procurement and outsourcing strategies designing & managing the supply chain chapter 7 shen...

Procurement and Outsourcing Strategies

Designing & Managing the Supply Chain

Chapter 7

Shen Qianru

[email protected]

Outline

Case: FreeMarkets Online, Inc.

Introduction

Outsourcing Benefits and Risks

A Framework for Buy/Make Decisions

E-Procurement

A Framework for E-Procurement

Summary


FreeMarkets OnLine is an electronic markets company which provides interactive bidding among competing suppliers generated price savings

It created a fair and open exchange software which is necessary for Competitive Bidding Event(CBE)

The company were successful at developing reasonable expertise and market knowledge, to lead the art and science of making markets for custom products, where each buyer in the market has his own set of objectives and issues


The marketConcentrate in the middle- components that were not commodities, but for which competitive supply markets exists

No-toolingCustom components

Low-toolingCustom components

Transferable-tooling custom components

FastenersService center metalsSpecialty chemicalsElectronic components

Machines partsMetal fabricationsCorrugated packagingPrinted circuit boards

StampingsCastingsPlastic moldings


The sales modelDirect sales model, which consisted of high bandwidth “client developers” networking into and establishing relationships with senior level purchasing, operations, and finance executives at large targeted corporations

The market-making processPhase 1: Identify savings opportunitiesPhase 2: Prepare total-cost RFQ(Request for Quoting)Phase 3: Identify, screen, and support suppliersPhase 4: Conduct on-line competitive bidding eventsPhase 4: Provide post-bid analysis and award support


The revenue modelA price model that was a hybrid of service fees and sales commissions

Going forward to scaleHorizontal market expansion or vertical market dominance?Technology and user support subscription licensing?Networked purchasing information systems?

Introduction

What is procurement and outsourcing?

Procurement is the acquisition of goods and/or services at the best possible total cost of ownership, in the right quantity and quality, at the right time, in the right place and from the right source for the direct benefit or use of corporations, or individuals, generally via a contract.

Outsourcing is subcontracting a process, such as product design or manufacturing, to a third-party company.

-Wikipedia

Introduction

Consider the successful short life-cycle products company-Nike, Apple, Cisco, etc. who rely heavily on outsourcing, particularly for manufacturing.

In 2001,Nike reported an unexpected profit shortfall due to inventory buildup in some products shortages for others as well as late deliveries

In 1999, Apple’s ability to satisfy customer demand was significantly reduced due to shortages in the G4 chip supplied by Motorola

In 2000, Cisco was forced to announce a $2.25billion write-down for obsolete inventory because of a significant reduction in demand for telecommunication infrastructure to which Cisco was not able to respond effectively.

What went wrong?


Motivations for outsourcing• Economies of scale

Reduce manufacturing costs through the aggregation of orders from many different buyers.

• Risk pooling

Buyers transfers demand uncertainty to the CEM(Contract Equipment Manufacturers)CEM aggregates demand from many buying companies thus reduces uncertainty and component inventory levels

• Reduce capital investment

Buyers transfers capital investment to the CEM. CEM can make this investment by sharing between many of its customers.


Motivations for outsourcing• Focus on core competency

The buyer can focus on its core strength(special talent, skills, knowledge sets)

• Increase flexibilityI. Ability to better react to changes in customer demand

II. Ability to use the supplier’s technical knowledge to accelerate product development cycle time

III.Ability to gain access to new technologies and innovation


IBM personal computer example(chapter 6) and Cisco case

Two substantial risks associated with outsourcing• Loss of competitive knowledgeI. May open up opportunities for competitors

II. Lose ability to introduce new designs based on their own agenda rather than the supplier’s agenda

III.Manufacture of various components to different suppliers may prevent development of new insights, innovations, and solutions.

• Conflicting objectivesBuyers: Increase flexibilitySuppliers: Long time, firm, stable commitment from the buyer; focus on cost reduction


Reasons for outsourcing• Dependency on capacity

The firm has the knowledge and the skills• Dependency on knowledge

The company doesn’t have the people, skills, and knowledges required to produce the component

Integral/modular product• Toyota’s example

Engine: Has both the knowledge and the capacity->100% internal productionTransmission: Has the knowledge and designs but depends on suppliers’ capacity->70% outsourcingVehicle Electronic Systems: Dependency on both capacity and knowledge->100% outsourcingThe more strategically important the component is, the smaller the dependency on knowledge or capacity


Integral/modular product• Modular product (e.g. personal computer)

Components are independent of each other,interchangeableStandard interfaces are usedComponent can be designed or upgraded with little or no regard to other componentCustomer preference determines the product configuration

• Integral product (e.g. motherboard)Not made from off-the shelf componentsDesigned as a system by taking a top-down design approachEvaluated based on system performanceComponents in integral products perform multiple functions


Product Dependency on knowledge and capacity

Independent for knowledge, dependency 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

A Framework for make/buy decisions

E-Procurement

Many manufacturer were desperately looking to outsource their procurement functionsHighly complex, significant expertise, costly

The value proposition offered to buyers by e-markets• Serving as an intermediary between buyers and suppliers

• Identifying saving opportunities

• Increasing the number of suppliers involved in the bidding event

• Identifying, qualifying, and supporting suppliers

• Conducting the bidding event

E-Procurement

Four types of e-market• Value-added independent (public) e-market

Offering additional services(inventory management, supply chain planning, financial services)

• Private e-marketA way to improve supply chain collaboration by providing demand information and production data; Consolidate purchasing power across the entire corporation

• Consortia-based e-marketEstablished by a number of companies within the same industry, to provide suppliers with a standard system that supports all the consortia’s buyers.

• Content-based e-marketfocuses on maintenance, repair, operation goods; focuses on industry-specific products

E-Procurement

Private marketplace Public/consortia marketplace

Owner A single buyer Independent owner of a group of companies from the same industry

Objectives 1.Share proprietary data2.Allow for logistics and supply chain collaboration

1.Buying and selling commodities by focusing on price

2.Finding new suppliers3.Buying and selling excess inventory

Participants Selected group of suppliers Open market

Buyer cost Building and maintaining the site 1.Subscription fee2.Licensing fee

3.Transaction fee

Supplier cost No fee 1.Transaction fee2.Subscription fee

Main problems 1.Intitial investment

2.Data normalization and uploading

1.Recent collapse of many marketplaces

2.Objections by referred suppliers because of price focus

3.Sharing of proprietary information4.Data normalization and uploading


Types of Goods Purchased by the Firm

• Strategic components: components that are part of the finished goods and are not only industry specific but also company specific

• Commodity products: components that can be purchased from a variety of vendors and whose price is determined by market forces

• Indirect materials: maintenance, repair and operations ;components that are not part of the finished products, manufacturing process

Level of Risk

• Uncertain demand: inventory risk

• Volatile market price: price risk

• Component availability: shortage risk

Framework for E-Procurement

• Indirect material: risk is typically low->content-based

• Strategic components: high-risk components->private or consortia based

• Commodity products: high risk, while variety of potential options to choose from


Base commitment level: long-term contract which is commitment level of supply

Option level: a commitment from the supplier to satisfy demand up to a certain level

Spot purchasing: buyers look for additional supply in the open market

Portfolio approach (appropriate trade-offs between risk and cost for commodity products)

Option

Level

High Inventory Risk

(supplier)N/A*

Low Price and shortage

risks (buyer)

Inventory

risk (buyer)

Low High

Base commitment level

*For a given situation, either the option level or the base commitment level may be high, but not both

Summary

Benefits and risks of outsourcing

Framework for making buy/make decisions

E-markets and their impact on business strategies

E-procurement and its framework

procurement and outsourcing strategies designing & managing the supply chain chapter 7 shen...

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