Microsoft Outsourcing Xbox Production

About Microsoft Formed in 1975; IPO in 1986 Global annual revenue of US $62 billion  Nearly 90,000 employees in 105 countries Develops, manufactures, licenses, supports a wide range of software products for computing devices Current Market Cap of $226.19B. Comparable economy: Egypt - GDP: $187,954B (Population: 79m) Thailand - GDP: 263,889B (Population: 66m) Microsoft achieved the position of world leader in software development by relying on no one but itself. But when Microsoft officials decided that they had a new kind of future in the Xbox--a piece of hardware--they also recognized that they faced several serious roadblocks to success. The software company had no factories, no real experience building things, and no stomach for the risks associated with a sudden plunge into the manufacturing business. Very quickly, officials realized that the company needed a partner to help with the heavy lifting. 2

Microsoft’s Challenges Primary a software company, however it long had a small but important hardware business selling computer mice, keyboards and joysticks under the Microsoft brand Xbox was different: it was a fully functional specialized computer with multiple components including microprocessors, memory chips, graphic chips and an internal hard drive. Microsoft quickly decided that it lacked the manufacturing and logistics capabilities to make the Xbox itself and manage a global supply chain. Although Microsoft had relied on outside vendors to manufacture simpler items such as mouse, keyboards, and joysticks, the Xbox venture was considerably more complex and ambitious. Microsoft officials worried openly about losing control of the process, not being apprised of major and minor problems until it was too late, and not being able to find a company that could deliver the initial 800,000 units required for a holiday season launch in November 2001. Installing a network of hardware factories and hiring competent employees for the production, would have caused very high costs and therefore a higher risk. Additional risks could have been not worthwhile, because the entire potential of the game console market was only about 23% of Microsoft’s revenues in 2001. In addition to that the competitors Sony and Nintendo were well known and integrated in the game console market – a difficile starting point for entering a market. 3

Outsourcing The procuring of services or products, such as the parts used in manufacturing a motor vehicle, from an outside supplier or manufacturer in order to cut costs Focus On Core Activities In rapid growth periods, the back-office operations of a company will expand also. This expansion may start to consume resources (human and financial) at the expense of the core activities that have made your company successful. Outsourcing those activities will allow refocusing on those business activities that are important without sacrificing quality or service in the back-office. Cost And Efficiency Savings Back-office functions that are complicated in nature, but the size of your company is preventing you from performing it at a consistent and reasonable cost, is another advantage of outsourcing. Operational Control Operations whose costs are running out of control must be considered for outsourcing. Departments that may have evolved over time into uncontrolled and poorly managed areas are prime motivators for outsourcing. In addition, an outsourcing company can bring better management skills to your company than what would otherwise be available. Flexibility Outsourcing will allow operations that have seasonal or cyclical demands to bring in additional resources when you need them and release them when you’re done. Loss of managerial control: Whether you sign a contract to have another company perform the function of an entire department or single task, you are turning the management and control of that function over to another company. True, you will have a contract, but the managerial control will belong to another company. Your outsourcing company will not be driven by the same standards and mission that drives your company. They will be driven to make a profit from the services that they are providing to you and other businesses like yours. Hidden Costs You will sign a contract with the outsourcing company that will cover the details of the service that they will be providing. Any thing not covered in the contract will be the basis for you to pay additional charges. Additionally, you will experience legal fees to retain a lawyer to review the contacts you will sign. Remember, this is the outsourcing company's business. They have done this before and they are the ones that write the contract. Therefore, you will be at a disadvantage when negotiations start. 3. Threat to Security and Confidentiality The life-blood of any business is the information that keeps it running. If you have payroll, medical records or any other confidential information that will be transmitted to the outsourcing company, there is a risk that the confidentiality may be compromised. If the outsourced function involves sharing proprietary company data or knowledge (e.g. product drawings, formulas, etc.), this must be taken into account. Evaluate the outsourcing company carefully to make sure your data is protected and the contract has a penalty clause if an incident occurs. 4. Quality Problems The outsourcing company will be motivated by profit. Since the contract will fix the price, the only way for them to increase profit will be to decrease expenses. As long as they meet the conditions of the contract, you will pay. In addition, you will lose the ability to rapidly respond to changes in the business environment. The contract will be very specific and you will pay extra for changes. 5. Tied to the Financial Well-Being of Another Company Since you will be turning over part of the operations of your business to another company, you will now be tied to the financial well-being of that company. It wouldn't be the first time that an outsourcing company could go bankrupt and leave you holding-the-bag. 6. Bad Publicity and Ill-Will The word "outsourcing" brings to mind different things to different people. If you live in a community that has an outsourcing company and they employ your friends and neighbors, outsourcing is good. If your friends and neighbors lost their jobs because they were shipped across the state, across the country or across the world, outsourcing will bring bad publicity. If you outsource part of your operations, morale may suffer in the remaining work force. -------------- 4

Advantages/Disadvantages Key Advantages Key Disadvantages Focus On Core Activities Loss of managerial control Cost And Efficiency Savings Hidden Costs Operational Control Threat to Security and Confidentiality Flexibility Quality Problems Tied to the Financial Well-Being of Another Company Bad Publicity and Ill-Will Focus On Core Activities In rapid growth periods, the back-office operations of a company will expand also. This expansion may start to consume resources (human and financial) at the expense of the core activities that have made your company successful. Outsourcing those activities will allow refocusing on those business activities that are important without sacrificing quality or service in the back-office. Cost And Efficiency Savings Back-office functions that are complicated in nature, but the size of your company is preventing you from performing it at a consistent and reasonable cost, is another advantage of outsourcing. Operational Control Operations whose costs are running out of control must be considered for outsourcing. Departments that may have evolved over time into uncontrolled and poorly managed areas are prime motivators for outsourcing. In addition, an outsourcing company can bring better management skills to your company than what would otherwise be available. Flexibility Outsourcing will allow operations that have seasonal or cyclical demands to bring in additional resources when you need them and release them when you’re done. Loss of managerial control: Whether you sign a contract to have another company perform the function of an entire department or single task, you are turning the management and control of that function over to another company. True, you will have a contract, but the managerial control will belong to another company. Your outsourcing company will not be driven by the same standards and mission that drives your company. They will be driven to make a profit from the services that they are providing to you and other businesses like yours. Hidden Costs You will sign a contract with the outsourcing company that will cover the details of the service that they will be providing. Any thing not covered in the contract will be the basis for you to pay additional charges. Additionally, you will experience legal fees to retain a lawyer to review the contacts you will sign. Remember, this is the outsourcing company's business. They have done this before and they are the ones that write the contract. Therefore, you will be at a disadvantage when negotiations start. 3. Threat to Security and Confidentiality The life-blood of any business is the information that keeps it running. If you have payroll, medical records or any other confidential information that will be transmitted to the outsourcing company, there is a risk that the confidentiality may be compromised. If the outsourced function involves sharing proprietary company data or knowledge (e.g. product drawings, formulas, etc.), this must be taken into account. Evaluate the outsourcing company carefully to make sure your data is protected and the contract has a penalty clause if an incident occurs. 4. Quality Problems The outsourcing company will be motivated by profit. Since the contract will fix the price, the only way for them to increase profit will be to decrease expenses. As long as they meet the conditions of the contract, you will pay. In addition, you will lose the ability to rapidly respond to changes in the business environment. The contract will be very specific and you will pay extra for changes. 5. Tied to the Financial Well-Being of Another Company Since you will be turning over part of the operations of your business to another company, you will now be tied to the financial well-being of that company. It wouldn't be the first time that an outsourcing company could go bankrupt and leave you holding-the-bag. 6. Bad Publicity and Ill-Will The word "outsourcing" brings to mind different things to different people. If you live in a community that has an outsourcing company and they employ your friends and neighbors, outsourcing is good. If your friends and neighbors lost their jobs because they were shipped across the state, across the country or across the world, outsourcing will bring bad publicity. If you outsource part of your operations, morale may suffer in the remaining work force. -------------- 5

About Flextronics Singapore-based Electronics Manufacturing Services (EMS) provider $13Billion Sales, 100K Employees in 28 countries Supplier to Dell, Ericsson, HP, Siemens, Sony & Xerox Microsoft had often employed the company to assemble mouse and other small PC-related gadgets, but it had not actively considered Flextronics for the Xbox project. Flextronics management contacted Microsoft and offered new ways of thinking about outsourcing challenges and supply-chain management. The discussion quickly alleviated any fears Microsoft officials had about turning over the manufacture of the Xbox to a third-party contractor. 6

Flextronics Advantage Uses “industrial park” strategy Can shift production from country to country Had excellent web-based information systems for real-time exchange Had experience with Microsoft (e.g. in computer mice) Outsourcing the production to Flextronics meant primarily profiting from their specialized engineers and workers, their highly cost-efficient industrial parks as well as their economies of scale. With the additional revenues generated by the Xbox contract Flextronics could certainly purchase materials and devices at even more favorable prices. They were already producing for various clients and could therefore compart the fix costs for infrastructure and facilities among them. On one hand, this gave Microsoft the possibility to save money and on the other hand, focus on their main products in the software sector as the retail of the new Windows XP in 2001, wholly in the sense of comparative advantages. Beyond that, the Xbox was designed and developed by both partners in cooperation, which created synergy effects by fusing know-how and creating new ideas. In conclusion, Microsoft benefitted from lower variable and fix costs at once, as well as a perfected product. 7

Xbox Market Launch PS2 released and was dominating market Game Cube announced for Christmas launch Xbox launch: 3 days before Christmas (US) 2 months before the Game Cube (Europe and Australia)

Xbox Market Launch Microsoft was able to balance demand and supply Over 25 million units were sold (2006) Outsourcing partner can be a competitive advantage

Xbox Market Launch Xbox was finally released on the 15th November 2001 in North America without any delays, three days before the Game Cube and punctually for the Christmas sales In Europe and Australia the Xbox appeared even 2 month before the Game Cube A very important point seen the market situation: The Sony PlayStation 2 was already released and imbibing market shares since the end of 2000. Nintendo had to announce delays for the Game Cube. It was hence crucial to enter the market before Nintendo and as quick as possible. The Xbox was finally released on the 15th November 2001 in North America without any delays, three days before the Game Cube and punctually for the Christmas sales. This was a strategic advantage realized due to Flextronics, which provided the capacities and the logistic structure in order to assure delivery times and the release date of the Xbox.  In Europe and Australia the Xbox appeared even 2 month before the Game Cube. Furthermore, the conditions as costs and earnings as well as terms of liabilities are contractually fixed and thus more transparent. Thanks to that Microsoft is able to better plan their game console business. 10

Success Story + = Outsourcing success blueprint: Choose a partner, not a contractor Set expectations early in the process The following steps helped make the Microsoft-Flextronics endeavor an outsourcing success story and provide a blueprint that other companies can apply to their own partnering projects: Choose a partner, not a contractor. In the electronics manufacturing services (EMS) world, quality is never a variable; manufacturing firms have the requisite expertise and capability needed to produce a top-of-the-line electronics product. Microsoft did not simply use price as the obvious distinguishing factor. Flextronics won Microsoft's business because it offered the elements that showed it was a real team player. These elements included a willingness to collaborate with Microsoft as well as in-depth IT solutions across all aspects of Flextronics's manufacturing and design process that provided visibility into a global process. 2) Set expectations early in the process. From the start, Microsoft and Flextronics worked together to outline each company's roles and responsibilities and to ensure that all parties knew what was expected of them in all anticipated scenarios. The contract addressed topics such as how the various parties would communicate, what the production schedule would look like, what the contingency plans would be when something didn't go as planned, and who would assume the various risks involved. As a result, the relationship quickly became a successful hybrid of the two most traditional outsourcing arrangements: Microsoft never turned over complete responsibility to Flextronics or passively waited to hear about progress. Neither did it act as a typical employer, dictating tasks and keeping Flextronics in the dark about its long-term plans for the product. Instead, the two companies worked together collaboratively from the beginning. + = 11

Conclusion Sophisticated and effective outsourcing relationships are becoming more typical in every industry Microsoft's decision to outsource the Xbox manufacturing illustrates just how sophisticated and effective partnering with outside contractors can be in the twenty-first century, no matter what the industry or product Sophisticated and effective outsourcing relationships are becoming more typical in every industry. Many of the world's leading companies such as Microsoft Corporation (Redmond, WA) and Dell Computer Corporation (Round Rock, TX) have embraced outsourcing and harnessed the expertise and capabilities of their outsourcing partners for their own success. The company must integrate the contract manufacturer into the project at an early stage of development and manage a sophisticated supply chain. The company also must manufacture and distribute globally, ramp up production as product acceptance takes hold, and ensure market supply. It must achieve very high levels of product quality and dependability. Microsoft's decision to outsource the Xbox manufacturing illustrates just how sophisticated and effective partnering with outside contractors can be in the twenty-first century, no matter what the industry or product. 12

Thank You Q&A 13