Small Firms Are Better Partners than Holding Companies

Small Firms Are Better Partners than Holding Companies

If you want to work with a supplier who will work with you as a partner so both parties can benefit, you have a better chance of this with smaller, family-owned businesses than large holding companies.

 

U.S. Department of Labor studies consistently show that small, privately-held manufacturers are the employment backbone of our industrial economy. Many such companies are family-owned and run. In my mind there are several intrinsic traits that differentiate these types of firms, including:

  • A keen sense of pride. Sure, people that run larger, publicly-held firms can also be proud of what they do. But it is a different type of pride. In my experience owners of small, family-owned/run companies tend to regard their role as a kind of stewardship regarding the welfare of both their employees and the communities they operate in. If you doubt this, just look at the walls of their offices to see the acknowledgements of local charitable organizations for their support, particularly those that are youth-focused.
  • Flexibility. Small family-owned/run firms are not restricted by the rigid processes and rules that tend to exist in larger, publicly-held firms. If a customer asks one to try something that is out of their normal powerhouse, they are usually open to trying it. Again, in my experience, this can do attitude usually exists in spades at small, family-owned/run companies.
  • Small family-owned/run suppliers are extremely loyal to customers that treat them fairly. They care about their customer’s success and engage with them in a collaborative—not a commercial—way.

 

Small family-owned/run firms tend to be in it for the long haul and certainly don’t view manufacturing as a “get rich quick” scheme. They are willing to risk dips in quarterly financial results to make sure their customers are well supported. Their owners hope to get an honest return on their time and investment but seem to get the bulk of their satisfaction through the act of solving problems and just plain old making things.

The antithesis of this type of a small family-owned/run firm is the holding company. A holding company buys and manages other companies, usually manufacturers. They are typically run by financial people looking to maximize return on their investment in any way possible. Consequently, a holding company’s aim in buying a manufacturer is strictly commercial. They maximize ROI by either:

  • Turning their purchases into cash cows—slashing costs (translate: headcount and pay) and milking them for all they’re worth. They know that this will probably lead to deterioration of their companies but figure this is ok as long as they manage to achieve the needed payback before this happens.
  • Cleaning up their balance sheets (usually again, through headcount and pay cuts, as well as shutting down portions of the companies that don’t meet their ROI targets) and then selling off for a handsome profit. You know what I’m talking about. Sort of like the reality TV shows where people buy properties on the cheap, fix them up cosmetically, and then try to flip them.

As a technical buyer I had to deal with several cases where a small family owned/run supplier sold out to a holding company. This often occurred during a generational transition when the founder’s kids decided to take what they could get so they could go off and live easier lives, i.e., running a manufacturing firm is usually a 24 x 7 commitment and—take my word for it—not easy. And since holding companies represent one of the few options privately-owned businesses have when cashing out, they often sell for well under par. The aftermath of such sales usually doesn’t bode well for OEM customers that don’t have readily available alternative options such that they can’t be leveraged.

One of the tasks I was given when I got into management was to put together a divisional supplier development group. Believe it or not, one of the largest challenges in launching this type of a function is finding suppliers who will accept the offer of assistance (maybe not so hard to understand given how low the trust factor has become between OEMs and their suppliers!). Because as a technical buyer I had developed some pretty healthy working relationships with ownership of several small, family-owned/run companies, these were the suppliers I hoped to mine in developing proof-of-concept case studies of our supplier development strategy and process. And, in fact, I was generally successful in getting a foot-in-the-door when approaching them.

One of the targeted suppliers, though, resisted my offers to work with them. I was a bit surprised by this. The situation became clear, however, when the buyer who now worked with them came by my desk one day to tell me that he had just been informed that they had been purchased by a holding company, which I’ll refer to as 666 Corp. I was further surprised when the buyer went on to say that the previous owner had told the new owners about our offer of supplier development assistance and that they wanted to talk to me about it. Whoa, that sure seemed like a horse-of-a-different-color given my experiences with holding companies!

A day or two later I was in this holding company’s factory manager’s office laying out the parameters and framework of our assistance. He told me he wanted our help in developing a total factory reconfiguration. I was excited since most of the assisted suppliers up to that point had only wanted help in tweaking their current operations, i.e., this meant that the potential for cost reduction would be greater. I explained to the guy that we worked under a shared savings formula where the goal was to make the pie bigger, allowing both parties to benefit. He agreed and signed the standard memorandum of understanding (MOU).

The supplier in question was a manufacturer of hydraulic components. Their products were mid-range in complexity—meaning tight tolerances were needed—but their manufacture involved a manageable number of parts and a limited number of processes. We tagged a sample of jobs to establish Manufacturing Critical-path Time (“true” lead-time) baselines and then put together a revised manufacturing plan which would significantly reduce them. The plan was then presented at a meeting with the holding company’s factory manager as well as some of their home-office financial people. My people had an idea about what the potential cost reduction would be but in our program we never dictated saving amounts. Rather, we would ask the supplier to have their accountants quantify the projected financial impact based on their own internal financial practices. In the end both parties projected that a double-digit cost reduction percentage would be the likely result. I told 666 Corp. people that my group was willing to work with them on the actual implementation and would wait for their request to move forward on it. They explained that there were timing issues that needed to be worked out and that it might be several weeks before we heard back from them.

The next thing I heard about this supplier came a few weeks late when the buyer told me that the supplier’s chief engineer—as well as several other long-term salaried employees—had been let go. He went on to say that he had been informed that the plant was relocating from its current local site to a suburb of a major metropolitan area. I was shocked and called the former chief engineer with whom I had previously had a close working relationship. He told me that evidently the decision to move the factory had been made prior to his employer’s purchase by 666 Corp. Further, he said he only found out that he would likely be let go when a friend told him about a job very similar to his being prospected out on the headhunter circuit and in investigating this he found out it was for his current job!

I called the supplier’s factory manager and asked for a meeting. The next day I met with him in his office and he told me that the decision to move was based on the idea that total shop reorganization could most effectively be executed through a greenfield site approach. From my earlier conversation with their former chief engineer I suspected that 666 Corp. had asked for our assistance under false pretenses and seemed to be spreading the story that the move and associated layoffs were a result of my company’s supplier development recommendation. In other words, I had been played for a chump. On the other hand, the project would yield a significant price reduction for my company so I felt the project needed to be supported.

In the meeting I referenced the MOU saying my employer would live up to it as long as its other terms were honored, including sharing cost savings, of which my company was slated to get the greater share. He replied that his corporate office still wanted to share savings but felt the ratio should be flipped, i.e., they should get the larger part. I answered “no” and went on to say that the engineering work that had been done was our intellectual property, as stated in the MOU. Consequently, if 666 Corp. went ahead and implemented the plan on its own the matter would end up in litigation. His response was that since an MOU was not a contract they had the flexibility to make changes to it and that it was their intention to implement the reorganization plan we had put together for them, one way or the other. He went on to further say that if the matter did get to court it would likely take years to be heard and that in the meantime they’d take all of the savings.

Well, I had a response to this, too. I told him that in addition to my role in starting up supplier development I was also manager of strategic sourcing, i.e., I had ultimate authority over supplier selection. I said if 666 Corp (now you understand why I gave them that name!) wanted to play hardball with my employer we would immediately institute the 90-Day Notice of Severance Clause on our purchase order boilerplate and after that would resource all of our business from them. I also reminded him that in the 90-day transition period they would be obligated to maintain regular supply to us—also as per the boilerplate—which is considered a commercial contract under the Uniform Commercial Code. Since we represented almost 20% of their annual revenue I knew that this stand would create some shock waves back at their home offices.

In the end 666 Corp. got back to me and said they’d honor the MOU. I countered by saying that we had written-up the MOU in contract form and that they would need to sign it before we proceeded. They got the message, signed the contract and my supplier development group—for the most part—oversaw implementation of the production plan we had developed for them. But this whole episode had left a bad taste in my mouth so I met one last time with 666 Corp’s factory manager (with my buyer present). I told him of my conversation with his former chief engineer and that I had subsequently independently verified his story. I went on to say that my employer had spent years developing a trusting, collaborative working relationship with the supplier’s previous ownership and that much of that trust had been destroyed in just a few months through the shenanigans of his employer. I said that going forward my company was open to development of a similar trusting, collaborative working relationship but that they had to re-earn this status. And, until they had, we would be working with them on a commercial basis.

I never heard back from this supplier. They must have decided that based on our help they now had a more marketable asset since I heard from a colleague that a couple years after our engagement the supplier had again been sold. If this is true I suspect 666 Corp. made a big profit because the changes we had planned and implemented for them were anything but cosmetic. Because of them and the ongoing more collaborative style of the new ownership, they still remain a supplier to the OEM that I had worked for all those years ago.

Who got hurt by this? Not my employer since I hadn’t let 666 Corp.’s executives bully me. We got a significant price reduction. Not the holding company, since they probably made out like bandits when they resold their investment. The longer term employees of the supplier—many with over 20 years of seniority—were the big losers, having lost their jobs. And the community where the old factory was located also lost.

So what have I have learned about the difference in dealing with small family-owned/run firms and holding companies?

  • If you want to work with a supplier who is interested in finding-the-middle-ground and working to increase the size-of-the-pie so both parties can benefit, you have a better chance of this with smaller, family-owned/run businesses.
  • If you want to be in competition on a daily basis with your supplier for a bigger-piece-of-the-same-sized-pie, i.e., a win-lose relationship, buy from holding companies. And when you do, make sure that every detail of the relationship is tightly defined—meaning no wiggle room—in a signed contract because if you don’t they will try to take advantage of you.

Now for a bit of personal opinion. Both of my grandfathers owned small businesses, one being a farmer and the other having his own fishing business. In addition, my wife was raised on a family dairy farm. As a result I admit up front that I’m biased. Over the last generation or two family farms have been disappearing at an increasingly fast rate with large corporate farms supplanting them. I understand that as this has happened efficiencies in food production have improved. But as a result I think we’ve also lost both a bit of product quality—ever compared grocery store produce with what you can get at a farmer’s market?—and, perhaps more importantly, an important part of the culture that our country was founded on, i.e., individualism.

I have the same feeling about seeing small, family-owned/run businesses selling out to holding companies which, unfortunately, has accelerated over the last 25 years due to globalization. Sure, theoretically there are efficiencies that may result from this transition but there is no doubt in my mind that U.S. society will also lose a lot if we continue to allow the number of small, family-owned/run businesses to decline. The reason for this decline is that these small firms have had to compete on their own against foreign competitors who received strong financial backing from their governments.

Recently there was an article posted on IndustryWeek about whether or not a reduction in taxes on manufacturers would or would not increase jobs. As with all things, I think that blanket statements rarely hold and for that reason believe that tax breaks on some manufacturing categories will result in significant job creation while others will only lead to small increases, if any. From my seat in the ballpark U.S. corporations are doing pretty well and don’t need significant tax relief, i.e., tweaking should do. Wasn’t it just eight or so years ago that the stock market dropped below 7,000 and now has recently hit 20,000, an almost three times increase? I think that the data will show that when big corporations get tax breaks they mostly result in increased stockholder return, only delivering incremental (at best) job creation.

On the other hand I think the data will also show that tax breaks to family-owned/run small- and medium-sized manufacturers lead to statistically significant increases in manufacturing employment. In terms of return on public investment, then, such targeted tax breaks deliver “more bang for the buck.” If it were up to me I’d focus on providing significant tax breaks to the small guy to ensure that U.S. manufacturing doesn’t go the way of the family farm. Sure, there needs to be ongoing tweaks to how we tax large corporations since the worldwide competitive climate is always changing. But something of the “being able to pull your own self up by your bootstraps” culture that our society was based on will be lost if we don’t step up and start supporting the little guys.

My next column will relate the story of two competing suppliers—one who accepted supplier development assistance and the other who didn’t.


This article was originally published on IndustryWeek, a companion site of Material Handling & Logistics.
TAGS: MH&L Wire
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