1,1,1,1,1,Chapter 9: Procurement and Outsourcing Strategies,1,Dr. YANG Ruina,2,2,2,2,2,Agenda,Introduction Outsourcing Buy/make Decision Procurement Strategy Summary,3,Introduction,Outsourcing components have increased progressively over the years.,4,Introduction,Some Famous Examples of Outsourcing: Fashion Industry (Nike) (all manufacturing outsourced) Electronics Industry Cisco (major suppliers across the world) Apple (over 70% of components outsourced),5,Not Just Manufacturing but Product Design, Too,Taiwanese companies now design and manufacture most laptop sold around the world. Brands such as Hewlett-Packard and PalmOne collaborate with Asian suppliers on the design of their PDAs.,6,Questions/Issues with Outsourcing,Why do many technology companies outsource manufacturing, and even innovation, to Asian manufacturers? What are the risks involved? Should outsourcing strategies depend on product characteristics, such as product clockspeed, and if so how?,7,Discussion Points,Buy/make decision process Advantages and the risks with outsourcing Framework for optimizing buy/make decisions. Effective procurement strategies Framework for identifying the appropriate procurement strategy Linkage of procurement strategy to outsourcing strategy. The procurement process Independent (public), private, and consortium-based e-marketplaces. New developments mean higher opportunities and greater challenges faced by many buyers,8,Outsourcing Benefits,Economies of scale Risk pooling Reduce capital investment Focus on core competency Increased flexibility,9,Outsourcing Risks,Loss of competitive knowledge Conflicting objectives - flexibility vs. long-term, stable commitments, etc.,10,Examples of Outsourcing Problems IBM,PC market entry in 1981 Outsourced many components to get to market quickly 40% market share by 1985 beating Apple as the top PC manufacturer Other competitors like Compaq used the same suppliers IBM tried to regain market by introducing the PS/2 line with the OS/2 system Suppliers and competitors did not follow IBM market share shrunk to 8% in 1995 Behind Compaqs 10% leading share Led to eventual sale of PC business to Lenovo,11,Examples of Outsourcing Problems Cisco,2000 problem: Forced to announce a $2.2 billion write-down for obsolete inventory 8,500 employees were laid off. Significant reduction in demand for telecommunication infrastructure Problem in its virtual global manufacturing network Long supply lead time for key components Would have impacted delivery to customers Cisco carried component inventory which were ordered long in advance of the downturn. Competition on limited supplier capacities Long-term contracts with its suppliers,12,Framework for Make/Buy Decisions,How can the firm decide on which component to manufacture and which to outsource? Focus on core competencies How can the firm identify what is in the core? What is outside the core?,13,Two Main Reasons for Outsourcing,Dependency on capacity Dependency on knowledge,14,Outsourcing Decisions at Toyota,15,Product Architectures,Modular product Made by combining different components Components are independent of each other Components are interchangeable Standard interfaces are used Customer preference determines the product configuration. Integral product 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. Evaluated on system performance, not on component performance Components perform multiple functions.,A Framework for Make/Buy Decisions,17,Outsource or Not?,Customer Importance How important is the component to the customer? What is the impact of the component on customer experience? Does the component affect customer choice? Component Clockspeed How fast does the components technology change relative to other components in the system? Competitive Position Does the firm have a competitive advantage producing this component? Capable Suppliers How many capable suppliers exist? Architecture How modular or integral is this element to the overall architecture of the system?,Examples of Decisions,Importance of Procurement,20,Procurement Strategies,Impact of procurement on business performance 2005 profit margins for Pfizer (24%), Dell (5%), Boeing (2.8%). Reducing procurement cost by exactly 1% of revenue would have translated directly into bottom line, i.e., net profit. To achieve the same impact on net profit through higher sales Pfizer would need to increase its revenue by 4.17 (0.01/0.24) % Dell by 20% and Boeing by 35.7% The smaller the profit margins, the more important it is to focus on reducing procurement costs.,21,Appropriate Strategy,Depends on: type of products the firm is purchasing level of risk uncertainty involved Issues: How can the firm develop an effective purchasing strategy? What are the capabilities needed for a successful procurement function? What are the drivers of effective procurement strategies? How c