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ICG Risk Blog - [ Cost pressures on supply tiers prompt loss of supplier intellectual property ]

Cost pressures on supply tiers prompt loss of supplier intellectual property

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Suppliers worry that design reviews by an OEM prior to contract award are efforts to extract price concessions, extracting information to compare (1) proprietary cost buildups and (2) ideas among competing suppliers. OEMs, for their part, may be mistaken in asking the supplier for full disclosure of the supply chain during this period of minimum trust and maximum fear, a more common occurrence among the three "US" OEMs than Toyota or Honda.

In reality, the supplier has often not gone to the cost and effort to fully detail the part. OEM staff profess outrage when they 'find out' this is the case. We ask them what they expected. Would they not do the same were circumstances reversed?

The following [sanitized] exchange involves AutoCo and CarCo, two automotive OEMs, MetalCo, a Tier One supplier, and MasterCo, a related subsidiary. AutoCo is under financial pressure to produce improved results. Such pressure always creates hot spots under excruciating demand, to the point of program cancellation and (participant) job loss.

This redacted segment illustrates how financial pressures on AutoCo were converted into a loss of intellectual property by the supplier (MetalCo). Once compromised, the intellectual property was transferred without controls, more easily coming to the attention of both competitors and collectors.

This example includes impacts from as yet unabsorbed mergers, resulting from suppliers' efforts to build capacity in the face of OEM requirements. Problems often extend beyond regularizing amortization when some suppliers fail to understand that the OEM had asked for increased capacity or capability, not increased cost, and thus have failed to restructure the acquisition. The supplier may be too distracted, may not know how to do the analysis, or did not want to interrupt its current relations with its subsuppliers to perform the streamlining. When we see a supplier that has not restructured its acquisition costs, we know that they have not restructured their supply chain's IP protection.

In this case, pressure was transmitted from the OEM (AutoCo) to a specific program that was under threat of cancellation. As we so often see in such cases, loose corporate guidance and personal fear combine to put the supplier at maximum risk:

AutoCo Finance: I have checked your SEC 10K filing and it states that MetalCo uses a straight line, 10-yr. amortization of capital investment. Why are you using a 7-year amortization of capital investment with us in this quote?

MetalCo Controller: Were you looking at the 10K for MetalCo or for MasterCo?

AutoCo Finance: MetalCo.

MetalCo Controller: We are trying to commonize our accounting practices after the mergers and have yet to accomplish this.

AutoCo Finance: Can we assume then for this [part for model year 20XX] that you will have this straightened out and adjust the piece price down to reflect a 10-year amortization?

MetalCo Sales: We must weigh the risks we take on and make certain that we are acting responsibly for our health, for our shareholders. We have weighed our risk and feel that we must use this 7-year amortization. Can we be sure that AutoCo won't take the business elsewhere before ten years of production? Should we risk being stuck with this capitalization and no business to pay for it?

AutoCo Finance: I think that we are showing commitment to do business with you by continuing our discussion and calling for this session to spend two days trying to understand the best way to invest in this machine line and brainstorm ideas for leaning that process.

MetalCo Sales: I don't think we want to talk about this in this forum. Well, okay! Let's get it out on the table. We are all thinking about it. We are sharing information and cooperating despite the fact that you continue to market test and will probably source lowest price quote, no matter how cooperative we have been, how good our product is, how flexible our proposed process is to deal with your changing volumes. We are competitive.

AutoCo Buyer: I think you are talking about the past. It has been month's since we were market testing. Your quote has improved (reduced) since then. We are here to find the best way to design this line and help reduce capital, labor and tooling costs.

AutoCo Finance: I think the fact that we keep meeting with you and are hosting this session evidences that we are serious in pursuing you as the supplier.

MetalCo Sales: You are market testing right now and we know it. Where is your intent letter? We haven't received it!

AutoCo Buyer: There is no market testing currently.

MetalCo Sales: Unfortunately, our tool suppliers talk and we are aware that one of them is participating in a quote for a competitive supplier for this business. Of course, every idea that we have had for this part is explained to the machine supplier so that they can quote machinery for our line. Then, they incorporate that idea when they quote to our competitors in your market test.

AutoCo Finance: The only reason that we would seek other costs would be to try to understand if your costing is competitive. We feel that we are demonstrating our interest and probable commitment to you.

The AutoCo staff have now indirectly admitted that they bootlegged one supplier's data to a competitor(s) in order to secure a part at lower cost - either as price leverage upon MetalCo or by contracting to another supplier using MetalCo's IP.

Additionally, in a subsequent part of this meeting, the process of another OEM, CarCo, was mentioned as a possible solution. It would take little effort to identify the CarCo supplier whose IP was compromised.

It is an understatement to say that this is a typical instance in US automotive OEM-Supplier relationships, that these relationships are porous and that as a result their IP protection is poor.

The unintended consequence is that, unknown to AutoCo leadership, AutoCo staffers had broadcast MetalCo's information through a diffuse and uncontrolled network of suppliers and subsuppliers, a process that we see as more the norm than the exception. Unless the supplier puts in place workable security controls at the business level to deal with IP protection (such as probes from an alerted collector seeking further data on proprietary processes), MetalCo can only expect further losses through these 'normal' supply chain negotiations.

Postscript: The pressure on AutoCo continues to the point that, during piece part negotiations, suppliers are told when they cannot meet AutoCo's target price: "Meet this price or we take your [insert part name here] to China."

Gordon Housworth



InfoT Public  Intellectual Property Theft Public  Risk Containment and Pricing Public  Strategic Risk Public  

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