Managing Global Supply Chains Focus on China & GZ Introductory Course

Todays Schedule 9:00 - 9:30 - Welcome, trip Logistics, syllabus review 9: :15 - Lecture on Global Sourcing & Outsourcing; 10:15- 10:40 - Team prep 10:40- 11:30ish - Review of the Scotts case - Group presentations & discussion 11:40 -12:30 - Lunch 12:30-3:00 - Beijing portion coordinated by Dr. Gillpatrick

Agenda - Topics Trip Logistics – Linda & Rachel Syllabus overview – Intro to class Globalization Outsourcing as a business strategy Definitions and concepts Rationales for outsourcing The outsourcing process Risk assessment Success factors Scott’s case – Team analysis

Globalization Globalization can be cultural, political, & economic. –Cultural: A new Universalism (laws versus Jihad) –Political: policies regarding factors of production (oil) –Economic: Markets and Production Globalization of Production – low-cost factors of production – Ricardo’s comparative advantage

Globalization Globalization – Interdependent and integrated world economy All firms export and import – 97% of firms in US <500 employees 2006 over 2,500 trade treaties have been signed vs. 181 in Globalization of Production – low-cost factors of production: China; “Weapons of Mass Production”

Globalization -World Bank – states that by % of econ activity by developing nations, today 35% (Viet Nam, Indonesia, etc) -Foreign Direct investment is easier with technology -Multinationals moving east are not the only participants; Haier & Li-Ning for ex. -Backlash against market economy in some nations (Russia) -China is even different by province (Shenzhen vs. Hong Kong vs. Shanghai) -Outsourcing & Jobs – Social Justice vs. Economics -Consumer savings vs. job displacement -Division of income widens -Environment degradation in developing nations

Outsourcing as a sourcing strategy Previously: Mainly outsourcing of manufacturing activities Trend was for low-cost labor Currently: Complete business functions are outsourced Common viable business strategy Innovation & design are now included

Definition of outsourcing Characteristics of outsourcing: “Normal” In-house activities performed are transferred to a third party Assets, knowledge and sometimes employees are sent to the external party Extended and long term embedded relationship Both parties experience new costs and risk profiles

Forms of outsourcing services Labor outsourcing Mixed & consigned outsourcing Complete turnkey outsourcing Contractor provides… Facilities Some employees Some or all of the following: Employees Materials Process and Systems Technology and Equipment Facilities Management Employees Materials Process and Systems Technology and Equipment Facilities Management  Decision rights  Codified knowledge Host firm provides… Some employees Materials Process and Systems Technology and Equipment Management Some or all of the following: Employees Materials Process and Systems Technology and Equipment Facilities Management Program management  Tacit knowledge Chandrashekar, 2000

Definitions Off-shoring: Off-shoring relates to the commissioning of work and ownership to another country. Maintain ownership. Partial outsourcing: only a part of an integrated function is outsourced. The coordination of the function, activities, and decision rights still lie with the client (the buyer). Turnkey outsourcing: applies when the responsibility for the execution of the entire function (or activities) lies with the external provider. This includes not only the execution of the activities, but also the coordination of these activities. May also include decision rights and design.

Rationales for outsourcing Strategic reasons for outsourcing 1. Improve company focus 2. Gain access to world class capabilities & Markets 3. Get access to resources that are not available internally 4. Accelerate reengineering benefits 5. Improve customer satisfaction 6. Increase flexibility 7. Sharing risks Tactical reasons for outsourcing 1. Reduce control costs and operating costs 2. Free up internal resources 3. Receive an important cash infusion (next slide) 4. Improve performance 5. Ability to manage functions that are out of control All these reasons underlie one overall objective: to improve the overall performance of the outsourcing firm

Why Outsource?

Cash-to-Cash Cycle Time 0ENLI009 Inventory days + Days sales outstanding – Average payment of supply period for materials Inventory 0OPPLAN012 Forecast Accuracy 0OPPLAN008 Production Lead Times 0OPMAKE017 Perfect Order Fulfillment 0OPDEL061 Faultless Invoices 0OPDEL023 Scheduled Achievement 0OPMAKE022 Delivery Performance to Scheduled Commit Date 0OPDEL019 Returns 0OPDEL067 Scrap 0OPMAKE023 Fill Rates 0OPDEL025 Order Fulfillment Lead Time 0OPPLAN030 Machine wait time 0OPMAKE007 Yield 0OPMAKE033 Number of Supply Sources 0OPSO012 Total Source Lead Time 0OPSO041 0ENLI015 Sales 0ENPR026 0ENLI003 0OPPLAN017 One example of why to outsource

Three phases: Strategic phase (why, what, who?) Transition phase (how?) Operational phase (how to control?) Figure 8.4 The outsourcing process Competence analysis Assessment & approval Contract negotiation Project execution & transfer Managing relationship Contract termination Strategic phaseTransition phaseOperational phase Adapted from Momme, 2002

Strategic phase 1.Motives for outsourcing Focus on core competences Focus on cost efficiency/ effectiveness Focus on service 2.Which activities or functions are outsourced Transaction cost approach Core competence approach 3.Qualifications of the supplier Technical and managerial qualities to achieve demanded level of performance

Four phase model Phase 1 Market search Preliminary assessment Potential supplier list Phase 2 Detailed audit Confidentiality agreement Approved supplier list Phase 3 Contract negotiation Order issue Kick-off meeting Execution Phase 4 Supplier report card Post contract review Continuous improvement Supplier validation Customer Focus Market benchmark Continuous improvement opportunities Identification and assessment Project execution Audit and approval Performance management Adapted from Momme, 2002

The Transition phase Contract negotiation Contract forms a legal basis for relationship Contracts depends on characteristics of outsourced activity The contract type has a great impact on the success of the joint operation Project execution and transfer Outsourcing transition can be very complex The transfer should be conducted using project management principles Test phase before going ‘life’

The operational phase It is in the operational phase that the outsourcing will deliver its expected results Successful outsourcing depends heavily on close cooperation with the supplier Six core values as being critical to a successful outsourcing relationship Core valuesSupporting factors  Shared goals and objectives  Mutual dependence  Open lines for communication  Concern for the other’s profitability  Mutual commitment to customer satisfaction  Trust Developing a personal relationship Having professional respect Investment of effort by top management Commitment to continuous improvement McQuiston (2000)

Critical success factors of outsourcing Understanding company goals and objectives Inclusion of outsourcing in the strategic vision and plan Selecting the right supplier A properly structured contract Open communication with the individual groups involved Ongoing management of the relationship (not embeddedness) Senior executive support and involvement Careful attention to personnel issues & resources Constant reflection on core competencies and IP versus outsourcing, including decision and alienable rights

Outsourcing – factors to consider? - Labor efficiency – Lean applied? % of COGS? -DFM 60% of cost is in design phase -Shipping & expediting – flexibility? -Training -Quality – eats up all savings (reputation & Warranty) -Capacity / utilization – if not >80%? -Cheap labor – Not static -Plant start-up costs? -Support & travel -Knowledge protection, transfer, & codification -Culture

Why design for manufacturability matters Management involvement 100% Cumulative percent of cost 0% Product development Total life cycle costs Ability to control costs Production Support 60% to 80% of total life cycle costs are largely determined during development

Outsourcing – factors to consider? -Where are the markets? Toyota in Silicon Valley, Boeing & Oakley in Calif. -Composition of COGS is direct labor? If <7-15% as with high tech, <3% of some apparel -Lean can drive down cycle times to hours, making offshore logistics the impediment -Build to order allows for less E&O as well as agility to customize products & lower lead-times -Consumer – Do they care if “built in USA?”

Where to Outsource? Factors to consider: -Costs: labor, infrastructure -Skill pool: labor, IT, language -Environment: regulations, bureaucracy, corruption -Quality of Infrastructure – Roads, Airports, ports -Risk: Earthquakes, war, politics -Market potential: China vs. Vietnam

China Labor Market – Relate to the NPI case? Facts: FDI-$500B; Directly Employ 16M people 112M factory workers 200 largest exporters, 153 were from FDI Is unrest growing? 280K labor disputes 2009 Wages increased 9%/yr since 2002 Surplus labor or shortage? Half the number of <16-29yrs by 2020

Final Alternatives Near-shoring – Mfg located in low cost region, but supplier in local market Best-shoring – MFG offers alternatives pending risk and complexity Out-source / Co-located – Factory within a factory

Scotts Miracle Gro Case In-House, Outsource, or Off-Shore?

Scotts Questions What is the purpose of the exercise in your opinion, why would a firm want to outsource / offshore this type of product in its portfolio? What are the internal / external political and ethical issues associated with this decision? Are they relevant to the company, product, and global sourcing? What are the strategic risks and benefits of outsourcing / offshoring production of the Temecula plant to a location in Mainland China? Include all “hard and soft” items in a risk & benefit format. Financially compare the options of staying in Temecula and moving to China. Provide the “soft variables” when arguing against the quantifiable numbers in the analysis.

Scotts Questions Consider the following in your financial analysis: 5 year horizon, volumes & material costs are stagnant in Temecula Taxes excluded, lease in Temecula could be cancelled New molds in China are estimates only by students Shipping rates Exchange rates Production Costs (Labor, overhead, plant / equip) Governance Costs (Management Overhead & Start-up costs)

Break into Teams…..

Scott’s Case My Numbers: - Temecula: $61,234,227 - Outsource: $55,003,263 - Offshore: $60,003,275

Scott’s Case Offshore is burdened: by $8M up front investment minus the savings in EMS GM% Outsourcing is burdened: Risk for currency exchange of 5% annually Start-up costs of $1.5M Lease buy-back $1.5M Freight costs of $7M Temecula is burdened: High labor, electricity, lease of building, etc. What is beyond the numbers?????

Scott’s case Variables: -Ramp -Inventory -SKU proliferation -Closing time of Temecula -Seasonality -Made in USA -China market? -What did they do? Keep Temecula