Slides 7 Outsourcing and Procurement Strategies Global Supply

Slides 7 Outsourcing and Procurement Strategies Global Supply Chain Management Outsourcing and Procurement Strategies 1

Introduction w Outsourcing (products or components) has increased over the years w Examples – Nike: all manufacturing outsourced – Electronics Industry • Cisco (major suppliers across the world) • Apple (over 70% of components outsourced) w Even design is being outsourced…. w Example – East/South Asian companies now design and manufacture laptops (and other electronic devices) for western firms Procurement and Outsourcing Strategies Slide 2

Questions w Why do many (technology) companies outsource manufacturing, and even innovation, to Asian manufacturers? w What are the risks involved? w How can an outsourcing strategy depend on product design characteristics? w How does a procurement strategy depend on supply risk and profit impact? w How do supply chain (push/pull) and procurement strategies depend on product? Procurement and Outsourcing Strategies Slide 3

Tentative Outsourcing Benefits w Economies of scale – Aggregation of multiple orders (by suppliers, from several firms) in purchasing and in manufacturing w Risk pooling – Demand uncertainty transferred to the suppliers – Suppliers reduce uncertainty through risk-pooling w Reduce capital investment – Capital investment transferred to supplier – Supplier’s higher investment shared between firms Procurement and Outsourcing Strategies Slide 4

Outsourcing Benefits w Firm can focus on core competency – Firm (buyer) can focus on its core strength – Allows firm to differentiate from its competitors w Increased flexibility – Ability to better react to change in customer demand – Ability to use supplier’s technical knowledge to accelerate product development, product cycle time – Gaining access to new technologies, innovation – Critical in certain industries, two typical examples: • High Tech: technologies change frequently • Fashion: products have a short life cycle Procurement and Outsourcing Strategies Slide 5

Risk 1 Loss of Competitive Knowledge w Outsourcing critical components to suppliers may open up opportunities for competitors (classical example: IBM-PC, clones+Compaq) w Company can lose its ability to introduce new designs based on own agenda, rather than the supplier’s agenda (IBM-PC, Micro. Soft DOS) w Outsourcing manufacturing of components to different suppliers may prevent development of new insights, innovations, and solutions (that require cross-functional teamwork) Procurement and Outsourcing Strategies Slide 6

Risk 2 Conflicting Objectives w Demand Issues – In a good economy • Demand is high and a conflict can be addressed by buyers who are willing to make long-term commitments to purchase minimum quantities specified by a contract – In a slow economy however: • Significant decline in demand long-term commitments entail financial risks for the buyers w Product design issues – Buyers insist on flexibility • like to solve design problems as fast as possible – Suppliers focus on cost reduction • implies slow responsiveness to design changes. Procurement and Outsourcing Strategies Slide 7

Example Outsourcing Problem Cisco was forced to announce a $2. 2 billion write-down for obsolete inventory, 8, 500 employees were laid off. w Sudden demand reduction telecom products w Problems in its virtual global manufacturing network: – The long supply lead time for key components would have impacted delivery to customers – The competition for limited supplier capacities had forced Cisco to sign long-term supplier contracts – So Cisco carried component inventory which were ordered long in advance of the downturn…. and was overwhelmed with more of it…. . in a downward market…… Procurement and Outsourcing Strategies Slide 8

Framework for Make / Buy w How can a firm decide which product or even component to manufacture and which to outsource? w Focus on core competencies – How can the firm identify what is in the core? – What is outside the core? Procurement and Outsourcing Strategies Slide 9

Two Key Outsourcing Reasons w Dependency on capacity – Firm has skills and knowledge required to produce the component – For “capacity” reasons decides to outsource w Dependency on knowledge – Firm does not have skills and knowledge required to produce the component – Outsources in order to have access to these capabilities (additional to capacity reasons) Procurement and Outsourcing Strategies Slide 10

Outsourcing at Toyota w Engines: – Company has knowledge and capacity – All engines are produced internally w Transmissions – Company has knowledge and designs all components – Depends on its suppliers’ capacities (for 70%) w Vehicle electronic systems – Designed and produced by Toyota’s suppliers. – Company depends on supplier’s capacity and knowledge w Toyota varies outsourcing practice based on strategic role of components/subsystems – The more strategically important, the smaller the dependency on knowledge or capacity Procurement and Outsourcing Strategies Slide 11

Product Architectures w Modular product (example: computer) – – – Made by combining different components Components are independent of each other Components are interchangeable Standard interfaces are used Customer preference determines the final product configuration w Integral product (example: airplane) – Made up of components whose functionalities are tightly related – Not made from off-the-shelf components – Designed as system by using top-down design approach – Evaluated on system not on component performance – Components perform multiple functions Procurement and Outsourcing Strategies Slide 12

Framework for Make/Buy Decisions (developed by Fine) Product Dependency on knowledge and capacity Independent for knowledge, dependent for capacity Independent for knowledge and capacity Modular Outsourcing is risky Outsourcing is an opportunity Opportunity to reduce cost through outsourcing Integral Outsourcing is very risky Outsourcing is an option Keep production internal So: Outsourcing is less of an option with integral products and will hardly provide an opportunity Procurement and Outsourcing Strategies Slide 13

Procurement Strategies w The smaller the profit margins, the more important it is to focus on reducing procurement costs w Strategy for procurement will further depend on type of products the firm is purchasing, on the level of risk and on the uncertainty w Helpful here is Kraljic’s Supply Matrix Procurement and Outsourcing Strategies Slide 14

Kraljic’s Supply Matrix w Firm’s procurement strategy should depend on two dimensions – profit impact (including: ) • Volume purchased/ percentage of total purchased cost/ impact on product quality or business growth – supply risk (including: ) • Availability/number of suppliers/competitive demand/ make-or-buy opportunities/ storage risks/ substitution opportunities Procurement and Outsourcing Strategies Slide 15

Kraljic’s Supply Matrix Procurement and Outsourcing Strategies Slide 16

Kraljic’s Supply Matrix w Top right quadrant: – Strategic items where supply risk and impact on profit are high (e. g. processors in a computer) – Highest impact on customer experience – Price is a large portion of the system cost – Typically have a single supplier – Focus on long-term partnerships with suppliers w Bottom right quadrant Items with high impact on profit Low supply risk, many suppliers, Leverage items, (e. g. leather for shoes) Small percentage of cost savings will have a large impact on bottom line – Focus on cost reduction by competition between suppliers – – Procurement and Outsourcing Strategies Slide 17

Kraljic’s Supply Matrix w Top left quadrant: High supply risk but low profit impact items. Bottleneck components (e. g. water, electricity) Do not contribute a large portion of the product cost Suppliers have power position Ensure continuous supply, even possibly at a premium cost – Focus on long-term contracts or by carrying stock (or both) – – – w Bottom left quadrant: – Non-critical items (e. g. office utensils, stationary) – Simplify and automate the procurement process as much as possible – Use a decentralized procurement policy with no formal requisition and approval process Procurement and Outsourcing Strategies Slide 18

Supplier Footprint w Supply Strategies have changed over the years – American automotive manufacturers • 1980 s: Suppliers either in the US or in Germany. • 1990 s: Suppliers in Mexico, Spain, and Portugal. • 2000 s: Suppliers in China – High-tech industry • 1980 s: Sourcing in the US • 1990 s: Singapore and Malaysia • 2000 s: China w Challenge: – Framework that helps organizations determine the appropriate supplier footprint – Strategy should depend on the type of product or component purchased Procurement and Outsourcing Strategies Slide 19

Functional vs. Innovative Products (based on Fisher) Functional Products Innovative Products Slow Fast Predictable Unpredictable Profit Margin Low High Product Variety Low High Average forecast error at the time production is committed Low High Average stockout rate Low High Product clockspeed Demand Characteristics Procurement and Outsourcing Strategies Slide 20

Supply Chain Strategy (Fisher) w Functional Products – Diapers, soup, milk, tiers – Appropriate supply chain strategy for functional products is push – Focus: efficiency, cost reduction, and supply chain planning. w Innovative products – Fashion items, cosmetics, or high tech products – Appropriate supply chain strategy is push-pull – Focus: high profit margins, fast clock speed, unpredictable demand, responsiveness, maximizing service level, order fulfillment Procurement and Outsourcing Strategies Slide 21

Procurement Strategy (Fisher) w Functional Products – Focus should be on minimizing total landed cost • • • unit cost transportation cost inventory holding cost handling cost duties and taxation cost of financing – Sourcing from low-cost countries is appropriate w Innovative Products – Focus should be on reducing lead times AND on supply flexibility. – Sourcing close to the market area or short lead time may be achieved using air shipments Procurement and Outsourcing Strategies Slide 22

SUMMARY w Outsourcing has both benefits and risks w Buy/make decisions should depend on (Fine): – Whether a particular component is modular or integral – Whether or not a firm has the expertise and capacity to manufacture a particular component or product. w Procurement strategies vary from component to component – Four categories of components, strategic, leverage, bottleneck and non-critical items (Kraljic) w Distinguish Modular and Functional Products – Impact on Supply Chain and Procurement Strategies Procurement and Outsourcing Strategies Slide 23