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After having full exposure to the cost structure of De Havilland’s Dash 8 airplane I immediately became aware of their high manufacturing cost which has been caused by the high cost of sourcing the flap shrouds and bay doors from Dollard Plastics of Montreal. The latter showed no flexibility on reducing their prices on the above parts when the former was in search of ways to improve their production efficiencies by reducing the cost attributed to Dash 8 airplane. Kim Tomar, the Financial Analyst at De Havilland had realized that issue and therefore started the process of finding a new business partner who is capable of meeting a set of standards that De Havilland had developed earlier for their procurement department, had started the process about year and half earlier than the expiry date with the incumbent supplier.
After receiving 9 bids to supply the needed parts, I have recommended Morton to De Havilland’s Source Selection Board (SSB) as prospective vendor for selection provided that Morton must pass the set of standards which I mentioned above. Based on the initial information from the normalized bids from all nine bidders, the lowest bid was Morton Enterprises. Their bid was 18% lower than their nearest competitor, and when I compared prices of the needed components to the prices supplied by current providers they were between 54% and 75% less expensive. However, beyond parts cost reduction we are also interested in establishing long-term co-operative contracts with the vendor. So, apart from determining who had the best price offer, I need to determine whether Morton is sufficiently stable to be relied upon in the long run. So my strategic intention here is to negotiate an agreement with Morton that will be of the greatest value possible to De Havilland keeping in mind our goal of longer-term agreements and reducing the amount of vendors we deal with. A good decision from SSB will allow De Havilland to achieve this objective.
2. Fundamental Issue:
Long Term – Strategic
The total parts cost of Dash 8 airplane at De Havilland represented 60-65% of their total manufacturing cost. It’s is evident that the company has recognized that and they have taken steps to solve this issue. A further indication that the company is operating at high cost is their previous failed attempt when they requested a 25% discount on all parts across the board. Dollard Plastics of Montreal is currently supplying the company with the parts needed but at about 3 times higher than Morton’s quote.
2.1 Sub Issue: Short/Long Term - Strategic
The uncertainty that De Havilland is going through at this point in terms of choosing the right supplier who is going to be reliable enough to commit to a 5 year fixed contract with the company. 3. Environmental and Root Cause Analysis The De Havilland has established itself as a major player in the Canadian aircraft manufacturing industry which had been founded in Britain early last century by a parent company. The company had been acquired few times through merger and acquisition by the government and other major players in the industry like Boeing who acquired the company in 1986 and sold it in 1992 to Bombardier Inc. and the Ontario government for a split of 51%-49% respectively. During these years, Boeing had redeveloped De Havilland’s procurement process to the existing cycle. Under the current purchasing process all new and expired parts under contract must follow the systematic procedures which starts at engineering and existing parts department and go through the bidder selection board, source selection board and finally to the negotiation team who either succeed or fail in reaching a mutual contractual agreement with a business partner.
In order to deal with its high manufacturing cost, De Havilland made an attempt to renegotiate their
existing contract for the supply of flap shrouds with Dollard Plastics and failed because Dollard refused to budge down on their prices. It’s obvious that the two parties here didn’t enjoy a long term relationship because Dollard didn’t even try to offer a solution or an alternative in order to keep their customer satisfied. De Havilland however, is looking for ways to leverage their relationship with their supplier in order to improve their production efficiencies due to lower cost and since Dollard Plastics didn’t cooperate, the company started to search for alternatives a year and half ahead of time hopping to find a business partner who is willing to commit to a long term relationship with them and most important, give them a better price on their parts. In this situation, De Havilland followed the standard procurement procedures which they have on hand, and as a result they were able to receive a total of 9 bids including the incumbent supplier.
After the evaluation process, Morton Enterprises which had the lowest bid was picked as a potential supplier of flap shrouds and bay doors. Surprisingly enough, the total difference in cost between the incumbent supplier and Morton was a substantial saving amount of $ 2,061,180 ($ 2,810,174 – 748,994) to the company. In other words, de Havilland could realize a 275% savings in production cost if it switches to Morton’s.The question that naturally rises is: is Morton’s price(cost) low because they use low quality materials or just because they are more efficient than the other vendors or they are maybe trying to buy the contract out and make up the difference in other service factors such as transportation, supply and support? The nonrecurring cost could be used as a signal of the quality of materials used by Morton before the actual quality analysis takes place. However, Morton chose to allocate the tooling cost across production rather than including it as a single non-recurring charge in their bid and so we do not know whether or not they use high-quality materials.
Naturally what comes to mind at this point is the fact that De Havilland may consider cancelling their contract with Dollard upon short notice in order to take advantage of such lucrative deal despite the possibility of paying contract cancelation penalty to the supplier. The question here is: should De Havilland switch over right away or wait till August 1993 to start with Morton provided that the negotiation was successful? In order to realize their potential cost savings and establish a long term relationship with Morton, De Havilland may have to go through a long and painful negotiation process with Morton’s negotiation team. There are few uncertainties and obstacles which have to be addressed and cleared before any negotiation between the two parties. Strategic behavior is a potential obstacle to successful negotiation between De Havilland and Morton. Having at least two other vendors (Das Composites and Lakeside Industries) that made bids close to that of Morton, De Havilland could overplay their hands hoping that Morton would lower their prices even more. The question for De Havilland here is also to ask themselves: will we be negotiating with the real decision making individuals or there are other decision making authority out there such as Devon, their parent company who may influence Morton’s decision? Same thing apply to us: is Bombardier aware of what we are doing and would certainly approve our decision? On the other hand, the fact that De Havilland received favorable bids from other vendors may increase their bargaining power in the negotiation with Morton. Furthermore, the gain to De Havilland from this negotiation (part cost reduction, lower transaction costs etc.) is expected to be larger than the gain to Morton, which makes the former party to the negotiation to be more impatient than the latter and as a result, the bargaining power of De Havilland further decreases. On the ethical issue, will De Havilland try to exploit Morton’s current marketing strategy by expecting further lower prices and better quality service which may not be favorable to both parties in the long run and particularly to Morton? Will the government of Ontario exploit their authority by favoring a
local producer over Morton’s?
4. Alternatives and Options 4.1 Alternative 1: Negotiate the deal with Morton. In addition to negotiating the price, such factors as transportation, supply, support and quality should be negotiated as well. Advantages: a) Lower parts and transaction costs will result in lower manufacturing cost for Dash 8. b) 5 year fixed contract term will translate into a manufacturing cost stability. d) Long term relationship was a supply chain partner is achieved. e)The opportunity to better integrate Morton’s IT with De Havilland and as a result achieve lower cost due to lead time reduction and economies of scale. Disadvantages: a) Product’s quality and services may not be actually be the same as promised. b) The 5 year fixed contract term put Morton at disadvantage in case of supply risk. Alternative 2: Negotiate separate agreements on the same basis and contractual terms with Das Composite and Lakeside Industries who were the next lowest bidders after Morton. These negotiations should be in the same time period as Morton’s and the successful outcome should function as a best alternative to a negotiated agreement (BATNA) for De Havilland if negotiations fail with Morton’s. Advantages: a) Improve negotiation skills for De Havilland by learning new aspects from other suppliers.
b) Increased confidence and negotiations power due to forming more BATNAs. Disadvantages: a) Negotiating multiple agreements is time consuming. 5. Recommendation and Implementation: I do recommend alternative 1 as the best choice for De Havilland at this point because this option will solve their problem in 2 ways: reduce their manufacturing cost and establish a long term relationship with Morton. 5.1 Implementation Set up a post bid clarification meeting with Morton Enterprises in order to clarify their pricing and all terms to the agreement and ensure that they are realistic and firm and get a written commitment from them before final decision to award. Bid clarification meeting will include experts from the Material, Finance, and Engineering and Quality Assurance teams of de Havilland. After bid is approved, then both parties will sign the contract so that the supply will commence as per the agreement. 6. Monitor and Control Each party should designate a representative such as account manager whose main duty is to meet periodically with the other party’s representative in order to discuss the progress and help troubleshoot any issues. In case of major issues or if any opportunity arises, then a meeting between the appropriate people should be scheduled to deal with it. 7. Conclusion: Despite the uncertainties that De Havilland had faced regarding the reliability of Morton as a supply chain partner, the outcome of their relationship with Morton for the next 5 year will mean one thing: Higher profits. For Morton however, they may not achieve high profits
on the parts in the short run but the opportunities to sell other services to De Havilland are tremendous. At the end both parties will win.