IBM asked SMT and one other, much larger company to bid on 80 more units of a pa
ID: 377402 • Letter: I
Question
IBM asked SMT and one other, much larger company to bid on 80 more units of a particular computer product. The RFQ (request for quote) asked that the overall bid be broken down to show the hourly rate, the parts and materials component in the price, and any charges for subcontracted services. SMT quoted $1.62 million and supplied the cost breakdown as requested. The second company submitted only one total figure, $5 million, with no cost breakdown. The decision was made to negotiate with SMT. The IBM negotiating team included two purchasing managers and two cost engineers. One cost engineer had developed manufacturing cost estimates for every component, working from engineering drawings and cost-data books that he had built up from previous experience and that contained time factors, both setup and run times, for a large variety of operations. He estimated material costs by working both from data supplied by the IBM corporate purchasing staff and from purchasing journals. He visited SMT facilities to see the tooling available so that he would know what processes were being used. He assumed that there would be perfect conditions and trained operators, and he developed cost estimates for the 158th unit (previous orders were for 25, 15, and 38 units). He added 5% for scrap-and-flow loss; 2% for the use of temporary tools, jigs, and fixtures; 5% for quality control; and 9% for purchasing burden. Then, using an 85% learning curve, he backed up his costs to get an estimate for the first unit. He next checked the data on hours and materials for the 25, 15, and 38 units already made and found that his estimate for the first unit was within 4% of actual cost. His check, however, had indicated a 90% learning-curve effect on hours per unit. In the negotiations, SMT was represented by one of the two owners of the business, two engineers, and one cost estimator. The sessions opened with a discussion of learning curves. The IBM cost estimator demonstrated that SMT had in fact been operating on a 90% learning curve. But, he argued, it should be possible to move to an 85% curve, given the longer runs, reduced setup time, and increased continuity of workers on the job that would be possible with an order for 80 units. The owner agreed with this analysis and was willing to reduce his price by 4%. However, as each operation in the manufacturing process was discussed, it became clear that some IBM cost estimates were too low because certain crating and shipping expenses had been overlooked. These oversights were minor, however, and in the following discussions, the two parties arrived at a common understanding of specifications and reached agreements on the costs of each manufacturing operation. At this point, SMT representatives expressed great concern about the possibility of inflation in material costs. The IBM negotiators volunteered to include a form of price escalation in the contract, as previously agreed among themselves. IBM representatives suggested that if overall material costs changed by more than 10%, the price could be adjusted accordingly. However, if one party took the initiative to have the price revised, the other could require an analysis of all parts and materials invoices in arriving at the new price. Another concern of the SMT representatives was that a large amount of overtime and subcontracting would be required to meet IBM’s specified delivery schedule. IBM negotiators thought that a relaxation in the delivery schedule might be possible if a price concession could be obtained. In response, the SMT team offered a 5% discount, and this was accepted. As a result of these negotiations, the SMT price was reduced almost 20% below its original bid price. In a subsequent meeting called to negotiate the prices of certain pipes to be used in the system, it became apparent to an IBM cost estimator that SMT representatives had seriously underestimated their costs. He pointed out this apparent error because he could not understand why SMT had quoted such a low figure. He wanted to be sure that SMT was using the correct manufacturing process. In any case, if SMT estimators had made a mistake, it should be noted. It was IBM’s policy to seek a fair price both for itself and for its suppliers. IBM procurement managers believed that if a vendor was losing money on a job, there would be a tendency to cut corners. In addition, the IBM negotiator felt that by pointing out the error, he generated some goodwill that would help in future sessions.
For this Case study answer each question with at least 250 words:
What are the advantages and disadvantages to IBM and SMT from this approach?
How does SMT’s proposed learning rate compare with that of other industries?
What are the limitations of the learning curve in this case?
Explanation / Answer
1) Advantages and Disadvantages to IBM from this approach are:
The advantage to IBM is that, there is a 'quotient of trust' in this deal. SMT had followed systematic approach in all the aspects of the costing. It took a 360-degree angle in the negotiation process. This indicates that, there is a first level of trust that SMT had created near IBM. Since every negotiation should start with trust, IBM was absolutely happy that they have a reliable supplier that has been appropriately evaluated and should be able to perform in accordance with the contract. This indicates that IBM has been able to get reliable suppliers during its contracts with the suppliers and this is an indication of a good and long term relationship with its suppliers.
The disadvantage is that, IBM may be paying slightly more than they might have been able to purchase the parts for on an ad hoc basis. Also the delivery time is more. This is a disadvantage because, any customer who pays more is expected to get the stock delivered on time. But in this case, it is taking a slightly longer time, because SMT is more concerned about delivering at an absolutely high quality. Therefore, it is taking more than expected time in its deliveries.
Advantages and Disadvatages to SMT from this approach are:
SMT has been lucky enough to get a contract deal from IBM. IBM being a gaint may strike a deal with some other supplier. But, it was very particular in negotiating with SMT, which is the biggest advantage to it. Therefore, getting a business opportunity from a giant company like IBM is a huge advantage to SMT.
Although IBM feels that it is paying more, SMT could not make a proper margin in this contract. In order to get the deal SMT had lowered the prices, and IBM although paid more from its end, it was still less to SMT when compared to what other suppliers charge for the similar processes. That is because, there could be an inflation in the cost of the raw materials, and if the cost of the raw materials increase, there will a certain percentage of loss to SMT. If SMT has indeed underestimated its costs by a significant amount, IBM's knowledge of its business and its honesty in sharing information may prove to be beneficial.
2) SMT's proposed learning rates are higher when compared to other industries. SMT had been operating at 90% learning curve rates which is the highest in the industry. Even IBM do not have such learning curve rate. That is why, SMT is very lucrative to IBM.
So, the learning rates of SMT can be said to be considerably higher in the industry untill there is someone who could offer at more than 90% learning curve rates. It is very important to note that, better the learning curve rate, higher will be the prices.