Supplier Alliance at Quaker Oats

Author(s):

Richard L. Pinkerton, Ph.D., C.P.M.
Richard L. Pinkerton, Ph.D., C.P.M., Chair and Professor of Marketing and Logistics, The Sid Craig School of Business, California State University, Fresno, Ca 93740-8001, (559) 278-7830, E-mail: richard_pinkerton@csufresno.edu, www.csufresno.edu
Richard G. Reider
Richard G. Reider, Director, Packaging Purchasing, Quaker Oats Company, Chicago, IL 60604-9001, (312) 222-6778, E-mail: richard_reider@quakeroats.com

85th Annual International Conference Proceedings - 2000 

Abstract. This session describes how Quaker Oats Company of Chicago, IL formed an alliance with Graham Packaging of York, PA. Graham is a leading global manufacturer of custom blow molded plastic containers. Plastic bottles are the largest single quantity and cost item purchased by Quaker Oats. Topics include how to determine an alliance partner, how to negotiate a massive joint building construction and equipment project, and what kind of contract facilitates a "win-win" relationship based on trust and sharing of cost information. This alliance actually became a joint venture with Quaker building an addition for the plastic bottle plant and Graham investing in the equipment and people and for operating the plant at the Quaker Gatorade plant in Atlanta, Ga.

Introduction. Founded in 1901, Quaker Oats had sales of $4.6 billion in 1998 produced by 11,860 employees. Aside from the historical brand of Quaker Oats. Gatorade had $1.7 billion in worldwide sales and is far and away the number one brand in the sports beverage category with 82 percent share of market in the U.S. Other well known brands include Cap'n Crunch cereal, Life cereal, Chewy Granola Bars, Quaker Fruit and Oatmeal breakfast bars, Rice-A-Roni, Near East and Aunt Jemina syrups and pancake mixes.

Plastic Bottles: Big Business at Quaker Oats. Quaker is one of the world's largest purchasers of plastic bottles for sports drinks with Gatorade as one of the great global brands. Total U.S. case volume is roughly 100,000,000 cases sold mostly from April through September. The incumbent bottle supplier had been supplying since 1986 and had grown with Quaker from 10mm to over 1,400mm bottles by 1998. Because the initial emphasis had been on bottle supply and performance, the supplier had negotiated a price based on new investment and defined quantities. Over the 12-year period new negotiations had taken place, but the supplier had managed to increase/retain its high start-up margins.

The incumbent supplier did offered various means of cost reduction which were not sufficient.

Quaker after Snapple and Supply Chain Management. By 1997, new purchasing management was engaged to find supply chain cost efficiencies. The bottle was a logical first place to look, i.e., the low hanging fruit. A quick analysis indicated that the material cost was less than 40 percent of the bottle price, a ratio that indicated there was tremendous margin for the supplier if production costs were low. After paying what the company thought was reasonable price for many years, it was now immediately apparent to Quaker that the bottle price was too high.

A cross-functional team of accounting, engineering, technical, and purchasing staff was formed to model the bottle manufacturing cost. After numerous trips to plants and consultants, an independent model confirmed our initial belief, bottle prices could be reduced substantially. The current supplier was not willing to reduce the price even though Quaker understood and demonstrated the profit was excessive. Competition for the Quaker business would be the strategy.

The Alliance Options. Selecting an alliance was driven by the larger requirements of needing to reduce cost, improve quality and service, and determining which was the best method to get there.

The options were:

1. Merchant supplies the total product.
2. Self-manufacture with key raw material suppliers.
3. In-house plant operated by the supplier, an alliance would be needed due to: long-term commitment needed, on-going cost containment, contractual issues regarding having another company operate on our premises.

Merchant supply was rejected due to:

1. Absence of lower cost alternative merchant supply (freight cost hurdle).
2. No known way to gain effective cost understanding /cultural improvement with arm/s length relationship (lack of both parties' commitment).

Self-manufacture was rejected due to:

1. Not a Quaker Oats competency.
2. Supplier's cost of capital was generally lower than ours-best to use their money.

In-house plant was chosen because:

1. Best cost-no freight, direct feeding of filling line eliminates palletizing, fresher materials.
2. Best opportunity to institutionalize continuous improvement. Alliance relationship comes from the open book need to drive improvement. Quaker and Graham agreed to act as one company on each other's behalf.

Negotiating an Alliance.

The Quaker Negotiation Team included:

The Director of Packaging Purchasing

Senior Manager of Purchasing

Supervisor of Finance

Industrial Engineer

Manager, and Supply Chain Planning.

The Graham Packaging Company team included:

Senior Vice-President and General Manager, Food & Beverage Business Unit

Director of Sales, Beverage Business Unit

Director of Finance, Beverage Business Unit

Quaker visited eight bottle companies, two consulting companies, one practitioner of in-plant molding, two machinery suppliers, and two resin manufacturers. This effort took approximately one year and involved many, many sessions. In addition, Quaker refined the performance "should cost model" with the cross- functional team as mentioned earlier. Finally, trust-building sessions were held with two potential suppliers (the finalists). These sessions included senior management dinners, use of an outside consultant as a facilitator on partnering and frequent mutual visits.

In the survey to understand the market, it was determined that Graham Packaging of York, PA had the capability to meet our needs because of it's focus on our type of bottle and it's proven record with customers. A key to our beginning a relationship was to build trust and to center it around a disclosure of bottle costs.

Graham and Quaker held a series of meetings to define what each company wanted from a potential business relationship. It was determined that both were aligned on views of how to jointly create value. Quaker discussed Graham's target ROI needs and Graham acknowledged and understood Quaker's needs for low cost bottles. A key Quaker issue was , how to find a supplier who would manage the risk of unused bottle-making capacity after the substantial Gatorade seasonal peak and do it to Quaker's benefit. Graham agreed early in the discussions to price the bottle on a highly utilized machine basis in spite of Quaker's inability to commit to fill the equipment 100 percent of the year. Graham would find other customers if needed to keep the plant running and to maintain the full economic benefit for both companies.

Although the basis for the agreement ended up to be partnering, it did not start that way. As both parties discussed how to work to manage cost and find efficiencies, the only apparent way was to create an open-book accounting relationship.

At the core of supply chain management, the reason why trust fails to develop between buyer and supplier, and why maximum value in the relationship is not created, is because parties hide information from each other. The largest source of hidden information is cost. Opening the books is the best way to eliminate distrust and truly find a better relationship that would warrant any company investment in developing a relationship.

The Contract. Without divulging confidential information, the arrangement is not long term if Graham does not perform adequately. The incentive for the relationship to be constantly renewed has been built in through periodic "re-awarding" of the business based on performance. While those close to the relationship know this is not needed, the board of directors needed these safeguards.

Construction on the in-plant facility at the Gatorade plant in Atlanta, GA has been competed. Quaker spent $10MM in plant expansion; Graham spent $28MM on equipment, and will own and operate the plant and be responsible to meet certain quality and efficiency standards. If Graham fails to meet these standards, they will bear the cost of non-performance.

Type of contract:

1. Evergreen from 1 fixed period to another.
2. Completely open book-Quaker pays all expenses and a fixed return on invested capital (which was mutually costed).
3. Cancelable for failure to perform.
4. Volume sensitive: Quaker will compensate for volume shortfalls. However Gatorade has not failed to grow at least 9 percent per year over the last 18 years. Never bet against your own business.

How is the Alliance Working and Future Alliances? The bottles produced in the in -house plant are the lowest cost bottles in the Quaker system. The alliance has produced much better-more accurate forecasting which helps lower cost by schedule stabilization. While this is not the only cost reduction benefit in the endeavor, it demonstrates the need to capture and analyze total cost of ownership. The few start-up quality issues were resolved very quickly and as one would expect, the delivery and other service aspects are "perfect". Joint quality improvement initiatives enabled by the alliance are generating impressive results on the Quaker Oats filling lines as improved quality translated to increased productivity, reduced scrap, and lower costs. Joint cost savings initiatives and the "open-book" approach are also already delivering bottle cost savings to Quaker that exceed ingoing project objectives by over $1 million annually.

As to other alliance possibilities, Quaker would like more in other packaging materials but the packaging industry is very "old school" and adversarial. Consolidations result in frequent management changes which negate building long term relationships. In the field of packaging, costs are driven by machinery utilization so huge volumes are required for economics of scale. This is especially true for flexible film and folding cartons. Perhaps Quaker can partner with other non-competitors to consolidate and achieve the volume but that's another story.

REFERENCES

Dobler, Donald W. and David N. Burt, Purchasing and Supply Management: Text and Cases, NY, NY. The McGraw-Hill Companies, Inc. 6th Edition, 1996, page 13.

Burt, David N. and Richard L. Pinkerton, A Purchasing Manager's Guide to Strategic Proactive Procurement, NY, NY. Amacom, Division of the American Management Association, 1996, pages 8-9.

Burt, David N. and Michael F. Doyle, The American Keiretsu, Homewood, IL, Business One Irwin, 1993, page 33.

Riggs, David A. and Sharon L. Robbins, The Executive's Guide to Supply Management Strategies: Building Supply Chain Thinking into All Business Processes, NY, NY. Amacom Division of the American Management Association, 1998, page 114.

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Long, Chip and Gay Meyer, Sacred Cows Make the Best Barbecue: Supply Chain Management: A Revolutionary 26-Week Action Plan, Vision + Press, P.O. Box 3417, Seal Beach, CA 90740, 1998

Robert B. Harifield and Ernest L. Nichols, Jr., Introduction to Supply Chain Management, Upper Saddle River, NJ, Prentice Hall, 1999.

The NAPM Info Edge Series: Tempe AZ

1. Alliances: How to enter an alliance relationship. Feb. 1999, Vol. 4, No. 6, by Paul A. Ries, C.P.M.
2. Alliances: How to maintain an alliance relationship. March 1999, Vol. 4, No.7, by William S. Wehr. C.P.M.
3. Alliances: How to end an alliance relationship. April 1999, Vol. 4, No.8, by Lorrie K. Mitchell.
4. Understanding Supply Chain Management. March 1998, Vol. 3, No. 7, by Stephen L. Kesinger, C.P.M.

John A. Carlisle and Robert C. Parket, Beyond Negotiation: Redeeming Customer Supplier Relationships. NY, NY John Wiley & Sons. 1989

Jordan D. Lewis, Partnerships for Profit: Structuring and Managing Strategic Alliances. NY, NY. The Free Press, 1990.

Figure not available in text-only version of this article.

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