It's an approach that may pay short-term dividends for the automakers, but one that, if continued, could lead to major problems. Due to endless price squeezing by the OEMs, profit-starved suppliers may be forced to drastically cut spending in key areas such as product development and quality management systems, in an effort to stave off bankruptcy. The results could include a serious deterioration in U.S. vehicle quality.

If this outcome is to be avoided, the auto manufacturers and suppliers must develop new ways to work together.

Take it or leave it
Despite their loss of U.S. market share in recent years, American automotive manufacturers remain substantially bigger than even their largest suppliers, and the size of their contracts can make or break a supplier's business. As a result, the OEMs are quite easily able to push their margin pressures down the supply chain. Suppliers, fearful of losing OEM business, are basically powerless to resist.

When the automakers offer retail buyer incentives such as the recent spate of 0% financing deals, they expect -- and in some cases, demand -- commensurate cost reductions from their suppliers. Ford Motor Co., for example, has demanded and received annual price cuts of 3% to 5% from several suppliers over the past few years, and other OEMs have extracted similar supplier concessions.

Further, as various under-the-hood components are replaced by more sophisticated versions -- electrically controlled units for hydraulics, for example -- the automakers expect that the price for the replacements will be similar to that of the parts replaced. This is despite the fact that the replacement components are often not only more capable than the earlier versions, but are also more costly to produce.

In addition to shifting the cost pressure, OEMs are also increasingly shifting more manufacturing responsibilities down the supply chain. They expect suppliers to conduct significant design work upfront and assume responsibility for tooling and other capital investment associated with new vehicle programs. This trend is likely to increase, given the current OEM push toward more module and systems level sourcing.

OEMs are also demanding higher warranty risk sharing and more stringent quality -- for example, lower parts per million defects-from their suppliers. Automakers, particularly the Big Three, are institutionalizing processes that span the entire supply chain to identify the root cause for any product failure and assign responsibility. General Motors, for example, has a system in place to load a supplier with warranty costs when the supplier fails to successfully address any root cause issue associated with a product failure.

With the size of OEM contracts increasing, especially as car makers push to produce more car models on fewer underlying vehicle platforms, suppliers understand fully the power of the OEMs to impact supplier economics. In response, suppliers have dutifully and successfully responded by aggressively cutting their costs. Indeed, a sample of the top 20 suppliers shows that many have held on well to their operating margins over the last five years.

Complicating the situation for many suppliers is the fact that this intense cost cutting is happening at a time when they are grappling with integrating acquisitions they have made over the past few years, in an effort to become larger to better meet OEM demands. They are also faced with building additional capabilities to handle increased manufacturing responsibilities outsourced to them from OEMs, particularly in systems and modules.

In the face of these relentless pressures, suppliers are increasingly asking, "Where's the payback?" Any value created by suppliers is quickly pulled back by the OEMs. Supplier initiatives that lead to cost reductions are not being met by a positive response from the automakers.

This situation is likely to mean that something else will have to give. With supplier budgets slashed, and management focused on costs and building capabilities, there may be little money left to fund quality management, particularly at the systems and modules level.

This could lead to supplier bankruptcies or an exodus of suppliers from the sector. And as surviving suppliers focus on cost-cutting at the expense of activities such as quality management and product innovation, the result could be serious deterioration in vehicle quality. The kind of product failures and recriminations that recently rocked Ford and Firestone could become more commonplace.

Reward quality
If these problems are to be avoided, OEMs and suppliers must rethink their interactions and processes for quality management.

For OEMs, the key will be to shift to more collaborative or partnership-style relationships that differentiate among suppliers based on quality performance, and reward those who achieve the best results. This approach must go hand-in-hand with risk and warranty-cost sharing imposed on the supplier base.

For suppliers, meeting certain quality standards will be critical to achieve recognition from OEMs. In components, quality specifications such as low defect rates and high durability should be the focus. But superior quality performance in systems and modules encompasses a broader definition that includes not only overall performance, but also the ability of a system to provide "surprise and delight" on affected vehicle attributes. Supplier innovation on systems-level features thus becomes an important part of superior quality performance.

In creating a collaborative approach, OEMs need to involve the supplier during the entire product life cycle, from product development to post-launch.

During the product development phase, it is imperative that OEMs include suppliers early in quality discussions. A joint effort in the initial phase can do a lot toward ensuring initial high quality ratings, such as those measured in the annual J.D. Power and Associates Initial Quality Study. This can be critical for achieving driver loyalty, and in the long term, the ability to set and maintain premium vehicle pricing levels.

In the product concept phase, OEMs must share with suppliers the customer satisfaction and attribute performance priorities based on JD Power scores and the impact of supplier modules on overall customer satisfaction.

In the product design phase, OEMs and suppliers must jointly think through quality problem prevention measures. Quality systems must be mirrored at both the OEM and suppliers throughout the design phase. Specifications for subassemblies must be robust, to not only ensure superior product quality but also manufacturing compatibility and process quality.

In the verification planning and testing phase, failure mode effects analysis (FMEA) and test methods must be developed jointly between OEMs and suppliers to develop test criteria that deliver not only superior quality and durability, but also attribute performance.

In the prelaunch phase, there must be close cooperation on early problem resolution to ensure a smooth start-up and production-process stabilization. Also, defect identification and eradication tools such as statistical process control and focus FMEAs should be instituted by both OEMs and suppliers.

Post-launch, a collaborative approach continues to be important. Ratings for long-term product and service quality hinge on continued performance and quick resolution of service issues. During early series production, quality issues and field failures must be examined in a collaborative way to ensure that necessary design or manufacturing changes are quickly made.

Continuing warranty issues must also be resolved through a collaborative approach. Warranty issues must be prioritized in terms of economic and strategic importance, and resolved through focus teams cutting across functions at both the OEM and supplier end. In some cases, these teams will need to jointly problem-solve. The defect resolution cycle of prioritization, problem solving, idea generation and approval for solutions and cross-functional execution should be institutionalized. Demonstrating results of this focus team approach early, along with strong and visible support by upper management, could help institutionalize the approach.

For OEMs, there must be end-to-end accountability for warranty issues, rather than parts of issues being disaggregated to various functional groups, such as engineering or manufacturing. In addition, suppliers should be quickly brought into the process and provided with appropriate information. For suppliers, likewise, similar end-to-end accountability is required internally, and supplier interactions with subsuppliers must be streamlined to ensure quick defect resolution.

On-site Help
Interestingly, most of the infrastructure and resources required for superior quality management in terms of people and processes exist today. Suppliers already provide on-site engineering support for their OEM customers, for example. These on-site engineering teams, typically charged with product development responsibilities, should also have added responsibilities of exceeding expectations on the quality front.

Collaborative OEM/supplier execution of quality management processes today is far from best practice. Automakers and suppliers clearly need to understand that the benefits of world-class quality management, in terms of warranty cost reduction, improved customer satisfaction and customer loyalty, will far outweigh the incremental costs needed to implement them.

Without this understanding, and without steps to initiate closer collaborative quality management, both OEMs and their suppliers could face an even rockier road ahead.