Procurement and Outsourcing Strategies

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Procurement and Outsourcing Strategies

• Designing Managing the Supply Chain
• Chapter 7
• Shen Qianru
• qr_shen_at_pusan.ac.kr

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Outline

• Case FreeMarkets Online, Inc.
• Introduction
• Outsourcing Benefits and Risks
• A Framework for Buy/Make Decisions
• E-Procurement
• A Framework for E-Procurement
• Summary

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Case FreeMarkets Online, Inc.

• 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

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Case FreeMarkets Online, Inc.

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

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Case FreeMarkets Online, Inc.

• 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

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Case FreeMarkets Online, Inc.

• 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?Networke
  d purchasing information systems?

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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
• 
  

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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, Apples 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?

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Outsourcing Benefits and Risks

• 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.

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Outsourcing Benefits and Risks

• Motivations for outsourcing
• Focus on core competencyThe buyer can focus on
  its core strength(special talent, skills,
  knowledge sets)
• Increase flexibility
• Ability to better react to changes in customer
  demand
• Ability to use the suppliers technical knowledge
  to accelerate product development cycle time
• Ability to gain access to new technologies and
  innovation

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Outsourcing Benefits and Risks

• IBM personal computer example(chapter 6) and
  Cisco case
• Two substantial risks associated with outsourcing
• Loss of competitive knowledge
• May open up opportunities for competitors
• Lose ability to introduce new designs based on
  their own agenda rather than the suppliers
  agenda
• 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

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A Framework for Buy/Make Decisions

• Reasons for outsourcing
• Dependency on capacityThe firm has the knowledge
  and the skills
• Dependency on knowledgeThe company doesnt have
  the people, skills, and knowledges required to
  produce the component
• Integral/modular product
• Toyotas exampleEngine Has both the knowledge
  and the capacity-gt100 internal
  productionTransmission Has the knowledge and
  designs but depends on suppliers capacity-gt70
  outsourcingVehicle Electronic Systems
  Dependency on both capacity and knowledge-gt100
  outsourcingThe more strategically important the
  component is, the smaller the dependency on
  knowledge or capacity

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A Framework for Buy/Make Decisions

• Integral/modular product
• Modular product (e.g. personal computer)Component
  s are independent of each other,interchangeableSt
  andard 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

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A Framework for Buy/Make Decisions
A Framework for make/buy decisions
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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

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E-Procurement

• Four types of e-market
• Value-added independent (public)
  e-marketOffering 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 consortias buyers.
• Content-based e-marketfocuses on maintenance,
  repair, operation goods focuses on
  industry-specific products

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E-Procurement
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A Framework for E-Procurement

• 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-gtcontent-based
• Strategic components high-risk
  components-gtprivate or consortia based
• Commodity products high risk, while variety of
  potential options to choose from

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A Framework for E-Procurement

• 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)

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