In my overview titled Small and Medium Enterprises in Asia (Dawn Oct 11th) it was stated that key to the success of Japanese SME lay in its subcontracting system. The present article therefore is devoted to unfolding the salient features of the concept and practice.
Subcontracting, in the context of SME, is defined as manufacturing of products, parts, accessories and rendering of services like maintenance, repair, inspection, auditing, training, creation of software, etc. commissioned by a larger enterprise (called parent enterprise) on a smaller enterprise (called subcontracting enterprise).
Subcontracting enterprises are a subset of the small and medium enterprises and account for 56 per cent of the SME in Japan. ubcontracting transactions enable a parent enterprise to minimize its in-house operations so as to prevent over-growth of its organization.
In Japan the scope of subcontracting transactions is defined as transactions of a parent firm having paid up capital in excess of Y 100 million with a ubcontractor having a capital of less than Y 100 million; transactions of a parent firm having paid up capital in excess of Y 10 million but less than Y 100 million with a subcontractor having a capital of less than Y 10 million.
The ratio of the subcontracting enterprises in various fields in Japan is as follows:
Transportation equipment 81 per cent, electric appliances 80 per cent, textiles and related products 80 per cent, general purpose machinery 75 per cent, precision machines 71 per cent, synthetic rubber/ resin products 70 per cent, and steel and non ferrous metals 58 per cent.
A large automobile manufacturing company in Japan typically has 20,000 to 35,000 sub-contractors. The company deals directly only with 200 primary sub-contractors, each of whom has its own down the ladder linkages with secondary and tertiary sub-contractors, such that none amongst them has to reckon with no more than a few dozen at the most.
The resulting pyramid type of the production system having a large base makes it possible for a large number of small enterprises to participate in the product system. This explains the existence of the huge number of small/micro companies in Japan.
This large number of small sub-contractors enables production to be highly specialized with quality of the highest order. Close inter-firm communication that exists in the Japanese industry generates matching high efficiency leading to significant reduction of cost per unit.
In sub-contracting transactions the parent enterprises being large in size and resources often tend to overwhelm the sub-contracting enterprises which are in no position to argue and resist. Instances of various types of violations by the parent companies in their contractual dealings with the sub-contracting enterprises are described as follows:
1- A parent firm had entrusted a sub-contractor with manufacture of parts and the sub-contractor obtained raw material accordingly. Subsequently, the parent firm cancelled the balance of the order on the plea that that demand for their product had dwindled and their inventory had got blocked.
2- The parent firm entrusted a sub-contractor with manufacture of parts. The sub-contractor had almost completed to work when the parent firm informed that the delivery date would have to be postponed because they (parent firm) had to change their production program so as to accommodate an urgent demand for some other product.
3- A parent firm entrusted a sub-contractor with manufacture of parts. The manufacturer set up his machines and started the production. After a few weeks the parent firm intimated some amendments to the drawings, and refused to receive the already produced quantity.
4- An inspection company was commissioned to undertake pre-shipment inspection at the manufacturer's premises. When the inspector reported for work on the scheduled date they were informed that the consignment was not yet ready for inspection. The parent firm declined to pay the compensation for the aborted visit.
5- An inspection company was commissioned to undertake inspection of steel coils weighing 8300 tons on an agreed per ton rate. The actual weight of the coils turned out as 8600 tons. The parent company insisted on paying the inspection charges for 8300 tons only.
6- A parent firm usually paid to sub-contractor after delivery of the goods. The sub-contractor requested for early clearance of his dues in view of his financial stringency. The parent firm did pay earlier (within 30 days) but only when the sub-contractor conceded a substantial discount.
7- A parent firm assigned an order to a sub-contractor with a delivery period of one week; but the very next day desired for completion of the order within three days. The sub-contractor regretted because of labour shortage.
The parent firm unilaterally changed the delivery date inspite of the circumstances explained by the sub-contractor. The sub-contractor tried his best by resorting to maximum overtime and could complete the order within four days. The parent firm adamantly applied a penalty for late completion.
8- A parent firm usually requires its sub-contractors to produce and deliver its clothes bearing the brand name of the parent firm. The parent firm forced the sub-contractor to take back the unsold clothes at the end of the season.
9- A parent firm usually entrust its dyeing work to a sub-contractor. When it receives the work from the sub-contractor it refused to accept it because of color and unevenness, which was in reality no different from the lots supplied in the past.
In the Japanese law, unreasonable price bargaining means, unjustly fixing a lower rate than what is ordinarily paid for similar work content. The ordinarily paid price means the price usually paid in the business segment to which the sub-contractor belongs.
Fixing sub-contracting charges by the following method on the part of parent firm comes under unfair business practice. (a) To cause the sub-contractors to quote charges in anticipation of high volume of work but in actual practice transact much smaller quantum of business.
b) To unilaterally determine the sub-contracting charges on the basis of assumed market price of the concerned product. c) To treat a particular sub-contractor discriminately without any justifiable reason, and determine in his case the sub-contracting charges lower than for the other contractors.
d) To determine the sub-contracting charge at a unit rate lower than the ordinary rate for the same kind of work simply because the work is for a particular region or a customer.
Business environment in the country being the responsibility of the state, onus lies on the governments to take initiatives to protect the interest of the sub-contractors against the excesses perpetrated by the parent firms. Extensive legislation was done in Japan to encourage and stabilize sub-contracting. Law for the Promotion of Small and Medium Enterprises was promulgated in 1970.
The law on the Prevention of Delay in the payment of Sub-contracting Charges and Related Matters was enacted in 1956 to protect the interest of the sub-contractors for the sake of sound development of the national economy.
This law imposes the following obligation on the parent enterprises; The purchase order must abide by the rules of the Fair Trade Commission. Subcontracting charges must be cleared within 60 days of the delivery of the product.
If payment is not made within this period an interest amount calculated according to the rule of the Fair Trade Commission must be added on to the amount payable. The law also prohibits the parent from the following actions:
Refuse to receive the work from a subcontractor without cogent reason. Refuse payment to the subcontractor for reason for which the subcontractor is not responsible. In our culture, inspection not having been finalized, verification of the bill not having been received from the purchaser (which are matters internal to the parent firm), often constitute the reasons for non-payment by the due date.
Again, it is not uncommon for the concerned accounts man to be busy with audit, budget, board meeting or simply being on leave to ward off the subcontractor. Cases of files not traceable are also not few and far between.
Avoid dealing with a subcontractor or reduce assignments for him just because he has lodged a complaint with the Fair Trade Commission or the Small and Medium Enterprise Agency against some inequity experienced by him on the part of the parent enterprise.
A code of Promotion Standards was specified for adherence by respective enterprises in regard to the following matters:
*Raising of productivity, quality and performance of the products.
*Clarifying precisely the scope of the orders and order placement methods.
*Modernizing of equipment.
*Improving of technology.
*Encouraging Cooperative business activities.
*Improving of methods of determining unit prices and inspection methods.
*Promotion of organizations.
*Other matters.
The SMEs are required to form profession-wise associations to coordinate the aforesaid matters regionally and nationally with Small and Medium Enterprises Agency and the respective government department/institution.
In Japan parent enterprises tend to have dealings with subcontracting enterprises continuously for long periods. In such dealings a parent enterprises makes a basic dealing contract, presents it to the subcontracting enterprise for agreement.
The basic dealing contract includes payment, transfer of ownership, and other common items in transactions. In addition a parent enterprise issues an order sheet specifying quantity, unit price, an advance amount payable.
The National Association for Subcontracting Enterprises Promotion has worked out a prototype of a basic dealing contract for each industry. Local Government Associations for Subcontracting Enterprises Promotion are also involved in this work.
Number of disputes or claims in subcontracting deals reported to the National Association for Subcontracting Enterprises Promotion has shown that 43 per cent of these pertain to delay in payments of subcontracting charges.
In case of a dispute, the subcontractor is required to take up the matter with the Association for Subcontracting Promotion which will hear from the Parent Firm as well and mediate a solution.
If necessary, cases are put up before a Claims and Disputes Settlement Committee which is a third party organ of the said Association. The Committee consists of representatives of subcontracting enterprises, lawyers and officials of public administrative organizations, as well as other persons of learning and experience.
Keeping in view the experiences of the South East Asian countries in so far as practice of subcontracting is concerned we should proceed in Pakistan as follows:
1- Define the scope of subcontracting enterprises.
2- Promote formation of Associations of various types of trades and professions.
3- Undertake with help of these Associations a duly segmented census of the subcontracting enterprises. Provide attractive incentive for those participating in this census.
4- Identify and prescribe Promotion Standards for the working of subcontracting enterprises.
5- Enforcement of these standards should be through financial and administrative incentives.
6- The Associations should be responsible for organizing cooperative/collective working of the enterprises in the form of clusters, centre-satellites etc.
7- Various laws and regulatory measures as referred in this article should be introduced on top most priority.
8- All activities and legislations concerning promotion of the small and medium enterprises should be done with active participation of the said associations and on the advice of experienced consultants. Bureaucracy should take the lead in making it all happen.