Problem
Bill Huff was a subcontract supply manager for Randall Corporation, located in Houston, Texas. His major supplier for mechanical subassemblies was Qualco Corporation of Los Angeles, California. In early 2002, Bill found out that Qualco was experiencing some financial difficulties. By May 2002, these financial problems had worsened, and Bill wondered what, if anything, he should do. Randall Corporation Randall Corporation was a large supplier to the military, with total sales in excess of $3 billion. Depending on the nature of the contract and Randall's capabilities, some military work would be subcontracted. Bill Huff was responsible for a variety of subcontracts, including mechanical subassemblies to machine shops. Because of the critical nature of the subcontracted subassemblies, Bill thought that quality was the most important criterion for selecting suppliers. The next most important criterion was on-time delivery.
Delivery times were important to ensure that the prime contract was completed on time and to avoid penalties for late completion that were usually part of the prime military contract. Randall's policy was to maintain a minimum of three suppliers, and this was frequently a requirement that was included in the prime military contract as well. Furthermore, Randall's policy was to add suppliers as the volume of purchases increased. The volume of purchases of mechanical subassemblies required five suppliers under this policy. A supplier could not be added without eliminating another; if a supplier were dropped, another had to be added. Supply Market In Bill's opinion, many machine shops could produce good-quality mechanical subassemblies of the type required by Randall. These companies were typically small businesses owned by independent entrepreneurs. The profit margins for these companies were typically 5 to 6 percent of sales.
For the mechanical subassemblies that Bill bought, location was not an important consideration because the freight costs were very low in comparison to the price of the products. When a military contract required mechanical subassemblies, Bill would award the business among his five suppliers. In 2001, Bill had placed 40 percent, or $2.5 million, of his total mechanical subassembly volume with Qualco; the remaining 60 percent was evenly divided among the other four suppliers. In 1997, just before Qualco became a supplier for Randall, Qualco's sales were $900,000. Qualco had become Randall's major supplier for mechanical subassemblies because of its superior performance. The company always met its delivery schedule, and the quality of its products was unsurpassed. In addition, its prices were about 12 percent below competitive machine shops. When Bill originally started to contract with Qualco, he was concerned about these low prices. He wanted his suppliers to make reasonable profits and therefore become good, long-term sources of supply. He found that Qualco's labor rates, machinery, and capabilities were similar to other machine shops he was using.
However, Qualco was able to obtain much lower scrap rates than the rest of the industry. As a result, Qualco could charge lower prices and still maintain healthy profit margins. Over the last three years, Qualco had been an excellent supplier. Qualco had also helped Randall by producing prototypes of subassemblies, which were useful in evaluating military systems before production. Financial Problems at Qualco In December 2001, the sales representative for Qualco told Bill that Qualco was having difficulty paying its representatives. At the same time, Bill observed that Qualco had remodeled its offices in a luxurious style. The owner of the company had recently taken his family on two cruises, and he had purchased a new luxury automobile.
In April 2002, the sales representative for Qualco told Bill that Qualco owed him $18,000 for back salary and bonuses. At about the same time, the owner called Randall's accounts payable department. He complained that a $40,000 invoice was two days overdue. He said to them, "I need the money. I may have to shut down if you don't pay me now." In May 2002, Bill learned that Qualco had "factored" its accounts receivable at 3 percent with National Acceptance Corporation. Based on these events, Bill was concerned about the financial management and stability of Qualco. He was worried that he would suddenly be faced with the loss of his major supplier of mechanical subassemblies. Bill also knew that he would have to award subcontracts for a new $320,000 mechanical subassembly within two weeks. This requirement could grow to $2 million worth of subassembly business.
Task
A. What is the relationship between financial soundness and supplier performance?
B. What action should Bill take? Adapted from a case copyrighted by the Institute for Supply Management (formerly the National Association of Purchasing Management). Reprinted by permission. Alan Brokaw wrote this case during one of the ISM-sponsored case writing workshop.