Session 6 Case discussion

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:
a. Merchant supplies the total product.
b. Self-manufacture with key raw material suppliers.
c. In-house plant operated by the supplier, an alliance would be needed due to: longterm commitment needed, on-going cost containment, contractual issues
regarding having another company operate on our premises.
Merchant supply was rejected due to:
a. Absence of lower cost alternative merchant supply (freight cost hurdle).
b. 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:
a. Not a Quaker Oats competency.
b. Supplier's cost of capital was generally lower than ours-best to use their money.
In-house plant was chosen because:
a. Best cost-no freight, direct feeding of filling line eliminates palletizing, fresher
materials.
b. 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 inplant 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:
a. Evergreen from 1 fixed period to another.
b. Completely open book-Quaker pays all expenses and a fixed return on invested
capital (which was mutually costed).
c. Cancelable for failure to perform.
d. 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.

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a. Alliances: How to enter an alliance relationship. Feb. 1999, Vol. 4, No. 6, by Paul
A. Ries, C.P.M.
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