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Business Relationships Control
I. Executive Summary
Ethical issues should enable an organization to build trust which is central to building relationships with suppliers that create value and fitness for purpose. Paradoxically, ACS seeks to achieve value and fitness for purpose internally through six sigma and lean principles but its the implementation of its code of conduct being a contractual requirement. This adversarial approach to supplier relationships is counterproductive in achieving value and fitness for purpose from its supplier chain.
In the wake of the Enron collapse, Bottorff commented, “One of the great lessons of the post-Enron economy is that poor ethics has finally been recognized as a leading killer of organizations”. This new threat to survival has led many organizations to develop compliance and social responsibility programs to positively exonerate themselves, by assuring all whom they come into contact with that an ethical culture is alive and thriving throughout the organization.
This paper focuses on Honeywell ACS (Automation and Control Systems) and looks at what impact its own ethics and values are having on its efforts to drive value and fitness for purpose through enhanced relationships with strategic suppliers.
III. Overview of Honeywell Automation and Control Solutions
Honeywell International Inc is a USD31Billion Fortune 75 company, listed on the New York Stock exchange. As a global conglomerate, Honeywell International Inc has largely grown through acquisition, with the last major purchase being the British company, Novar Plc, in April 2005 to boost its ACS division. There are four major divisions of Honeywell International Inc - Aerospace, Specialty Materials, Transport and ACS (Automation and Control Solutions).
ACS has an annual revenue of USD11Billion, 40,000 employees and 100 factories globally forming ISC - Integrated Supply Chain. Within ACS, there are seven strategic business units that supply ‘Electrical Infrastructure for Buildings’ which is a vast array of mechanical and electronic based sensors and controls for building control management systems, fire detection, security, air handling systems, electrical wiring devices (plugs and sockets), etc.
IV. Honeywell Operating System
The integrating mechanism used by Honeywell ACS to optimize activity across the seven business units, to align, standardize and focus on organizational objectives, is called HOS (Honeywell Operating System). HOS is defined by Honeywell as “…a comprehensive, integrated approach to managing the Integrated Supply Chain (ISC). It is based on the Toyota Production System and builds on our use of Six Sigma Plus tools in eliminating variation and improving our work processes on a rapid and continuous basis.
The system will change the way we currently act, work and lead. Key elements of the system include standardized work, direct, visible product flows, continuous improvement through rapid, low-cost experimentation, immediate problem-solving and having leaders act as mentors and coaches to enable shop-floor success. We expect the system to drive exceptional performance in safety, quality, value and delivery”.
The compelling reason for implementing the HOS was highlighted by Lysons “Where such integration is not achieved, the result will be waste, conflict and low productivity, or sub-optimization….”
Honeywell uses Six Sigma methodologies to achieve ‘Fitness for Purpose’ -a phrase originally coined by Joseph Juran in the context of quality. Lysons describes the emphasis Juran was making towards quality as ‘….linked to product satisfaction and dissatisfaction to deficiencies or defects in a product or service’.
Value is driven through the application of lean methodologies described as a chain of activities or processes that add value to a product and those that do not (the latter therefore is waste) or as ‘something that the customer would be prepared to pay for if they were aware of its existence’. As pointed out by Greenhalgh ‘Getting rid of the activities that don’t add value gives you a lean manufacturing or service delivery process - and also a lean organization’.
According to Lysons supply chains and value chains are synonymous “A linear map of the way in which value is added by means of a process from raw materials to finished product (including service after delivery)”. The role suppliers take in Value and Fitness for Purpose is summed up in Honeywell’s ethical policy - Code of Business Conduct “Honeywell’s suppliers are our partners in Six Sigma Plus. The high caliber of the materials, goods and services they provide is linked directly to the quality, reliability, value and prompt delivery of the Company’s products and thus to our satisfaction”
V. Honeywell Code of Business Conduct
The Honeywell code of business conduct is a 36 page document published on the companies corporate website. A corporate guide to employees and any one else that may enter into a commercial relationship (who must read and agree to abide by its contents) with the organization, it is a set of rules and guidelines on Honeywell’s approach to doing business.
This is made very clear in Section 1 - Implementation where it is stated ‘….all directors, officers and employees and all representatives, including all agents, consultants, independent contractors and suppliers of Honeywell, are responsible for complying with all applicable laws and regulations in each country in which the company does business and for knowing this code of conduct and other policies of the company…’. It goes on to state ‘…Violations of law or this code or other policies of the company are subject to discipline, which may include termination. Business units are responsible for ensuring that their policies and practices are consistent with this Code.’
b. Relevant areas of the code to Suppliers
The text of the code does in some cases provide guidance and in others be very specific around the do’s and don’ts of doing business as either an employee or in one of the many capacities of a third party mentioned above.
From a supply chain stand point, the following areas are of some relevance and should be considered for further analysis in context of their potential impact on the supplier;
- We maintain accurate books and records and report results with integrity
- We protect the Environment
- We do not employ child or forced labor
- We seek long term relationships
i. We maintain accurate books and records and report results with integrity
The focus of this requirement is related to legislative changes in the post-Enron era where changes in accounting practices were made and the Sarbanes-Oxley Act of 2002 (SOX) was introduced due to a decline of public trust in accounting and reporting practices.
a. Main Provisions of the Act
According to Engel, SOX compliance was initially focused on internal financial accounting issues. Now attention has shifted to look at the complete supply chain where ‘it is the supply chain leaders’ responsibility to interpret the impact that SOX compliance has on a company’s supply base and to work with a company’s compliance leaders to ensure that supply chain leaders have appropriate control’.
Engel goes on to point out that there are three primary areas for any publicly traded company on the U.S stock exchange to comply with;
- Internal process controls (Sections 302& 404): Calls for the creation and maintenance of viable internal controls.
- Section 302 was intended to lay foundations to help restore investor confidence in the integrity of financial and other reports
- Section 404 requires a company to file an internal audit control with its annual report
- Off-balance sheet obligations (Section 401a): Requires the listing and disclosure of off-balance sheet transactions and obligations.
- To include pertinent off balance sheet arrangements for supply chain executives e.g. certain guarantee contracts, for minimum volumes over a specific period
- Contingent Interests such as such as VMI (Vendor Managed Inventory) that may be considered an asset
- Timely reporting of material changes (Section 409): Requires the timely reporting of events that materially impact financial reporting.
- Related to outsourcing, if there is a disruption for whatever reason, a process is needed to report the financial interruption
b. Implications of compliance from the Supply Chain
According to a report by the APICS group, SOX is a particular issue when organizations have poor inventory transaction control such as:
- Inaccurate inventory balances (raw materials, work in progress, finished goods, etc)
- Reduced ‘Faith in System Data’
- Ad Hoc and “just in case” purchasing and shop floor ordering
- Rushed deliveries
- Poor manufacturing yields
- Reduced product quality and increased returns
- Sales allowances and credits from an operating perspective
- Understated reserves for financial reporting purposes
As a minimum, the implementation of SOX should be driving value through reporting requirements demanding improved data accuracy leading to improved inventory transaction control.
c. Impact of SOX on ACS Suppliers
As a publicly listed company, the impact on Honeywell and its suppliers should be far reaching. As mentioned in the APICS report above, the key to compliance from a supply chain perspective is with the accuracy of inventories, which play a key role in establishing true net worth of a business. As with most modern manufacturing organizations, Honeywell aims to implement VMI (vendor managed inventory) with all its major suppliers; this plays a key part in increasing ‘value’ through the removal of wastes from the value chain.
Typical wastes would include assets tied up in working capital (stock) thus reducing cash flow and transactional costs e.g. raising purchase orders. A key benefit of VMI would be the improvement of manufacturing process efficiency by allowing the supplier to determine when and how many parts to produce. The argument for VMI is therefore compelling. To conform with section 401a, VMI cannot be considered as an asset, as such ACS seeks to implement ‘Right of Return’ contracts with suppliers with the specific objective of being able to prove to auditors that it claims no title to material sitting in its warehouse.
The issue faced by ACS when implementing the agreement is rejection from the suppliers that they have made customized product (material converted to ACS specifications) based on a schedule provided by ACS and that cannot be re-sold, therefore the value of the parts to them is negligible.
The only solution thus far proposed (and rejected by most ACS suppliers) is that right of return requirements are factored into the overall purchase price.
ii. We Protect the Environment
The code does not elaborate on what is expected from suppliers in this regard. None of the supplier audits or the ‘Common Assessment’ makes reference to any specific environmental objectives that a supplier must meet or comply with e.g..;
- Re-cycled / sustainable content in products
- Lifecycle costing
- Controls of dangerous substances
- Energy saving programs
a. ROHS (Restrictions on Hazardous Substances)/
WEEE (Waste Electrical and Electronic Equipment) Compliance
An area where ACS does make their suppliers aware of their environmental requirements is with European Union’s ROHS / WEEE compliance.
ROHS, which went into effect July 2006, limits the use of six substances in electrical and electronic products. WEEE, which went into effect August 2005, requires producers to provide recovery and recycling programs for the processing of electronic waste. Non-compliance to these hazardous substances and recycling directives pose potential financial risk to manufacturers as well as other members of the supply chain. These risks include banned or delayed shipments, product recalls, regulatory fines, exclusion from important markets and potential damage to a corporation's or its brand's reputation.”
In summary, ROHS is concerned with the content of the inbound material and WEEE is concerned with how waste product is handled at the end of the process.
Honeywell design rules dictate that where possible products should be designed to ROHS standard, this is reflected in section 5.2 of the Honeywell Strategic Supply agreement where ROHS compliance is required.