going to do my part to help you reduce your costs.” I can almost hear the excitement in his voice as he said, “terrific! I like to hear your ideas”. I wanted him to know that I was sincere, so I said, “I thought you would, so go check your fax machine.” There were a few moments of silence as he went over to the fax machine. I could hear the fax paper being torn off the machine as he called to our chairman. There a lot of hushed discussions that went on and then the chairman got back on the phone. “What’s this?” He said. “I think, it’s quite simple. It’s my resignation” I could tell there was some confusion in his voice as he said, “but you can’t do that, we need you to help implement all of these changes!”. I wanted to make sure that there was no misunderstanding, so I said, “I understand, but I think the time has come for me to perhaps consider some other options. I will hand things over to my staff tomorrow and my resignation will be effective the end of the week”. And I hung up the phone.

Without going into a lot of details there was a lot of discussion about my leaving the company and why. But the bottom line was, I could see failure in the future, you don’t start selecting suppliers on a low price alone, because the costs of accepting poor quality parts, trying to inspect them, trying to rework them, and having production held up because of lack of good parts is going to outweigh any higher price that a good supplier was going to charge. I knew that the company was going to be in real trouble.

FAST FORWARD IN TIME THREE YEARS…

I had left the company, and started my own training and consulting firm. I was happy in my work and had the opportunity to help other companies not make the same mistake that my prior company had made. And then, I got another telephone call from one of my old employees. “You’ll never believe this, but the company has declared bankruptcy, and they’re auctioning off all of the assets next week. If you want to come and bid on some of the old equipment I think you’ll find it interesting.” Well, I did go. I did buy a few things for my current employees. The interesting thing was I purchased for a few dollars things that I had spent hundreds of dollars for when I was working with the company. But now the company was gone.

Why? The answer was simple. The MBA VP did have his way. They did go out for competitive bid and they did start selecting suppliers because their price was the lowest. As a result, the increased costs of inspection, rework, scrap, and delay in productivity finally cost him so much that they could not continue to run the company. So, the difference between price and cost can be significant. But a degree in stupidity can be even more deadly because if people cannot recognize the hidden costs of nonconformance….their decisions will ultimately affect employees, customers and all the other related stakeholders of the company.

Solution? DON’T select suppliers based on price alone or you’ll have “…a dark and stormy night…”

 

 

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