Outsourcing strategy

7/27/2019 Outsourcing strategy

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Procurement and Outsourcing

Strategies

Designing & Managing the Supply Chain

Chapter 7Shen Qianru

[email protected]


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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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FreeMarkets OnLine is an electronic marketscompany 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 hisown set of objectives and issues


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The marketConcentrate in the middle- components that were not

commodities, but for which competitive supply markets

exists

No-tooling

Custom components

Low-tooling

Custom components

Transferable-tooling

custom components

Fasteners

Service center metals

Specialty chemicalsElectronic components

Machines parts

Metal fabrications

Corrugated packagingPrinted circuit boards

Stampings

Castings

Plastic moldings


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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 process

Phase 1: Identify savings opportunities

Phase 2: Prepare total-cost RFQ(Request for Quoting)

Phase 3: Identify, screen, and support suppliersPhase 4: Conduct on-line competitive bidding events

Phase 4: Provide post-bid analysis and award support


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

commissions

Going forward to scale

Horizontal market expansion or vertical marketdominance?

Technology and user support subscription licensing?

Networked purchasing information systems?


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Introduction

What is procurement and outsourcing?

Procurementis 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 ofcorporations, or individuals, generally via a contract.

Outsourcingis 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 productscompany-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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Motivations for outsourcing Economies of scale

Reduce manufacturing costs through the aggregation of orders

from many different buyers.

Risk poolingBuyers 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 investmentBuyers transfers capital investment to the CEM. CEM can make

this investment by sharing between many of its customers.


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Motivations for outsourcing Focus on core competency

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

knowledge sets)

Increase flexibility

I. Ability to better react to changes in customer demand

II.Ability to use the suppliers technical knowledge to accelerate

product development cycle time

III.Ability to gain access to new technologies and innovation


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IBM personal computer example(chapter 6) andCisco case

Two substantial risks associated with outsourcing

Loss of competitive knowledge

I. May open up opportunities for competitors

II. Lose ability to introduce new designs based on their own agenda

rather than the suppliers agenda

III.Manufacture of various components to different suppliers may

prevent development of new insights, innovations, and solutions.

Conflicting objectivesBuyers: Increase flexibility

Suppliers: Long time, firm, stable commitment from the buyer;

focus on cost reduction


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Reasons for outsourcing Dependency on capacity

The firm has the knowledge and the skills

Dependency on knowledge

The 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->100% internal

productionTransmission: Has the knowledge and designs but depends on

suppliers capacity->70% outsourcing

Vehicle Electronic Systems: Dependency on both capacity and

knowledge->100% outsourcing

The more strategically important the component is, the

smaller the dependency on knowledge or capacity


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

Components are independent of each other,interchangeable

Standard interfaces are used

Component 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 components

Designed as a system by taking a top-down design approach

Evaluated based on system performanceComponents in integral products perform multiple functions


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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


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E-Procurement

Many manufacturer were desperately looking to outsource their procurement functions

Highly 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-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-market

Established by a number of companies within the sameindustry, to provide suppliers with a standard system that

supports all the consortias buyers.

Content-based e-market

focuses on maintenance, repair, operation goods;

focuses on industry-specific products


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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 data

2.Allow for logistics and supply chain collaboration

1.Buying and selling commodities by

focusing on price

2.Finding new suppliers

3.Buying and selling excess inventory

Participants Selected group of suppliers Open market

Buyer cost Building and maintaining the site 1.Subscription fee

2.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 information

4.Data normalization and uploading


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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


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Base commitment level: long-term contract which is commitment level ofsupply

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 commitmentlevel 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

Outsourcing strategy

Documents

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