Procurement and Outsourcing Strategies

1
Procurement and Outsourcing Strategies
2

• Free the Market case
• What are Ariba, CommerceOne
• Who are they?
• How they are doing?
• Next week Wal Mart case (chapter 8)

3
Introduction

• In 1990s, firms considered outsourcing everything
  from the procurement function to production and
  manufacturing.
• One easy way to increase profit is by reducing
  costs through outsourcing. Between 1998 and 2000,
  outsourcing in the electronic industry has
  increased from 15 percent of all components to 40
  percent.
• Nike, focuses mainly on research and development
  on the one hand, and marketing, sales, and
  distribution on the other, outsources almost all
  of its manufacturing activity.
• Apple Computers also outsources most of its
  manufacturing activities 70 percent of its
  components including major products such as
  printers. Apple focused its internal resources on
  its own disk operating system and the supporting
  macro software to Apple products their unique
  look and feel.

4
Introduction

• Global virtual manufacturing strategy. Ciscos
  Internet-based business model has been
  instrumental in its ability to quadruple in size
  while increasing their productivity, and save
  560M annually in business expenses.
• Cisco established manufacturing plants all over
  the world and developed close arrangements with
  major suppliers.
• The approach was enabled by Ciscos
  single-enterprise system, which provides the
  backbone for all activities in the company, and
  connects not only customers and employees, but
  also chip manufacturers, component distributors,
  contract manufacturers, logistics companies, and
  systems integrators.
• Participants perform like one company as they all
  rely on the same Web-based data sources. All its
  suppliers see the same demand rather than on
  their own forecasts based on information flowing
  from multiple points in the supply chain. Cisco
  also built a dynamic replenishment system to help
  reduce supplier inventory.

5
Introduction

• The landscape has changed for Nike, Cisco, Apple,
  and other companies who rely heavily on
  outsourcing, particularly for manufacturing.
• In 2001, Nike reported an unexpected profits
  shortfall due to inventory buildup in some
  products, shortages for others and late
  deliveries. The company blamed both the weak U.S.
  economy and complications with the implementation
  of a supply planning system.
• In 1999, Apple was not able to satisfy customer
  demand due to shortages in the G4 chip supplied
  by Motorola.
• In 2000, Cisco was forced to announce a 2.25
  billion write-down for obsolete inventory. This
  was the result of a significant reduction in
  demand for telecommunication infrastructure to
  which Cisco was not able to respond effectively.
• We need to learn more about the buy/make decision
  process and the advantage and risk associated
  with outsourcing.

6
Outsourcing Benefits and Risks

• Some of the motivations for outsourcing are
• Economies of scale aggregation of orders from
  different buyers.
• Risk pooling transfer demand uncertainty to the
  Contract Equipment Manufacturer (CEM). EMS
• Reduce capital investment transfer to the CEM.
• Focus on core competency that differentiates the
  company from its competitors.
• Increased flexibility the ability to (i) better
  react to changes in customer demand, (ii) use the
  suppliers technical knowledge to accelerate
  product development cycle time, and (iii) to gain
  access to new technologies and innovation.

7
Risks Associated with Outsourcing

• Loss of competitive knowledge May open up
  opportunities for competitors, prevent the
  development of new insights.
• Conflicting objectives Suppliers and buyers
  typically have different and conflicting
  objectives, e.g., on flexibility.

8
A Framework for Buy/Make Decisions

• Reasons for outsourcing in two main categories
• Dependency on capacity The firm has the
  knowledge and the skills required to produce the
  component but for various reasons decides to
  outsource.
• Dependency on knowledge The firm does not have
  the people, skills, and knowledge required to
  produce the component and outsources in order to
  have access to these capabilities. Of course, the
  company has to have the knowledge and skills to
  evaluate customer needs and convert these into
  key requirements and characteristics that the
  component should have.

9
A Framework for Buy/Make Decisions

• The example from Toyota to illustrate the
  concepts
• Toyota has both the knowledge and the capacity to
  produce its engines and indeed 100 percent of the
  engines are produced internally.
• For transmissions, the company has the knowledge
  and indeed all the components but depends on its
  suppliers capacities, since 70 percent of the
  components are outsourced.
• Vehicle electronic systems are designed and
  produced by Toyotas suppliers. Thus, in this
  case the firm has a dependency on both capacity
  and knowledge.
• Toyota varies its outsourcing practice depending
  on the strategic role of the components and
  subsystems. This suggests the need for a better
  understanding of product architecture when
  considering what to outsource.
• Integral and modular products are distinguished.

10
A Framework for Buy/Make Decisions

• Modular products made by combining different
  components.
• Components are independent of each other.
• Components are interchangeable.
• Standard interfaces are used.
• A component can be designed or upgraded with
  little or no regard to other components.
• Customer preference determines the product
  configuration.
• Integral products made up from components whose
  functionalities are tightly related.
• Not made from off-the-shelf components.
• Designed as a system by taking a top-down design
  approach.
• Are evaluated based on system performance, not
  based on component performance.
• Components in integral products perform multiple
  functions.

11
A Framework for Buy/Make Decisions

• Very few products are either integral or modular.
  
• The degree of modularity or integrality may vary
  with PCs being on one end of the spectrum, that
  is, highly modular products, and airplanes being
  on the other end of the spectrum.
• For modular products, if the firm has knowledge
  but not capacity, then outsource manufacturing is
  appropriate if the firm has neither, outsourcing
  may be a risky strategy.
• For integral products, if the firm has both, then
  in-house production is appropriate. If not both,
  perhaps it is in the wrong business.

12
E-Procurement

• E-Marketplaces promises among other things,
  increased market reach for both buyers and
  suppliers, reduced procurement costs, and
  paperless transactions. (CommerceOne, Ariba)
• The procurement process is highly complex,
  requires significant expertise, and is very
  costly.
• Buyers need to have significant expertise in the
  procurement process, which many of them did not
  have.
• Vertical-industry focus versus horizontal-business
  -process functional focus
• Value proposition offered to buyers by many of
  the 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.

13
????
???
???
???
????
???
????
??
??????
????
??????
??
????????
??????
??
????
???????
????/?????
??
??????
???/???
????
????
??????
?????
????????
???
?????

??


??
EDI
??
EDI
EDI
14
E-Procurement

• Clearly, this business model is appropriate when
  buyers are focused on the spot market and
  long-term relationships with the suppliers are
  not important.
• The value proposition for suppliers are not as
  clear
• Allow relatively small suppliers to expand their
  horizon.
• Suppliers of fragmented industries can access
  spot markets where buyers are looking not for
  long-term relationships but rather for a great
  price at an acceptable quality.
• Allow suppliers to reduce marketing and sales
  costs and thus increase their ability to compete
  on price.
• Allow suppliers to better utilize their available
  capacities and inventories.
• Whether these benefits compensate for a reduction
  in revenue?
• Suppliers, especially those with brand-name
  recognition, may resist selling their services
  through e-markets.

15
B2B E-Commerce Frameworks
The role of frameworks in B2B transactions
16
Frameworks

• Open Buying on the Internet (OBI)
• eCo framework (CommerceOne)
• RosettaNet
• cXML (Ariba)
• BizTalk

17
Comparison of B2B Frameworks
18
Interface Comparison
19
E-Procurement

• How do e-markets generate revenue?
• Initially, many of the markets charged a
  transaction fee paid by either the buyer, the
  suppliers, or both.
• This fee was typically a percentage of the price
  paid by the buyer and varied from 1 to 5 percent.
  
• Transaction fees pose serious challenges to the
  market maker
• Sellers resist paying a fee to the company whose
  main objective is to reduce the purchase price.
• The revenue model needs to be flexible so that
  transaction fees are charged to the party that is
  more motivated to secure the contract.
• Buyers also resist paying a fee in addition to
  the purchase price.
• Low entry barriers to entry created a fragmented
  industry flooded with participants. Newly evolved
  charge mechanisms licensing fees (software) and
  subscription fees (membership).

20
E-Procurement

• The focus of value proposition was on market
  reach for buyers and sellers as well as lower
  purchase cost, but now
• Value-added independent (public) e-markets by
  offering additional services such as inventory
  management, SC planning, and financial services.
  Instill.com focuses on the food service industry.
  Others provides forecasting, collaboration, and
  replenishment tools.
• Private e-markets Dell, Sun, Wal-Mart, and IBM,
  among others. See the e-market as a way to
  improve SC collaboration by providing demand
  information and production data to their
  suppliers. Subway uses e-marketplace to
  consolidate purchase power.
• Consortia-based e-markets established by a
  number companies within the same industry.
  Covisint (automotive), Trade-Ranger (oil),
  Exostart (aerospace), and Converge and E2Open
  (electronic).
• Content-based e-markets MRO goods and industry
  specific products. Unify catalogs and provide
  effective tools for search and comparison. Aspect
  Development offers electronics parts catalogs.

21
Private versus Consortia-based e-markets
22
Public/consortia vs. Private e-marketplace
23
A Framework for E-Procurement

• Whether the firm should build a private
  marketplace, use independent markets, or perhaps
  participate in a consortia-based market? A
  framework is provided to allow executives and
  managers to better match procurement strategies
  with products.
• Distinguish between different types of goods
  purchased
• Strategic components Components that are part of
  the finished goods and are not only industry
  specific but also company specific. These are
  typically integral products, such as PC
  motherboard and chassis that are specific for
  every computer.
• Commodity products Products that can be
  purchased from a variety of vendors and whose
  price is determined by market forces. These are
  typically the modular components that go directly
  into the finished product, such as the memory
  unit in a PC.
• Indirect materials MRO and components not part
  of the finished product or the manufacturing
  process but are essential for the business.
  Examples include lighting, janitorial supplies,
  office supplies, fasteners, and generators.

24
A Framework for E-Procurement

• The appropriate procurement strategy clearly
  depends on the type of product the firm is
  purchasing as well as the level of risk the firm
  is willing to take. This risk is associated with
• Uncertain demand, implying inventory risk.
• Volatile market price, implying price risk.
• Component availability, implying a shortage risk
  with an impact on the firms ability to satisfy
  customer demand.
• Consider the purchase of commodity products. By
  their nature, these can be purchased either in
  the open market through on-line auctions or
  through the use of long-term contracts. Long-term
  contracts guarantee a certain level of supply,
  but may be risky for the buyer if realized demand
  is either lower or higher than the demand
  forecast.

25
A Framework for E-Procurement

• Indirect material The risk associated with which
  is typically low and hence the focus is on using
  content-based hubs, specifically, MRO hubs
  specializing in unifying catalogs.
• Strategic components These are high-risk
  components that can be purchased from a small
  number of suppliers. Thus, a private or
  consortia-based e-marketplace is more
  appropriate. The focus is to provide suppliers
  with real-time demand information as well as the
  buyers production plans, so that suppliers can
  better use their capacities and resources. The
  decision to employ either e-marketplace depends
  on
• Transaction volume
• Number of suppliers
• Cost to build and maintain a private site
• The importance of protecting proprietary business
  practices
• Technology and product life cycles

26
A Framework for E-Procurement

• Commodity products The most challenging product
  category, since many of these products go
  directly into finished goods, so the risk is
  quite high, while the firm has a variety of
  potential options to choose from. A portfolio
  approach focused on the appropriate trade-offs
  between risk and cost is used. To implement the
  portfolio approach, the firm use a combination of
• Long-term contracts where the buyer and supplier
  commit to a certain volume and the supplier
  guarantees a level of supply (referred to as the
  base commitment level) for a committed price.
• Flexible, or option, contracts, in which the
  buyer prepays a relatively small fraction of the
  product price up front, in return for a
  commitment from the supplier to satisfy demand up
  to a certain level. We refer to that level as the
  option level.
• Spot purchasing, in which buyers look for
  additional supply in the open market. Use the
  marketplace to find new suppliers and force
  competition between suppliers to reduce product
  price.

27
A Framework for E-Procurement

• How does the portfolio approach address risk?
• If demand is much higher than anticipated and the
  base commitment level plus the option level do
  not provide enough protection, the firm must use
  the spot market for additional supply. However,
  this is the worst time to buy in the spot market,
  since prices are high due to shortages. Thus, the
  buyer can select a trade-off level between price
  risk, shortage risk, and inventory risk by
  carefully selecting the level of long-term
  commitment and the option level.
• For the same option level, the higher the initial
  contract commitment, the smaller the price risk
  but the higher the inventory risk taken by the
  buyer. Contrarily, the smaller the level of the
  base commitment, the higher the price and
  shortage risks due to the likelihood of using the
  spot market. Similarly, for the same level of
  base commitment, the higher the option level, the
  higher the risk assumed by the supplier since the
  buyer may exercise only a small fraction of the
  option level.

28
(No Transcript)
29
Construction Management MH2 Case

• Historical View
• Builders
• TV Show Your New House
• Franchising
• MH2 Build internally and externally
• NASCAR Sponsorship
• MH2 Supply
• MH2 Finance
• MH2 Inspect

• Positioning
• SCM CPM, PERT
• ERP CMIS
• MES MH2 Build
• ASP MH2 Build
• B2B MH2 Build/Supply/Finance