Institute Of Management Studies

Outsourcing And Procurement

Summited To:Prof. Piyush kendulkar Summited By:Mahath Mohan MBA(DM) 4sem.

Outsourcing
Definition
The contracting or subcontracting of noncore activities to free up cash, personnel, time, and facilities for activities in which a company holds competitive advantage. Companies having strengths in other areas may contract out date processing , legal ,manufacturing, marketing , or other aspects of their businesses to concentrate on what they do best and thus reduce average unit cost. Outsourcing is often an integral part of downsizing or reengineering. Also called contracting out.

 Outsourcing components have increased progressively over the years Some industries have been outsourcing for an extended time
Fashion Industry (Nike) (all manufacturing outsourced) Electronics Industry
Cisco (major suppliers across the world) Apple (over 70% of components outsourced)

Benefits Of Outsourcing
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.

Benefits Of Outsourcing
Focus on core competency Increased flexibility
Buyer can focus on its core strength Allows buyer to differentiate from its competitors 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 and innovation. Critical in certain industries:
High tech where technologies change very frequently Fashion where products have a short life cycle

Risks In Outsourcing
Loss of Competitive Knowledge Outsourcing critical components to suppliers may open up opportunities for competitors Outsourcing implies that companies lose their ability to introduce new designs based on their own agenda rather than the suppliers agenda Outsourcing the manufacturing of various components to different suppliers may prevent the development of new insights, innovations, and solutions that typically require cross-functional teamwork

Risks In Outsourcing
Conflicting Objectives
Demand Issues
In a good economy Demand is high Conflict can be addressed by buyers who are willing to make longterm commitments to purchase minimum quantities specified by a contract In a slow economy Significant decline in demand Long-term commitments entail huge financial risks for the buyers
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.

Product design issues

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

Two Main Reasons for Outsourcing

Dependency on capacity
Firm has the knowledge and the skills required to produce the component For various reasons decides to outsource

Dependency on knowledge
Firm does not have the people, skills, and knowledge required to produce the component Outsources in order to have access to these capabilities.

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? How fast does the components technology change relative to other components in the system? Does the firm have a competitive advantage producing this component? How many capable suppliers exist? How modular or integral is this element to the overall architecture of the system?

Component Clock speed

Competitive Position

Capable Suppliers

Architecture

Procurement
Definition
The process of obtaining goods and services from preparation and processing of a requisition through to receipt and approval of the invoice for payment.

It commonly involves
(1) purchase planning, (2) standards determination, (3) specifications development, (4) supplier research and selection, (5) value analysis, (6) financing, (7) price negotiation, (8) making the purchase, (9) supply contract administration, (10) inventory control and stores .

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 can the firm ensure continuous supply of material without increasing its risks?

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: Taiwan and mainland China

Challenge:
Framework that helps organizations determine the appropriate supplier footprint. Strategy should depend on the type of product or component purchased

Benefits Of Procurement
Environmental benefits: Reduction in harmful emissions and waste generation - improved air and water quality Reduced use of natural resources Reduced environmental impact of your operations through your supply chain Meet existing and forthcoming legislation around the climate change agenda . Support resource efficiency . Social benefits: Improvements in working conditions - labour standards, health and safety Assist disadvantaged groups in society Improve wage rates to those in low pay through the London Living Wage policy Economic benefits: Improved efficiency in the public sector - more funds to invest in social and economic development Improving the efficiency and transparency of procurement procedures, structures, Financial savings.

Benefits Of Procurement
Other benefits: Fulfill the Government's commitment to place sustainable development at the center of public procurement policy Meet international obligations - for example, the EU Treaty commits member governments to integrate environmental protection into their policies. The Rio Declaration requires the reduction and elimination of unsustainable patterns of production and consumption. At Kyoto, the Government agreed to reduce greenhouse gas emissions by 12.5% on average for the period 2008-2012.

Risks In Procurement
Sole source risk is the risk of shutting down your supply chain indefinitely
because you have no alternative sources for certain suppliers. The best way to avoid sole source risk is to refrain from sourcing something that is only made by one supplier (such as a highly specialized semiconductor.) If you already have sole source parts, gauge your risk by estimating how much of your revenue will be impacted if the vendor shuts down. Those vendors with the greatest revenue impact are your largest risks. Mitigate sole source risk by tracking the financial health of those vendors and by actively working to redesign your products so that you have alternatives.

Large customer risk is the risk many procurement organizations miss,

and miss to their detriment if their organization is large! Large customer risk occurs when your business constitutes a significant overall percentage of a vendors total revenues at least 25% or more. When your fortunes swing, they are amplified for these vendors. A 10% cut in spend in a category for you may result in a 40% cut in cash flow for them and put them under. For this risk type, it is good to track what percentage your revenues are to your vendor and any time you creep over 25%, look for additional sources of supply.

Risks In Procurement
Lengthy switch-over risk is the risk that occurs because you are
working with a single vendor and changing over to an alternative will take a long time. This is different from a sole source vendor because there are alternatives. The Ariens article provides a great example of this type of risk. They were working with a single engine manufacturer for their snow blowers for a practical reason. It would probably have been too expensive to tool up and buy from two sources. This situation occurs a lot in indirect procurement as well companies typically engage one IT help desk provider, one ERP company, and one construction firm for building new facilities. Again, watching the financial health of these vendors is key. Prioritize your risk management efforts by estimating the potential monetary impact of failure of each lengthy switch-over source.

Procurement Strategy for the Two Types

Functional Products
unit cost transportation cost inventory holding cost handling cost duties and taxation cost of financing

Focus should be on minimizing total landed cost

Innovative Products

Sourcing from low-cost countries, e.g., mainland China and Taiwan is appropriate

Focus should be on reducing lead times and on supply flexibility. Sourcing close to the market area Short lead time may be achieved using air shipments

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 to manufacture a particular component or product. Variety of criteria including customer importance, technology clockspeed, competitive position, number of suppliers, and product architecture. Four categories of components, strategic, leverage, bottleneck and non-critical items

Procurement strategies vary from component to component

Four categories important in selecting suppliers: component forecast accuracy, clockspeed, supply risk, and financial impact.

Thank You