Procurement and Outsourcing Strategies

Designing & Managing the Supply Chain Chapter 7

Shen Qianru
qr_shen@pusan.ac.kr

Outline
Case: FreeMarkets Online, Inc. Introduction Outsourcing Benefits and Risks A Framework for Buy/Make Decisions

E-Procurement
A Framework for E-Procurement Summary

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

Case: FreeMarkets Online, Inc.

The market Concentrate 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 chemicals Electronic components

Machines parts Metal fabrications Corrugated packaging Printed circuit boards

Stampings Castings Plastic moldings

Case: FreeMarkets Online, Inc.

The sales model Direct 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 suppliers Phase 4: Conduct on-line competitive bidding events Phase 4: Provide post-bid analysis and award support

Case: FreeMarkets Online, Inc.

The revenue model A price model that was a hybrid of service fees and sales commissions Going forward to scale Horizontal 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, 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?

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.

Outsourcing Benefits and Risks

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

Outsourcing Benefits and Risks

IBM personal computer example(chapter 6) and Cisco 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 objectives
Buyers: Increase flexibility Suppliers: Long time, firm, stable commitment from the buyer; focus on cost reduction

A Framework for Buy/Make Decisions

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 example
Engine: Has both the knowledge and the capacity->100% internal production Transmission: 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

A Framework for Buy/Make Decisions

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 component Customer 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 performance Components in integral products perform multiple functions

A Framework for Buy/Make Decisions

A Framework for make/buy decisions
Product Dependency on knowledge and capacity Outsourcing is risky Outsourcing is very risky Independent for knowledge, dependency for capacity Outsourcing is an Opportunity Outsourcing is an Option Independent for knowledge and capacity Opportunity to reduce cost through outsourcing Keep production internal

Modular Integral

E-Procurement
Many manufacturer were desperately looking to outs ource 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

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-market A 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 same industry, 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

E-Procurement
Private marketplace Owner A single buyer Public/consortia marketplace 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
Open market 1.Subscription fee 2.Licensing fee 3.Transaction fee 1.Transaction fee 2.Subscription fee 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

Participants Buyer cost

Selected group of suppliers Building and maintaining the site

Supplier cost Main problems

No fee 1.Intitial investment 2.Data normalization and uploading

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->content-based Strategic components: high-risk components->private or consortia based Commodity products: high risk, while variety of potential options to choose from

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)
High Option Level Low Inventory Risk (supplier) Price and shortage risks (buyer) Low N/A* Inventory risk (buyer) 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