A Penny Wise and Pound Foolish

by Adrian Gonzalez
February 1st, 2012

How can a company that is so innovative in so many aspects of its business, also be so ordinary (or worse, the opposite of innovative) in others?

Apple has received a lot of negative press lately about its supplier practices in China, including an article published last week in The New York Times titled, "In China, Human Costs Are Built Into An iPad" by Charles Duhigg and David Barboza. The subtitle of the article should have been, "iPads are like sausages; it is better not to see them being made."

The article focused on many topics, including the poor working conditions at Foxconn, but here is the excerpt from the article that caught my attention the most:
Apple typically asks suppliers to specify how much every part costs, how many workers are needed and the size of their salaries. Executives want to know every financial detail. Afterward, Apple calculates how much it will pay for a part. Most suppliers are allowed only the slimmest of profits.‬

So suppliers often try to cut corners, replace expensive chemicals with less costly alternatives, or push their employees to work faster and longer, according to people at those companies.‬

 "The only way you make money working for Apple is figuring out how to do things more efficiently or cheaper," said an executive at one company that helped bring the iPad to market. "And then they'll come back the next year, and force a 10 percent price cut."‬

You too, Apple? A penny wise and pound foolish?

This approach to working with suppliers and outsource partners is so "old school" (yet still so common) that it is one of the ten ailments of traditional outsource relationships, as Kate Vitasek highlights in her book, "Vested Outsourcing: Five Rules that Will Transform Outsourcing." Here is an excerpt from the book:

We have all heard the warning to not be a penny wise and pound foolish. Unfortunately, many procurement professionals still labor in the Dark Ages and have not taken the maxim to heart. Too often companies profess to have an outsource partnership but, behind the scenes, they focus solely on beating up their service providers to get the lowest price.‬
Reread the excerpt from 

The New York Times article above and replace Apple with your company's name. Does the story sound familiar? If you worked in the US automotive industry, especially during the 1990s and early 2000s, you know this story too well...and how it ultimately ends.

But being "a penny wise and pound foolish" is the hardest ailment to cure because, as Richard MacLaren from Unipart Logistics stated so eloquently a couple of years ago at our Vested Outsourcing seminar, you must "have the courage to manage for the long term against the pressures we face today for instant results."

A company that best illustrates this courage and patience today is Amazon. Yesterday, the company reported a 57 percent drop in Q4 2011 profits compared to the same period a year ago, despite a 35 percent increase in revenues. These results were expected because, to the dismay of Wall Street, Amazon has been spending aggressively on distribution centers, technology, and its Kindle devices. Amazon is managing its business for the long term, not the quarterly financial expectations of Wall Street.

What is Jeff Bezos thinking? Here is an excerpt from an interesting 

New York Times article published in December 2011 ("Amazon Says Long Term and Means It"):

"If everything you do needs to work on a three-year time horizon, then you're competing against a lot of people," Mr. Bezos told reporter Steve Levy last month 

in an interview in Wired. "But if you're willing to invest on a seven-year time horizon, you're now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue. At Amazon we like things to work in five to seven years. We're willing to plant seeds, let them grow-and we're very stubborn."‬

And in October 2011, Rob Wheeler, a Fellow at the Harvard Business School's Forum for Growth and Innovation, wrote a blog posting titled, "Investors Punish Amazon for Investing in Disruptive Growth," where he shares the following observation:

But Amazon looks at the world in a different way. The company has a set of organizational capabilities and is not afraid to leverage them to pursue almost any disruptive opportunity. It's as if Amazon does not view itself as a retail company, but rather as an incubator for disruptive businesses. And in the process of building those businesses, the company is disrupting pretty much everyone except itself. By their nature, disruptive opportunities are small for a long time before they can contribute meaningfully to a large company's bottom line.‬

Back to Apple. I spoke with Kate earlier this month and she told me about another computer company that is taking a different approach with its suppliers. This company had historically been "a penny wise and pound foolish" until it finally realized that this approach wasn't going to lead them and their partners to a higher level of value and performance. So, the company embarked on a Vested Outsourcing journey, and one of the first steps it took was to give copies of the Vested Outsourcing book to its suppliers and hold what was essentially a "book club" meeting with them, where they openly and honestly discussed the following questions together: How could we work together differently? Should we change the dynamics of our relationship? Is this something we should do?

This is not a quick and easy journey. It took this computer company, for example, about 18 months to reach the point where it said, "This Vested Outsourcing approach to establishing and managing business relationships is strategic for us."

As cliched as it sounds, the hardest part is admitting that something isn't right, isn't working as as it should, and then taking that first step toward finding a better way. Some companies excel at this when it comes to designing products, others when it comes to designing business processes. Few excel at both, all of the time.