CALIFORNIA SYSTEMS CORPORATION (CSC) Executive Summary: Since CSC has decided to broaden its reach by entering the personal computing industry and made a strategic decision to outsource the DVD drives due to the manufacturing costs involved, it needs to decide on the sourcing strategy and select a supplier which would optimize its cost over the long run and result in profits for the company. On the basis of the suppliers considered, an evaluation scorecard has been formed which would rate the suppliers on the basis of the strategic and tactical factors.
It has been found that the E-Drive would be the optimal option to go ahead with and he company would use single sourcing as its means or procurement. E-Drive has the maximum score of 78. 4 on 100 in the supplier evaluation scorecard. Also financially E-Drive is an extremely stable organization when compared to the other three suppliers. The total cost per unit for E-Drive is the second lowest at $166. 7, has the highest inventory turnover of 9. 06, asset turnover ratio of 1. 64 and extends credit facilities to buyers.
It also operates with the highest contribution margin 35% in the industry, has cash reserves of $85 million which is evident from its high quick ratio (1. 05). The total cost involved in E-Drive is $83,347,727 which is second lowest to Sure Tech but provides a saving of $1. 19 million over Elecom and $2. 39 million over Park Technologies which would be about 3% savings on the total cost. E-Drive has been performing extremely well and is an innovative company implementing tools such as Just-ln-Time and Kanban cards to improve its operational efficiency.
The proximity of E-Drive was within a ten miles radius from CSC which would ensure not only a reduction in the transportation cost and faster deliveries but also an opportunity for an Earlier Supplier Integration methodology. E-Drive could deliver the drives every alternate days and this ability could be proven by reports during the site visit. EDrive being a domestic supplier eliminates the risk of associating with international trade barriers and currency fluctuation.
The only risk involved in E-Drive was that when the team visited the site the quality manager had stated that there had been some problem with the earlier batch size but the engineers were working on the problem and it could be resolved. Also, since we have time from January to August for production we could work internally with E- Drive on the quality and process checks thereby ensuring smooth ramp up and production with minimum defects and help it develop in future to ramp up by 25% in 4 weeks.
If we enter into a long term contract (more than one year) with E-Drive we could take advantages of single sourcing and on-time delivery which would be of strategic importance to our company. To mitigate the risk of supply disruption due to single sourcing, we could build a negotiating contract with E-Drive wherein we would hold two weeks inventory at our end and also convince them to hold some inventory as safety stock. Most of these contingency plans would be discussed during the negotiations of the contract with E-Drive.
Data Collection and Analysis Validate the data and spend. Analyze the four suppliers in the market for the given commodity. Identify the major cost drivers (tooling, transport, duties customs etc. ) Profile the commodity (bottleneck, leverage, routine, critical) Develop the Category Profile Analyze quality parameters (defects per million) and conduct spend analysis to identify service levels. Define the sourcing strategy statement and elements of the sourcing plan.
In case of CSC it is outsourcing. Develop the Sourcing Strategy Identify the negotiations leverages by evaluating the proposals. Define the strategic elements such as geographic scope, validity period of contract, payment terms and important milestones. Identify potential suppliers (Elecom, Sure Tech, E-Drive & Park) Selection of the supplier Universe Define decision criteria for qualification/selection. Create request for proposals and negotiation lists.
Consider supplier evaluation and possible briefing strategy for the suppliers by forming evaluation scorecard. Evaluation of bids on the basis of cost or competitive bidding. Bid Enquiry and Negotiations Supplier Selection Define the negotiation plan by considering the negotiation points, trade-offs, contingency plan, negotiation tactics etc. Analyze and compare supplier score and recommend solutions and buy-in steps. Prepare a risk mitigation plan (if required) Supplier approvals and selection along with debriefing of other suppliers.
Implementation of plan and focus on continuous improvement Monitor the contract and supplier with a review mechanism (with a set frequency) and help build a healthy win-win SOURCING STRATEGY: The DVD disk drive can be classified as a leverage commodity as it is of high volume one per assembled computer), is readily available from a pool of suppliers, is crucial to the business and contributes a large spend (approximately 18% of the cost of the computer). It is extremely important that each DVD drive function equally well so the that the cost of non conformity (which is as high as $300 and loss of goodwill) can be significantly reduced.
Also, the drives can be supplied by suppliers at the given cost and going forward as the demand for these items increases CSC can negotiate with the suppliers based on the volumes to reduced the cost. CSC has identified four key uppliers for the DVD drivers and the quality of these drives is extremely crucial for the company. CSC would also be investing heavily in the tooling and transportation of these units and in order to ensure smooth delivery of products to the consumers CSC would have to keep a buffer stock of these items.
Identifying suppliers is important for such key components especially when the market demand for these components is high and they form an integral part of the personal computer. From the strategic point of view a leverage commodity can maximize the commercial value and from a tactical standpoint it helps maintain competition. The steps mentioned above in the flow chart would be followed as a standard process to procure the disk drives and would serve as an important sourcing criteria leading to the final supplier selection. CSC has evaluated four key suppliers for the disk drives.
The sourcing team had to keep the important parameters of quality and transportation in mind. Also, an important consideration during the supplier selection would be that the company did not have an International Procurement Office and hence there was risk in selecting an international supplier. The other risks involved were the political risks and urrency fluctuations with foreign suppliers. Another important criteria in selecting the supplier was that CSC would be controlling the transportation link from the supplier to its premises but would take ownership of the goods only on arrival.
Since the executive management viewed the supplier selection process to be of critical importance to the company we had conducted site visits to collect data from the suppliers end. The site visit enabled the cross functional team to collect data on the financial aspects of the suppliers and experience firsthand the manufacturing setup and quality conformance. Based on the strategic outlook of CSC a supplier evaluation scorecard has been designed. A detailed explanation of the score card along with financial evaluation of each supplier and total cost data are presented in the next section of the report.
While evaluating the supplier the overall condition of the supplier and willingness to form a strategic alliance are also taken into consideration. Weight age is also given to available capacity and certain intangible factors which cannot be quantitatively proved but are important for the success of the organization. SUPPLIER EVALUATION AND SELECTION: FINANCIAL EVALUATION: (Refer Appendix 1) Based on the Financial Evaluation the following conclusion was made for each of the Elecom Technologies was the largest supplier the team has visited with sales of $6. 5 billion with a 30% market share.
The supplier was in sound financial condition with a good inventory turnover ratio of 5. 2 and as Asset turnover ratio of 1. 32 which was good for a large corporation. For such a large company which would ideally be dealing with many buyers it managed its accounts receivable well at about 49 days. It also had the highest leverage at about 2. 58 and a quick ratio of 0. 2 which clearly meant the company was not very liquid in terms of cash. Certain parameters where the company was lagging was in the long term debt to equity and debt to assets. It posed the lowest returns on equity at 6. 3% and also operated on a very narrow profit and contribution margin. This clearly meant that the bottom line needed to be managed more efficiently. For a company with revenue of $6. 5 billion its costs needed to be managed more efficiently and the company could improve on its operating margins. 2) SURE TECH: Based on the financial evaluation Sure Tech had a good asset turnover ratio of 1. 57 ut the company was relatively small. It had a good inventory turnover of 5. 43 and was extending about a month’s credit to its suppliers based on its accounts receivables of 29 days.
However, the company had a very high accounts payable days at 49 which shows payments may be an issue for the company. It had a good return on equity of 21 . 74% and profit margin of 6. 82%. Even though the financials may seem to be good the company had never received such a huge order earlier and was not sure if it could handle it. 3) E-DRIVE: On evaluating the financial statement of E-Drive it was found that in spite of being a arge corporation it had the highest asset turnover ratio of 1. 64 which means it was utilizing its assets well.
Moreover the company had an exceptional inventory turnover of 9. 06 which was way above the industry average and suggest faster replenishment of inventory. The company also had high cash reserves of $85 million and had an accounts receivable of 59 days and accounts payable of 35 days. The return on equity was the second highest amongst the four suppliers at 16. 86% which was a sign of a healthy company. It also had the highest contribution margin of 35% and a profit margin of 4. %. The quick ratio of the company was 1. 05 which is > 0. 8 indicating a healthy sign in terms of capital fund management.
Overall the company had very stable financial condition and was also working with state-of-the-art technology, had the best on time delivery statistics which was strategically important to CSC. 4) PARK TECHNOLOGIES: Park Technologies is a Korean based supplier with a 12% market share. From the two international facilities visited by the team Park Technologies was the better one. Financially it had a good asset turnover (1. 38) and inventory turnover ratio (7. 01). The uick ratio was 0. 74 which meant it managed funds well and return on equity was 9. 94%. This company performed on a stable basis compared to industry average.
TOTAL COST ANALYSIS: (Refer Appendix 2) The total cost analysis includes the various components cost which would be added the number of units projected for two years (as tooling is done only once), the transportation cost (as CSC would be paying for it), the quality non conformance cost which would add Just in case anything went wrong with product, the duties, customs, insurance and tariff cost, inventory and safety stock (which is assumed at 18% nnually and calculated by adding all the above mentioned cost per unit and then dividing it by 12 to arrive at a monthly holding cost for international suppliers and dividing by 24 to arrive at a fortnightly holding cost for domestic suppliers) and the inspection cost. This would help us arrive at the total per unit cost which CSC would incur and multiplying by the yearly sales projection would help us arrive at the total cost involved per supplier. On evaluating the total cost per unit it was found that Sure Tech has the lowest cost per unit of $163. 05 followed by E-Drive at $166. , Elecom at $ 169. 08 and Park Technologies at $171. 48.
If we consider a one year horizon the total cost of producing 500000 units is as follows: Elecom SureTech $81 E-Dnve $83??47,727 Park SUPPLIER EVALUATION CRITERIA: (Refer Appendix 3. contains all suppliers evaluation sheets) The supplier evaluation scorecard is formed keeping the strategic goals of CSC in mind. Each supplier is evaluated in seven main categories. These categories are the strategic categories which would ensure that the supplier performs at a certain level. These categories are then divided into sub-categories which could then e described as the tactical level operations which can be measured quantitatively. The categories are assigned weights given the role it plays in the manufacturing of the commodity.
The suppliers are given a score from 1 to 5 on each of the sub- categories where the scaling represents: 1 2 3 4 5 Poor Fair Average Outstanding QUALITY: This category is critical to the performance of CSC. Quality criteria measures the suppliers quality management process and philosophy. Given the importance of quality (CSC is known for its reliability of products) it is assigned the maximum weight-age of 25. The sub-categories in this division are defects per million (10 points) Innovation and investment in R (5 points) and Quality nonconformance cost (10 points). Defects per million gives us the understanding of the production capability and quality management of the supplier.
Innovation and investment in R represents the future outlook and quality consciousness of the supplier and the non-conformance cost gives the total loss per supplier due to a defective part. 2) DELIVERY PERFORMANCE: This represents the promptness with which the supplier can deliver the parts to CSC. Since delivery is the second most important criteria (CSC is known in the market for its ontime delivery) it is given a weight-age of 20 points. Within the delivery performance are Lead Time (8 points) Ramp up time required (5 points) and frequency of shipment (7 points). The on time delivery is a taken into the process category as it depends mostly on the operational efficiencies of the supplier.
Delivery would depend on the lead time taken to reach CSC and frequency of shipment would identify the need to hold inventory and thereby the inventory holding costs. Ramp up time was given 5 points as it would decide how quickly the upplier could gear up to the production requirements. Also, CSC in future may require the supplier to build up its capacity by 25% in four weeks and hence it was important to evaluate this criteria. 3) FINANCIAL CAPABILITY: This was important to analyze the financial health of the supplier. It was very essential to identify the status of the company to build a long term relationship and hence given a weight-age of 15 points overall.
The sub- categories considered here were Asset turnover Ratio (3 points) Inventory turnover ratio (5 points) Quick ratio (4 points) and debt evaluation (3 points). The asset turnover ratio represents the capability of the company to fully utilize its assets, inventory turnover means its ability to replenish inventory (higher the turnover the better), quick ratio represents the liquidity status and cash management ability and debt evaluation represents how much funding the company has through debt versus equity. 4) PROCESS AND TECHNOLOGICAL CAPABILITIES: This category defined the ability of the company to evolve technologically and the process efficiency standard it follows.
Understanding the importance of processes and standardization this criteria is given weight-age of 15 points as well. It is sub divided into On-time-delivery (7 points) process adherence (5 points) and capacity utilization (3 points). On-timedelivery was extremely crucial as a hold up in parts could affect the entire assembly. Process adherence was important to measure to analyze the consistency with which the supplier could operate and the capacity utilization was necessary to monitor to understand what portion of the plant would be dedicated to CSC’s production requirement. 5) MANAGEMENT CAPABILITY: Even though a subjective criteria it is important to measure the management capability of the supplier.
It is they who run the business weight-age of 10 and divided into two sub-categories: Involvement of the top management (5 points) which shows how closely the top management is involved in the business and labor relations management (5 points) which proves the effectiveness of the performance of the employees, their morale 6) COST STRUCTURE: This involves an in-depth understanding of the supplier’s total costs, manufacturing and overheads, and also the cost at which CSC would get the product. Understanding the total cost structure can help CSC determine how effectively the supplier can produce the product. This category was given a weight- age of 10 points. This includes the Unit cost (2 points) Tooling cost (2 points) Inventory holding cost (4 points) and inbound inspection cost (2points). Unit cost would determine the cost at which CSC could get the disk drives, tooling cost was the initial one time investment to set up the production for the disk drives, inventory holding cost was a recurring cost which CSC would incur month on month and hence it was given the maximum weight-age and inspection cost is also a recurring cost. ) MISCELLANEOUS: This category is given 5 points which includes contract enomination (2 points) whether it is a domestic or an international supplier and hence would determine whether currency fluctuations would play a role or no. Political risk (2 points) to determine the stability of international companies and overall industry perception (1 point). RECOMMENDATION: Considering all the recommendation and looking at the supplier evaluation score card the team has decided to go ahead with E-Drive as the preferred supplier. E- Drive was selected on the basis of the following criteria: ?„ E-Drive is financially a stable company with the highest asset turnover ratio (1. 4), inventory turnover ratio (9. 06), extends good credit to its buyers, has its cash flow managed well with a current ratio of 1. 35, a quick ratio of 1. 5 and has the highest contribution margin (35%) and profit margin at the industry average. This proves that the company is worth doing business with. ?„ Considering the delivery front E-Drive had an on-time-delivery record of 99. 5% and the lead time was Just 2 weeks. Since the company was located within a ten miles radius it could deliver the disk drives to CSC every alternate day. This would be extremely crucial to CSC. On the brighter side it could mitigate the risk of non conformities and reduce the burden of inventory holding cost as well. In the future if we wanted to expand the production by 25% we could strategically work with E-Drive to ramp up in 4 weeks. „ In terms of investment, considering one year sales projections, the total investment in E-Drive would be about $83,347,727 which was the second lowest only to Sure Tech which we have avoided due to it being a start up and has never handled such an order earlier. Compared to Elecom it provides a savings of $1. 19 million and against Park Technologies it provides a savings of $2. 9 million. ?„ E-Drive is also the second largest producer of disk drives worldwide and has a new technologies like Justln-Time and Kanban to improve its operational efficiencies. This shows the focus of the management in continuous improvement. ?„ The proximity of E-Drive with CSC could help forge a strategic relationship with the supplier and ensure multiple shipments.
Since, E-Drive was a domestic supplier there was no risk of currency fluctuation as the contract denomination would be in dollars. E-Drive also had a solid reputation in the industry of working along with its customers. „ It got the maximum score of 78. 4 on the evaluation scorecard due to the above mentioned factors. CSC should go ahead with single sourcing as it gives the opportunity of better pricing through large sales volumes. CSC can build a strong relationship with E-Drive since it is so close to CSC by ensuring frequent supplier visits and integrating the supplier during the early stage of development. This would ensure better quality through a continuous improvement process adherence.
Single sourcing could also reap the benefits of lower cost to source, process and inspect. It could lead to a reduction in he lead time and enhance on time delivery through optimizing its distribution and transportation scheduling. CSC could get the advantage of quality discounts through increased co-operation and communication in the supplier – buyer relationship. Single sourcing from E-Drive could lead to an accelerated learning curve which would be mutually beneficial to both the parties. The other reason of selecting a single source considering the pool of suppliers was that multi-sourcing could be risky for CSC. Ramp up in 4 weeks for additional production of 25% would be difficult.
We could not combine E-Drive and Elecom as the cost would shoot up. Also Elecom was reluctant to accept even the full order from CSC saying it was below the threshold required. It would also involve the risk of currency fluctuation as the contract denomination with Elecom would be in Yen. Combining with Park Technologies was considered earlier but then ruled out. Park Technologies had neither done business in USA nor had any staff or facilities here. Though the on time delivery was spectacular there was concerns if Park Technologies could deliver the same results in the US market. Also the inventory holding cost would shoot up as we would have to onsider one month’s inventory as a safety stock.
Also there was political instability in the Korean region. Combining with Sure Tech was ruled out because of the smaller nature of Sure Tech. They had never processed such an order and considering the importance of Disk Drives for the assembly it would lead to a risk giving the contract to Sure Tech. CSC should sign a long term contract with E-Drive as it expects a greater level of commitment from the supplier. In this way both the companies can create a Joint value for the organizations through information sharing, risk mitigation analysis, scheduling, cost reduction plans. A long term contract would serve as a blue print plan between the supplier and the buyer.
It would enable the company to ensure a constant supply. Considering the commodity and its importance in the final assembly, it is extremely crucial that the components be available without any disruptions. Short-term contracts at times would run in to this risk of non availability of parts. Another advantage which CSC could gain is access to the technology of Generally a long term contract exceeds a one year period and since the life cycle of 9000X is 2 years it may be viable to go ahead and sign a long term contract. These contracts force the supplier to improve their processes to spread their cost over a larger volume and also would allow CSC some access to the cost and price information.
CSC could also reward the supplier for coming up with cost saving methods. CSC could also leverage its position to drive the supplier towards a higher rate of performance improvement by accelerating on the learning curve and passing the savings benefits to CSC. From EDrive’s point of view the long term contract would be very beneficial as it would enable it to conduct better scheduling which would mprove its operational efficiency and materials planning. E-Drive can also manage its flow of funds through detailed advanced planning if the demand is relatively known from CSC. E-Drive can achieve economies of scale by spreading its cost over a larger volume.
While negotiating the contract with E-Drive the following things should be kept in mind:?„ The overall strategy of CSC and the importance of the disk drive in every assembled computer. ?„ Analyze the price carefully before negotiating and arrive at the least cost per unit to ensure bulk discounts and volume purchases. ?„ Discuss the quality issue very seriously. It has been analyzed the total cost of non conformity per assembled computer may be as high as $300. Hence quality plays an essential role during the discussion with the suppliers. ?„ Credit terms and mode of payment should be categorically discussed. Analyzing the financial statements CSC can bargain on the credit line extended by the supplier. ?„ It is extremely crucial to discuss the contingency plans with suppliers.
What capacity would the supplier allot to CSC and in case of revisions of orders would the supplier be in a position to increase the capacity by 25% in 4 weeks. „ Discuss the strategic plans of involving the supplier in the product design for future products to be launched. ?„ Discuss the importance of audits and quality checks and how cross functional teams from both companies could combine to arrive at strategic advantages. APPENDIX 1 : FINANCIAL EVALUATION Selected Financial Ratios Elecom Asset Turnover = Sales/Assets 1. 57 1. 64 1. 38 Inventory Turnover = Cost of Sales/Average Inventory 5. 20 5. 43 9. 06 7. 01 Receivable Days = Accounts Receivable/Sales X 360 49. 24 29. 45 59. 48 46. 36 Payable Days = Accounts payable/sales X 360 29. 13 49. 09 35. 22 33. 21 Leverage = Assets/Equity 2. 58