1. Procurement and Outsourcing Strategies Designing & Managing the Supply Chain Chapter 7 Shen Qianru qr_shen@pusan.ac.kr

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

3. 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

4. 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

5. 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

6. 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?

7. 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

8. 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?

9. 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.

10. 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 supplier’s technical knowledge to accelerate product development cycle time III.Ability to gain access to new technologies and innovation

11. 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 supplier’s 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

12. 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 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 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

13. 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

14. A Framework for Buy/Make Decisions ProductDependency on knowledge and capacity Independent for knowledge, dependency for capacity Independent for knowledge and capacity ModularOutsourcing is riskyOutsourcing is an Opportunity Opportunity to reduce cost through outsourcing IntegralOutsourcing is very riskyOutsourcing is an Option Keep production internal A Framework for make/buy decisions

15. 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

16. 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 consortia’s buyers. Content-based e-market focuses on maintenance, repair, operation goods; focuses on industry-specific products

17. E-Procurement Private marketplacePublic/consortia marketplace OwnerA single buyerIndependent owner of a group of companies from the same industry Objectives1.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 ParticipantsSelected group of suppliersOpen market Buyer costBuilding and maintaining the site1.Subscription fee 2.Licensing fee 3.Transaction fee Supplier costNo fee1.Transaction fee 2.Subscription fee Main problems1.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

18. 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

19. 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) Option Level HighInventory Risk (supplier) N/A* LowPrice and shortage risks (buyer) Inventory risk (buyer) LowHigh Base commitment level * For a given situation, either the option level or the base commitment level may be high, but not both

20. 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