procurment options

7/30/2019 Procurment Options

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9-1

Procurement Options:

Make or Buy Decisions

Outsourcing as an Option


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9-2

Introduction

Outsourcing components have increasedprogressively over the years

Some industries have been outsourcing

for an extended time Fashion Industry (Nike) (all manufacturing

outsourced)

Electronics IndustryCisco (major suppliers across the world)

Apple (over 70% of components outsourced)


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Questions/Issues with Outsourcing

Why do many technology companiesoutsource 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?


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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 outsourcingstrategy.

The procurement process Independent (public), private, and consortium-based

e-marketplaces. New developments mean higher opportunities and

greater challenges faced by many buyers


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9.2 Outsourcing Benefits and Risks

Benefits

Economies of scale Aggregation of multiple orders reduces costs, both in

purchasing and in manufacturing

Risk pooling

Demand uncertainty transferred to the suppliers

Suppliers reduce uncertainty through the risk-pooling

effect

Reduce capital investment Capital investment transferred to suppliers.

Suppliers higher investment shared between

customers.


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Outsourcing Benefits

Focus on core competency Buyer can focus on its core strength

Allows buyer to differentiate from its competitors

Increased flexibility The ability to better react to changes in customer

demand The ability to use the suppliers technical knowledge

to accelerate product development cycle time

The ability to gain access to new technologies andinnovation.

Critical in certain industries: High tech where technologies change very frequently

Fashion where products have a short life cycle


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Outsourcing Risks

Loss of Competitive Knowledge

Outsourcing critical components to suppliersmay open up opportunities for competitors

Outsourcing implies that companies lose theirability to introduce new designs based on their

own agenda rather than the suppliers agenda Outsourcing the manufacturing of various

components to different suppliers may preventthe development of new insights, innovations,

and solutions that typically require cross-functional teamwork


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Outsourcing Risks

Conflicting Objectives

Demand Issues In a good economy

Demand is high

Conflict can be addressed by buyers who are willing tomake long-term commitments to purchase minimum

quantities specified by a contract In a slow economy

Significant decline in demand

Long-term commitments entail huge financial risks forthe buyers

Product design issues Buyers insist on flexibility

would like to solve design problems as fast as possible

Suppliers focus on cost reduction implies slow responsiveness to design changes.


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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 thePS/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


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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?


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Two Main Reasons for

Outsourcing Dependency on capacity

Firm has the knowledge and the skillsrequired to produce the component

For various reasons decides to outsource Dependency on knowledge

Firm does not have the people, skills, andknowledge required to produce the

component Outsources in order to have access to these

capabilities.


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Outsourcing Decisions at Toyota About 30% of components in-sourced

Engines: Company has knowledge and capacity 100% of engines are produced internally

Transmissions Company has the knowledge

Designs all the components

Depends on its suppliers capacities

70 % of the components outsourced

Vehicle electronic systems Designed and produced by Toyotas suppliers. Company has dependency on both capacity and

knowledge


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Outsourcing Decisions at Toyota

Toyota seems to vary its outsourcingpractice depending on the strategic role of

the components and subsystems

The more strategically important thecomponent, the smaller the dependency on

knowledge or capacity.


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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 productconfiguration.

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 componentperformance

Components perform multiple functions.


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A Framework for Make/Buy

DecisionsProduct Dependency on

knowledge andcapacity

Independent forknowledge,dependent forcapacity

Independent forknowledge andcapacity

Modular Outsourcing is risky Outsourcing is anopportunity

Opportunity to reduce

cost through

outsourcing

Integral Outsourcing is veryrisky

Outsourcing is an

option

Keep production

internal


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Hierarchical Model to Decide

Whether to 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?


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Process of outsourcing

Deciding to outsource

The decision to outsource is taken at a strategic level and normally requires

board approval. Outsourcing is the business function involving the transfer

of people and the sale of assets to the Supplier. The process begins with

the Client identifying what is to be outsourced and building a business case

to justify the decision. Only once a high level business case has beenestablished for the scope of services will a search begin to choose an

outsourcing partner.

Supplier shortlist

A short list of potential suppliers is drawn-up from companies that are

capable of providing the services and match the screening criteria.

Screening can be enhanced by issuing a Request for Information (RFI) to a

wider audience.

Supplier proposals

A Request for Proposal(RFP) is issued to the shortlist suppliers requesting

a proposal and a price.
http://en.wikipedia.org/wiki/Request_for_Informationhttp://en.wikipedia.org/wiki/Request_for_Proposalhttp://en.wikipedia.org/wiki/Request_for_Proposalhttp://en.wikipedia.org/wiki/Request_for_Information


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Supplier competitionA competition is held where the Client marks and scores the supplier

proposals. This may involve a number of face-to-face meetings to clarify the

client requirements and the supplier response. The suppliers will bequalified out until only a few remain. This is known as down selectin the

industry. It is normal to go into the due diligence stage with two suppliers to

maintain the competition. Following due diligence the suppliers submit a

Best and Final Offer (BAFO) for the client to make the final down select

decision to one supplier. It is not unusual for two suppliers to go into

competitive negotiations.

NegotiationsThe negotiations take the original RFP, the supplier proposals, BAFO

submissions and convert these into the contractual agreement between the

Client and the Supplier. This stage finalizes the documentation and the final

pricing structure.

Contract finalization


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Contract finalization

At the heart of every outsourcing deal is a contractual agreement that defines how

the Client and the Supplier will work together. This is a legally binding document and

is core to the governance of the relationship. There are three significant dates that

each party signs up to the contract signature date, the effective date when the

contract terms become active and a service commencement date when the supplier

will take over the services.

Transition

The transition will begin from the effective date and normally run until four months

after service commencement date. This is the process for the staff transfer and the

take-on of services.

Transformation

The transformation is the term normally applied to the program of projects that are

included in the contract. These projects make the changes to the environment

required to meet the commitments in the proposal.

Ongoing service delivery

This is the execution of the agreement and lasts for the term of the contract.

Termination or renewal

Near the end of the contract term a decision will be made to terminate or renew the

contract. Termination may involve taking back services insourcing or the transfer ofservices to another supplier.
http://en.wikipedia.org/wiki/Governancehttp://en.wikipedia.org/wiki/Insourcinghttp://en.wikipedia.org/wiki/Insourcinghttp://en.wikipedia.org/wiki/Governance


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SUMMARY Outsourcing has both benefits and risks

Buy/make decisions should depend on: Whether a particular component is modular or integral

Whether or not a firm has the expertise and capacity tomanufacture a particular component or product.

Variety of criteria including customer importance,

technology, competitive position, number of suppliers, andproduct architecture.

Procurement strategies vary from component tocomponent Four categories of components, strategic, leverage,

bottleneck and non-critical items Some Categories important in selecting suppliers:

forecast accuracy, supply risk, and financial impact.

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