SCMP Module 2- Procurement

Case Study 1: De Havilland

Kayley FultonJanuary 24, 2013

Table of Contents
EXECUTIVE SUMMARY ........................................................................................................................... 3 ISSUE IDENTIFICATION ......................................................................................................................... 4 ENVIRONMENTAL AND ROOT CAUSE ANALYSIS........................................................................... 4 DE HAVILLAND .........................................................................................................................................................4 FLAP SHROUD BID ...................................................................................................................................................5 ALTERNATIVES AND OPTIONS............................................................................................................ 6 RECOMMENDATION AND IMPLEMENTATION ............................................................................... 8 RECOMMENDATION .................................................................................................................................................8 IMPLEMENTATION....................................................................................................................................................8 MONITOR AND CONTROL ..................................................................................................................... 9 CONCLUSION ........................................................................................................................................... 10

Executive Summary De Havilland is a world-class leader in regional aviation manufacturing with deep-rooted history in Canada. Throughout multiple changes in ownership, De Havilland adopted some best practices that ultimately help their current decision-making processes. Over time, De Havillands manufacturing costs have increased, particularly for their modern Dash-8 which accounts for up to 65% of said costs. Management has asked for a 25% cut in costs in order to remain accountable to its stakeholders. Dollard Plastics, the current supplier of flap shrouds, has refused to reduce their already high prices. A bid has been conducted to find other vendors that are viable sources of the item at much lower costs. Nine bids have returned, citing various price points of different materials to manufacture the part. Morton Enterprises, the lowest cost bidder is to be scrutinized to be the successful supplier. Due to various risk criteria (i.e., potential manufacturing delays due to only utilizing one supplier) it is not recommended to accept only one supplier but to have two based on a tiered system. There will still be massive cost savings over Dollard Plastics, however there will be less risk relying only on one supplier. The total value (quoted costs plus un-negotiated transaction costs) should be evaluated to determine the two successful vendors with 5-year, strategic contracts. The negotiations will be fair, however De Havilland will have the power position due to consolidation within the aviation manufacturing industry. Only relevant, decisionmaking players will be present to maintain efficient conversation. Semi-annual reviews will verify the success of the strategic arrangement.

SCMP Module 2- Procurement Case 1: De Havilland Kayley Fulton Issue Identification De Havilland has been cast with rising input and manufacturing costs and has recognized a need to reduce all costs by 25%. By doing this, the company has identified some vendors who refuse to grant cost savings to De Havilland, including the current flap shroud vendor, Dollard Plastics. After commencing and receiving bids to find a new vendor for the existing part, De Havilland must evaluate whether Morton Enterprises, the lowest bidder, can be a feasible vendor. It is important to De Havilland to reduce the number of vendors used to long-term, fixed priced vendors. Environmental and Root Cause Analysis De Havilland De Havilland has had an inconsistent past with it being purchased by four parties over the length of around 25 years. The frequent changes were due to the changing aviation market throughout history and De Havillands attempt to create a niche. When a larger company saw their success in a particular niche (i.e., the regional airline area), they would purchase to grow their own competitiveness. Although there have been many changes of ownership, De Havilland has adopted some sound business practices along the way. Boeing helped craft a purchasing cycle that De Havilland chose to adopt itself. Based on two tracks, the company either needs a new

product or an existing product based on the Engineering departments requirements. Potential vendors are scoped out and analysed by two boards representing many divisions. All vendors, new or existing, enter negotiations with De Havilland where the company establishes various price or needs targets to negotiate within. This procurement cycle is an effective (albeit cumbersome) method to find vendors with the best fit to De Havilland. Most recently, De Havilland has been directed by their most recent owners (Bombardier and the Government of Ontario) to cut costs by 25%. This decision has caused De Havilland to review the current vendor base and renegotiate savings. There are some potential root causes of this drastic decision: first, the bill of materials for the Dash 8 model take up 60-65% of De Havillands total manufacturing costs. Although modern and popular, the Dash 8 can only be as price-competitive as the vendors who supply to it. Furthermore, possibly due to the constant shift in leadership, there have been no longterm, strategic contracts initiated with vendors to reduce costs. This practice does not take advantage of locked-in pricing or annual audits to verify competitive pricing, causing vendors to be more likely to take advantage of their client. Flap Shroud Bid In the specific case of flap shroud equipment, Dollard Plastics has been put into a hard place where they refused any price-cutting initiatives. De Havilland was then forced to expand their horizons to where they found nine potential vendors, including Morton Enterprises. Morton Enterprises, located a considerable distance from De Havillands Ontario headquarters, is a flap shroud vendor with considerable cost savings over the current

Dollard Plastics (73.3% decrease). Mortons parent company, Devon Holdings PLC, has been steadily growing their aviation division; they have had difficulty maintaining stable profits. This inconsistency could be driving the need to undercut competitors to gain a stable, long-term client such as De Havilland (and potentially opening the door to an even more strategic client, Bombardier). Another reason their costs could be dramatically lower is due to poorer quality of materials, service, or manufacturing practices. Furthermore, some indirect costs (i.e shipping) have not been included on the bid, which could dramatically alter the price from what has been submitted. In the case of the flap shroud bid, a potential cause of bid results being skewed is that it is nearly impossible to normalize a bid with various materials. The potential bidders are using material choices such as nickel, graphite and aluminium, all with very different costs. Because there has been no specification made by engineering, all bids have been accepted, however if cost-reduction strategies are the main driver of the bid, then any higher-priced material will immediately remove a vendor offering such material out of contention. This gives an unfair advantage to the cheapest material vendor. Alternatives and Options There are three alternatives that De Havilland can choose between: 1. Negotiate with Morton Enterprises for them to become a long-term supply flap shrouds supplier. Although their price is very competitive, negotiate transportation/logistics, direct labour rates, spare parts policies, service levels and more. The advantages of this option include a 5-year, cost-stable relationship, drastic cost savings to the Dash 8, and ultimately, lowering De Havillands

manufacturing costs. There are some disadvantages: because of the low costs, it is not clear whether there are quality or service issues. Also, because of the far distance from Morton to the Ontario facility, hidden transportation costs could be great. A disadvantage for Morton could be the risk it takes on by fixing prices for 5 years, especially if input costs increase (i.e. steel). 2. Negotiate multiple tiered agreements with the top two bidders as they both have benefits De Havilland can reap. The best total-value vendor may serve as a firstcall vendor, whereas the other two would function as second or third call vendors. Apart from Morton, DAS Composites and Lakeside Industries (already a vendor) have low prices, and Lakeside already has intimate knowledge and proximity working with De Havilland. Other than cost savings over the present supplier, advantages include diffusing risk by utilizing more than one vendor for the flap shroud equipment. If one vendor were to run behind schedule, the others could serve as back up. A disadvantage is that having multiple vendors goes against De Havillands directive to have few yet strategic contracts. 3. Reconfigure the bid to normalize materials used for more comparable RFQs. Currently, there are various materials being submitted in the bid which all come back at different price points. When the management is looking for a 25% decrease in costs, the vendors who submit bids with higher quality/price will never be reviewed due to non-drastic savings. Furthermore, more transactional costs can be requested to get the full picture on the total cost. An advantage that if there were a communicated emphasis on low price versus quality and specified transaction costs, perhaps the bids would return differently with giving vendors a

fair chance. The disadvantage stands that reconfiguring the bid is time consuming and the vendors may find it redundant as they have already submitted their RFQs. Recommendation and Implementation Recommendation The most advantageous path for De Havilland to take would be to negotiate multiple tiered agreements with the best total-value bidders. The SSB must negotiate transaction costs as they are not fully specified in the bids. Once these have been factored in, the best two contracts can be awarded a first-call and second-call strategic agreement. Due to Lakeside Industries being in close proximity and having previous relations with De Havilland, Morton Enterprises and Lakeside Industries would be sufficient choices for a first- and second-call supplier (respectively). De Havilland never runs the risk of late equipment due to a sole dependence on a single supplier for particular equipment. Implementation The Best Alternative to the Negotiated Agreement (BATNA) is to provide another vendor with the opportunity to be either the first- or second-call supplier. Because there may be relatively few BATNAs for the vendor due to the aviation industry in North America being extremely consolidated, the vendor will have less opportunity to make demands of De Havilland. Key De Havilland members of the negotiation with either bidder include the Buyer, the Financial Analyst and the Quality Assurance representative. The Engineer need not be present as designs have already approved (hence moving past the SSB).

Higher management representatives from Morton or Lakesides aviation division will be present for the negotiations as they will have the decision-making power to accept or reject negotiations. De Havilland is looking for best- value pricing to hit their cost targets (while ensuring safety), whereas the bidders will be looking at striking long-term relationships with their potential client, preferably for the first-call vendor. Barriers to success may emerge due to the vendors not setting low transaction costs or improving quality or service levels for the price. De Havilland can be too persistent on driving down other costs, even though they will already be capturing significant savings by terminating their relationship with Dollard. Overall, the power relationship is held with De Havilland as they have many other vendors with proposals to chose from that meet standard requirements. Ethical considerations are important in the negotiation process too- there may be implications with terminating Dollards relationship in a short timeframe. De Havilland must also be cognisant not to play off the two bidders requests/concessions by pitting the two bidders against each other. Monitor and Control Bi-annually reviews with both key interests must take place to ensure needs are being met and both parties in the room share equal understanding. If production schedules cannot be met, it is imperative to keep the second-call supplier in close contact. Facility audits may take place at De Havillands discretion to ensure high quality service levels.

Conclusion De Havilland is a company that must be very accountable to its owners, as taxpayers are prime stakeholders. By directing De Havilland to reduce manufacturing costs 25%, an RFQ has already identified large savings from multiple bidders for the flap shroud parts. Morton Enterprises has come back as the least expensive bidder, but there are more considerations to evaluate. Due to the potential delays by having only one vendor for an important part, it is recommended to have a first- and second-call vendor to mitigate risk while still reaping the lowest total costs.