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"Forced" Cost Reduction - How to Respond Print
A negotiation tactic that has gained popularity among many large companies is the forced cost reduction approach. This tactic has been used for several years, but many more companies have used this tactic since the year 2000. Examples of companies that use "forced" cost reduction are: Ford, General Electric, General Motors, CNH and Daimler-Chrysler.  Let's explore the origins of forced cost reduction and how you should respond if this is used be your customer. The forced cost reduction tactic is an example of a win-lose strategy of negotiation. Negotiation guru, Herb Cohen, in his book, You Can Negotiate Anything, describes this approach as the "Soviet" negotiating style inspired by the actions of Nikita Khrushchev at the United Nations in the early 1980s.  The Soviet premier pounded his shoe in anger on the table and walked out of the meeting.  Later photos showed that he had both of his shoes on his feet. The shoe he used to pound on the table was an extra shoe he brought with him. His seemingly irrational and spontaneous actions were planned! According to Cohen the Soviet negotiating approach involves:
- Being bullish, personally offensive and emotional
- Demanding immediate price reductions that reduce supplier margins
- Not honoring existing contracts
- Threatening a loss of all business if prices aren't reduced.

Jose Ignacio Lopez and forced negotiation

In my view the man responsible for the new popularity of using the Soviet or forced negotiation approach in North America is Jose Ignacio Lopez Arriortua.  The business career of
Mr. Lopez is fascinating.  He was born in Spain's Basque region and earned a doctorate degree in industrial engineering from the University of Bilbao.  In his early business career, Jose Lopez worked for Firestone and Westinghouse before joining General Motors in Spain (Kerwin).
In 1986 he was promoted to chief of supply for GM- Spain.  Two years later he was named purchasing director for GM's European operations. President Jack Smith subsequently handpicked Lopez to run the North American purchasing operations for General Motors, which he did for less than one year. In 1993 Lopez left GM and was hired by Volkswagen as the head of worldwide production with a salary of $20 million over 5 years (Berkowitz). In his one year in North America he implemented a negotiating approach known by GM suppliers as the "Lopez effect. Many GM suppliers are still today talking about the Lopez effect and it became the blueprint for the forced cost reduction.

The Lopez approach to negotiating

Lopez established teams of buyers- he called his "warriors"- whose mission it was to wage war on supplier costs. The warriors were encouraged to be "lean and mean", and Lopez strongly encouraged his buyers to follow a diet of fruit and nuts (Kerwin).  Buyers were told to wear their watches on their right wrists to remind them their job was never done.  Lopez preached to suppliers that it was an honor for suppliers to do business with General Motors. 
All existing contracts were voided and all business was opened to the lowest-priced supplier.  Supplier blueprints were passed to competition ignoring intellectual property rights. GM only paid suppliers 90 to 95 percent of their invoices prices.  The GM buyers dictated to suppliers what the new prices would be.

Results of Lopez's "forced" cost reduction technique

The short-term result of the Lopez approach was a dramatic cost reduction at General Motors.  Costs were reduced by $2.3 billion from the purchased turnover of $50 billion (Rigsbee). In the longer term, the Lopez effect caused many suppliers to go out of business. Other suppliers switched product development resources to Ford, Toyota and Daimler- Chrysler.  They no longer wanted to do business with GM.

How to respond to the forced cost reduction approach

When I was in purchasing at CNH, we adopted the forced cost reduction strategy with our suppliers. Many other companies are using this method to achieve short-term cost reductions from suppliers.  What should you do if your customer sends you a forced cost reduction letter?

- What is your position?  Can your customer switch to another supplier and reduce costs, including costs of quality and supply chain?  If you are the low-cost supplier, you are in a great position.  The customer isn't going to switch suppliers and pay a higher cost!
- What are the switching costs?    For some products there are very high costs involved in switching suppliers. These costs include: buying new tooling, engineering and quality approval, testing and the costs of changing purchase orders and computer records. Depending on the product, it may take over a year to switch sources. Your customers, in most cases, don't want to switch suppliers and absorb the switching costs.
- What is the customer going to do? -  Will the customer grant your new business?  Consider granting a rebate if the customer places additional volumes with you instead of a granting a reduction of price.  Can you reduce prices if the specifications, materials or designs are changed?  Will the customer purchase larger quantities of low-margin materials?  What is the customer willing to do to help you reduce your costs?  Make cost reductions conditional on customer actions that reduce your costs.

The three questions above will assist you in responding to your customers forced cost reduction letter.
The following two actions will help you in the long-term so long term you are in a stronger position.

- Diversify your customer base- If the customer is not reasonable, your long-term strategy should be to diversify. If your customer uses the win- lose approach to negotiation you will want to find a way to get even in the long term.  Find other customers so you are not dependant on customers who use the forced cost reduction approach.

- Turn this into a win/win result - Many of our suppliers reviewed our forced cost reduction demands and they responded with positive suggestions on how we could work together and take costs out of the process. Many suppliers have aggressive year- over- year cost reduction programs, and these are suppliers we all want.

Conclusion - The forced cost reduction approach was developed from the Soviet negotiating style and made popular by Jose Lopez.  Forced cost reduction is a quick and increasingly popular method to reduce short- term costs. However, a win-lose strategy will damage the customer-supplier relationships in the long term- use it with caution, and if your customer institutes a "forced" cost reduction with your company remember my tips:
- What is your position?
- What are the switching costs?
- What is the customer going to do if you answer "no"?
- Diversify your customer base
- Turn it into a win/win result

 

By Mark S. Miller, C.P.M., C.I.R.M.    (c) 2006

Associate Professor- Carthage College

 References:

Cohan, Herb, You Can Negotiate Anything, Lyle Stuart, Inc., 1980

Kerwin, Kathleen, Schiller, Zachary, "GM Braces For Life After Lopez," Business Week, March 29, 1993, page 28

Berkowitz, Phillip O., Cisneros, Mary Elizabeth, "Avoiding the Lopez Effect", ebglaw.com.

Rigsbee, Edwin Richard, "The Boomerang Always Returns", speakers.com

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