Given the lack of automotive sales in the US, there sure have been a lot of automotive companies in the news these past few weeks. Last week we covered a few of those stories including a post on the long term prospects for blanket purchase orders to the use of price indexes by GM to help share the pain with the supply base. And late last week, we caught a story in which Chrysler filed suit against Johnson Controls (Johnson Controls’ legal department must be very busy these days) for overcharging the auto maker for its batteries used in cars for Mexico and the US. And the subject of many of these stories, is of course, metals.
In this most recent case, Chrysler has accused Johnson Controls (JCI) of overstating the lead content in its batteries. And because Chrysler must be paying JCI for batteries using some sort of index (most likely the LME) for the lead content of the batteries, Chrysler wanted to conduct an audit to make sure it was getting what it paid for. From an operational perspective, it’s always a great idea to randomly audit suppliers for their adherence to contract terms. But the case raises some other issues which are worthy of mentioning.
The first deals with product specifications, specifically tolerances for materials in the BOM (Bill of Materials). For example, one would expect a +/- acceptable tolerance for the amount of lead in the battery. I find it hard to believe that a PPAP process (the rigorous product approval process used in the automotive industry) would somehow not call out this requirement. But if it did not call it out, then Johnson Controls would have some discretion on the lead content. But if it did call out the tolerances and Johnson Controls undershipped the lead by weight but invoiced at an average weight called out in the contract, then Chrysler will likely have a case. Of course, in either scenario if JCI invoiced at one weight amount and through random sampling Chrysler discovered that the batteries contained a lower amount of lead, JCI would be liable. The lesson here is that when sourcing professionals use indexes in their contracts, they should tie those indexes to a weight with a tolerance both on a unit basis and/or on an aggregate basis. If the contract includes a price index provision not tied to a weight tolerance, a supplier, in theory, could report a “higher avarege weight” when the price goes up and a “lower average weight” when the price goes down.
The other broader issue to comment on is the effects of rising commodity prices on sourcing practices including supplier relationship management. Supplier audits can uncover dirty truths. And when your sales decline by over 20% in a quarter (I’m speaking of the large automotive OEM’s), it may just pay to do some digging…