Slides 7
Outsourcing and
Procurement Strategies
Global Supply Chain
Management
Outsourcing and Procurement Strategies
1
Introduction
 Outsourcing (products or components)
has increased over the years
 Examples
– Nike: all manufacturing outsourced
– Electronics Industry
• Cisco (major suppliers across the world)
• Apple (over 70% of components outsourced)
 Even design is being outsourced….
 Example
– East/South Asian companies now design
and manufacture laptops (and other
electronic devices) for western firms
Procurement and Outsourcing Strategies
Slide 2
Questions
 Why do many (technology) companies
outsource manufacturing, and even
innovation, to Asian manufacturers?
 What are the risks involved?
 How can an outsourcing strategy depend
on product design characteristics?
 How does a procurement strategy depend
on supply risk and profit impact?
 How do supply chain (push/pull) and
procurement strategies depend on product?
Procurement and Outsourcing Strategies
Slide 3
Tentative Outsourcing Benefits
 Economies of scale
– Aggregation of multiple orders (by suppliers, from
several firms) in purchasing and in manufacturing
 Risk pooling
– Demand uncertainty transferred to the suppliers
– Suppliers reduce uncertainty through risk-pooling
 Reduce capital investment
– Capital investment transferred to supplier
– Supplier’s higher investment shared between firms
Procurement and Outsourcing Strategies
Slide 4
Outsourcing Benefits
 Firm can focus on core competency
– Firm (buyer) can focus on its core strength
– Allows firm to differentiate from its competitors
 Increased flexibility
– Ability to better react to change in customer demand
– Ability to use supplier’s technical knowledge to
accelerate product development, product cycle time
– Gaining access to new technologies, innovation
– Critical in certain industries, two typical examples:
• High Tech: technologies change frequently
• Fashion: products have a short life cycle
Procurement and Outsourcing Strategies
Slide 5
Risk 1
Loss of Competitive Knowledge
 Outsourcing critical components to suppliers
may open up opportunities for competitors
(classical example: IBM-PC, clones+Compaq)
 Company can lose its ability to introduce new
designs based on own agenda, rather than the
supplier’s agenda (IBM-PC, MicroSoft DOS)
 Outsourcing manufacturing of components to
different suppliers may prevent development
of new insights, innovations, and solutions
(that require cross-functional teamwork)
Procurement and Outsourcing Strategies
Slide 6
Risk 2
Conflicting Objectives
 Demand Issues
– In a good economy
• Demand is high and a conflict can be addressed by
buyers who are willing to make long-term
commitments to purchase minimum quantities
specified by a contract
– In a slow economy however:
• Significant decline in demand and long-term
commitments entail financial risks for the buyers
 Product design issues
– Buyers insist on flexibility
• like to solve design problems as fast as possible
– Suppliers focus on cost reduction
• implies slow responsiveness to design changes.
Procurement and Outsourcing Strategies
Slide 7
Example Outsourcing Problem
Cisco
 Cisco was forced to announce a $2.2 billion
write-down for obsolete inventory, 8,500
employees were laid off.
 Sudden demand reduction telecom products
 Problems in its virtual global manufacturing
network:
– The long supply lead time for key components
would have impacted delivery to customers
– The competition for limited supplier capacities had
forced Cisco to sign long-term supplier contracts
– So Cisco carried component inventory which were
ordered long in advance of the downturn….and
was overwhelmed with more of it….. in a
downward market……
Procurement and Outsourcing Strategies
Slide 8
Framework for Make / Buy
 How can a firm decide which product or
even 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?
Procurement and Outsourcing Strategies
Slide 9
Two Key Outsourcing Reasons
 Dependency on capacity
– Firm has skills and knowledge required to
produce the component
– For “capacity” reasons decides to outsource
 Dependency on knowledge
– Firm does not have skills and knowledge
required to produce the component
– Outsources in order to have access to these
capabilities (additional to capacity reasons)
Procurement and Outsourcing Strategies
Slide 10
Outsourcing at Toyota
 Engines:
– Company has knowledge and capacity
– All engines are produced internally
 Transmissions
– Company has knowledge and designs all components
– Depends on its suppliers’ capacities (for 70%)
 Vehicle electronic systems
– Designed and produced by Toyota’s suppliers.
– Company depends on supplier’s capacity and
knowledge
 Toyota varies outsourcing practice based on
strategic role of components/subsystems
– The more strategically important, the smaller
the dependency on knowledge or capacity
Procurement and Outsourcing Strategies
Slide 11
Product Architectures
 Modular product (example: computer)
–
–
–
–
–
Made by combining different components
Components are independent of each other
Components are interchangeable
Standard interfaces are used
Customer preference determines the final product
configuration
 Integral product (example: airplane)
– Made up of components whose functionalities are
–
–
–
–
tightly related
Not made from off-the-shelf components
Designed as system by using top-down design approach
Evaluated on system not on component performance
Components perform multiple functions
Procurement and Outsourcing Strategies
Slide 12
Framework for Make/Buy
Decisions (developed by Fine)
Product
Dependency on
knowledge and
capacity
Independent for
knowledge,
dependent 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
So: Outsourcing is less of an option with integral
products and will hardly provide an opportunity
Procurement and Outsourcing Strategies
Slide 13
Procurement Strategies
 The smaller the profit margins, the more
important it is to focus on reducing
procurement costs
 Strategy for procurement will further depend
on type of products the firm is purchasing,
on the level of risk and on the uncertainty
 Helpful here is Kraljic’s Supply Matrix
Procurement and Outsourcing Strategies
Slide 14
Kraljic’s Supply Matrix
 Firm’s procurement strategy should
depend on two dimensions
– profit impact (including:)
• Volume purchased/ percentage of total
purchased cost/ impact on product quality or
business growth
– supply risk (including:)
• Availability/number of suppliers/competitive
demand/ make-or-buy opportunities/ storage
risks/ substitution opportunities
Procurement and Outsourcing Strategies
Slide 15
Kraljic’s Supply Matrix
Procurement and Outsourcing Strategies
Slide 16
Kraljic’s Supply Matrix
 Top right quadrant:
– Strategic items where supply risk and impact on
–
–
–
–
profit are high (e.g. processors in a computer)
Highest impact on customer experience
Price is a large portion of the system cost
Typically have a single supplier
Focus on long-term partnerships with
suppliers
 Bottom right quadrant
–
–
–
–
Items with high impact on profit
Low supply risk, many suppliers,
Leverage items, (e.g. leather for shoes)
Small percentage of cost savings will have a large
impact on bottom line
– Focus on cost reduction by competition
suppliers
Procurementbetween
and Outsourcing
Strategies
Slide 17
Kraljic’s Supply Matrix
 Top left quadrant:
–
–
–
–
–
High supply risk but low profit impact items.
Bottleneck components (e.g. water, electricity)
Do not contribute a large portion of the product cost
Suppliers have power position
Ensure continuous supply, even possibly at a
premium cost
– Focus on long-term contracts or by carrying
stock (or both)
 Bottom left quadrant:
– Non-critical items (e.g. office utensils, stationary)
– Simplify and automate the procurement process as
much as possible
– Use a decentralized procurement policy with no
formal requisition and approval process
Procurement and Outsourcing Strategies
Slide 18
Supplier Footprint
 Supply Strategies have changed over the years
– American automotive manufacturers
• 1980s: Suppliers either in the US or in Germany.
• 1990s: Suppliers in Mexico, Spain, and Portugal.
• 2000s: Suppliers in China
– High-tech industry
• 1980s: Sourcing in the US
• 1990s: Singapore and Malaysia
• 2000s: China
 Challenge:
– Framework that helps organizations determine the
appropriate supplier footprint
– Strategy should depend on the type of product or
component purchased
Procurement and Outsourcing Strategies
Slide 19
Functional vs. Innovative Products
(based on Fisher)
Functional Products
Innovative Products
Slow
Fast
Predictable
Unpredictable
Profit Margin
Low
High
Product Variety
Low
High
Average
forecast error at
the time
production is
committed
Low
High
Average
stockout rate
Low
High
Product
clockspeed
Demand
Characteristics
Procurement and Outsourcing Strategies
Slide 20
Supply Chain Strategy (Fisher)
 Functional Products
– Diapers, soup, milk, tiers
– Appropriate supply chain strategy for functional
products is push
– Focus: efficiency, cost reduction, and supply chain
planning.
 Innovative products
– Fashion items, cosmetics, or high tech products
– Appropriate supply chain strategy is push-pull
– Focus: high profit margins, fast clock speed,
unpredictable demand, responsiveness,
maximizing service level, order fulfillment
Procurement and Outsourcing Strategies
Slide 21
Procurement Strategy (Fisher)
 Functional Products
– Focus should be on minimizing total landed cost
•
•
•
•
•
•
unit cost
transportation cost
inventory holding cost
handling cost
duties and taxation
cost of financing
– Sourcing from low-cost countries is appropriate
 Innovative Products
– Focus should be on reducing lead times AND on
supply flexibility.
– Sourcing close to the market area or short lead time
may be achieved using air shipments
Procurement and Outsourcing Strategies
Slide 22
SUMMARY
 Outsourcing has both benefits and risks
 Buy/make decisions should depend on (Fine):
– Whether a particular component is modular or
integral
– Whether or not a firm has the expertise and capacity
to manufacture a particular component or product.
 Procurement strategies vary from component to
component
– Four categories of components, strategic, leverage,
bottleneck and non-critical items (Kraljic)
 Distinguish Modular and Functional Products
– Impact on Supply Chain and Procurement Strategies
Procurement and Outsourcing Strategies
Slide 23