make or buy decision - offshoring

Make or Buy – Consumer

Electronics Case Study: PhoneCo

Franco Monti,

Deloitte Consulting, Zürich

ETHZ, March, 2014

© PricewaterhouseCoopers Ltd. 1

CONTENTS

1. Far East Sourcing - project definition and project plan

2. Product positioning and scope

3. Value chain considerations

4. Business case formulation

5. Outsourcing scenario

6. Supplier selection in China

7. Risk management and special care


FAR EAST SOURCING - PROJECT DEFINITION

* Inclusively sales projections

• Project to provide feasibility scenarios and decision recommendations on December 1, 2002

• Underlying precondition: Far East sourcing must finance initial setup cost inclusively operational

cost in 2003 (i.e. break-even requirement)

Current platform primarily

designed for mid-range and

premium products ...

... however missing low-end

products and second design

options for Retail ...

... lead to tactical project

assessing how to source in Far

East

Situation

• Up to now mid-range

product series on own

platform with Elcoteq

• Low-end product of special

interest for PhoneCo

– complemented product set

– complete product set

– volume generation

– positive contribution to fix

cost

Complication

• PhoneCo likely to be

capable producing mid-

range on own platform

• however PhoneCo not

sufficiently competitive on

prices for producing low-cost

products

Project scope

• Far East sourcing

opportunities to be analyzed

to overcome complications

and prepare new business

model against increasing

competition

• Project to identify Far East

sourcing feasibility and

strategy in terms of:

– economics (business plan)*

– product definition and

development

– supplier selection and

sourcing arrangement

– supply chain management

– maintenance and repair


RIGOROUS APPROACH TO FAR EAST SOURCING REQUIRED

• Find

implications

on:

– Distribu-

tions

– Ware-

housing

– Order

fulfillment

• Identify

danger of loss

of content on

critical parts

of supply

chain

Ac

tivit

ies

• Understand

low-end

products

suppliers and

their products

• Identify entry

barriers and

danger of

substitution

• Define new

products USPs

and target

customer

benefits

• Define target

products

Ap

pro

ac

h

En

d p

rod

uc

ts

Low-end

market

overview and

product

definition

Value chain

target

structure

Product

sourcing

economics

Risk

analysis

Supplier

selection

and sourcing

arrangement

SCM Maintenance

Plan

• Low-end

products

market

overview

• Entry barriers

and substitutes

• USPs

• Product

descriptions

• Provide

value-chain

overview and

elements to

be out-

sourced

• Understand

sourcing

options

• Target value

chain

• Sourcing

options

• Identify value

chain

economics

• Establish

target

costing and

business

case

• Run

sensitivity

analysis

• Value chain

economics

• Product target

costing/pricing

• Far East

business case

• Sensitivity

analysis for

Far East

sourcing

• Assess all

risks of Far

East

sourcing

• Risk

mitigation

plan

• List possible

supplier

profiles

• Evaluate

supplier

responses

• Run

sensitivity

analysis

• assess

negotiation

strategy

• Find

scenarios of

sourcing

arrangement

• Supplier

profiles (incl.

financials)

• Negotiations

strategy

• Scenarios for

sourcing

arrangements

• SCM plan

• SCM

vulnerabilities

• Assess

options for

repair center

and

maintenance

• Repair and

maintenance

plan

Decision to outsourcing taken: Possible

arrangements


RESPONSIBILITIES AND NEXT MILESTONE

1.

2.

3.

4.

5.

6.

7.

8.

9.

Kick off

Low-end market overview

and product definition

Value chain target structure

Product sourcing economics

Risk analysis

Supplier selection and


SCM

Maintenance plan

Recommendations to

the board

Activities KW 44 KW 45 KW 46 KW 47 KW 48


PROJECT APPROACH - MISSING ITEMS ADDED DURING MEETING

Belongs to Activity

• Establish country and channel priorities for Far East

sourced products

• Identify legal implications

• Define necessary flexibility

– Shipment delay

– Forecast precision

– Stock building

• Decide how many products and platforms needed

• Identify process to feedback Far East sourcing

know-how into PhoneCo

• Clarify scenario differences for cordless and corded

sourcing

• Analyze quality issues to be closely monitored

• Establish financial model:

– implications on NWC

– cash out and liquidity impact

• Define new business behavior and sales approach

• Clarify customization issues per market and channel

Relevance

Low-end market overview and

product definition

Risk analysis

SCM

TBD


product definition

Supplier selection and


SCM

Product sourcing economics

TBD


product definition

Not yet relevant

Not yet relevant

Not yet relevant

Items


CONTENTS









FORCES AT WORK - LOW / MID RANGE HOME TELEPHONY

Competition among existing firms

Substitutes

New entrants

Bargaining power of customers

Bargaining power of suppliers

- Demand dominates supply

- Very long payment terms

- Requirement for highly customised products

- No more/less volume commitments

- Force supplier to take over logistics (eg. Telecom Italia)

- Obligation to significantly reduce procurement cost (10-20%)

- Eventually some cost and risk of switching suppliers

- low flexibility in contractual issues (eg. L/C, long lead time, large volumes etc.)

- Spot business helps to prevent volume discounts

- Extra services such as shop merchandising or logistic functions may lock a customer

- Other/ new Far East companies eg. design houses and manufacturer, especially if $ low

- Opportunistic penetration as spot business using known brand for short time (e.g. Bernina)

- Other (consumer) electronic brands with brand extension strategy e.g. Grundig

- Strong players from other geographic markets with geographic expansion strategy e.g. Atlinks

- Competition for fixed telephony through new GSM pricing

- GSM “home zone” offers replacement of fixnet (e.g. Genion)

- SMS-box reduces need for purchase of new phone with SMS feature

- VOIP and voice enabled universal PDA devices penetrate home telephony market

(e.g. Orange& Microsoft)

- Three big companies: Siemens (brand, all big NOPs’), Philips (brand), Sagem (all big NOP’s)

- successful Far East companies:

• DBTEL (established, reliable products),

• Binatone (simply does the business)

• Vtech (concentration on huge markets/NOP’s)

• Panasonic (brand, volume)

Characteristics


Products

presented with

feature list only

COMPETITOR PRODUCT POSITIONINGS, LOW / MID RANGE - INTERNET

EXAMPLE (1/3)

Products presented

with little text and

feature list

separately

Products positioned

through consumer

benefits and functions

Schmal und handlich

Doro

Hi-Tel

Panasonic

Siemens

79 € / 98 CHF

„Erweitere Deine Reichweite.“

„Bringen Sie Bewegung in Ihre

Telefonate!“

„Modernste Technik ganz einfach

genutzt. Es lässt sich kinderleicht

anschließen und liegt besonders gut

in der Hand.“

„Das einzigartige Styling besticht. Die

beeindruckende Farbpalette verblüfft. Und

der unglaubliche Funktionsumfang

überrascht immer wieder.“

„Produktfunktionen & Vorteile...“

„Design, völlig anders als bei herkömmlichen

Schurlostelefonen...“

„2 Telefonbücher für Familie und Freunde...“

148 CHF 98 CHF

129 CHF

138 CHF

Philips

Positioning

varies

significantly

across

packaging,

retail shelf

and on

internet

Source: Internet analysis


Brand

Price offer - “Cheap Jack”

Impression of

‘More for less’

Guarantee

Eye catcher:

price, non-

comparable,

cool features

However

real

customer

benefits

difficult to

identify

Technical Statement

COMPETITOR PRODUCT POSITIONINGS, LOW / MID RANGE - DIRECT

MAIL CAMPAIGNS (2/3)

Source: Mailing analysis


90 gramms

Impression

of randomly

selected

criteria

often

impossible

to judge

value or

even verify

by a

customer:

“you have

to believe this”

LCD screen permanent screen

Technical

Statement

COMPETITOR PRODUCT POSITIONINGS, LOW / MID RANGE - DIRECT

MAIL CAMPAIGNS (3/3)


TARGET PRODUCT POSITIONING FOR ANALOG CORDLESS

C 100

“Just” a cordless

telephone

Very simple to use,

no thrills, plug &

phone without

lengthy study of

user manual

Screen for display

of numbers

To be used in the

basement or

kitchen as second

or third phone

EUP 49 EUR

C 200

Entry comfort level

cordless telephone

with larger display

Smart menu for use of

features

Easy call of pre-

defined number for

kids (baby call)

Handfree speaking

with handset

Large enough memory

for friends and familly

numbers and names

EUP 79 EUR

C 150

Simple cordless

telephone - entry

model

Menu guidance for

ease of use

Basic telephone

book for storage of

some names and

numbers

Possibly with SMS

function targeted for

kids communication

EUP 69 EUR


CONTENTS









IDENTIFICATION OF THE TARGET VALUE CHAIN STRUCTURE

What is the objective of Far East sourcing?

• Reduce cost

• Accelerate new product introduction

• Improve access to markets through complete product set

• Learn from partnership (access to up-to-date technology)

• Reduce future capital requirement / increase cash flow

• Be 'asset light'

R&D

Product

develop-

ment

PCB*-

design

and

proto-

typing

PCB-

making

PCB-

assembly

and

testing

Assembly

and

testing of

sub-

systems

Assembly

and

testing of

final

system

Logistics • Distri-

bution • Ware-

housing • Order ful-

fillment

Marketing

and sales

Support

services

Marketing/

sales Product development PCB-making

Support

services

Final system assembly

and delivery Assembly

Which element in the value chain do I want to outsource?

ELECTRONIC MANUFACTURER EXAMPLE

*Printed Circuit Boards


ELCOTEC-SOURCING – TODAYS VALUE CHAIN

• All the major

processes are

PhoneCo own

processes (R&D,

Marketing, Sales,

Quality, Logistics)

• Tooling, Sourcing,

Manufacturing &

part of logistics

are outsourced

• This processes

must be changed

if we want to do a

far-east-sourcing

Customer 1

DTAG

Customer 2

Swisscom

Customer 3

Retail CH

CMS

CMS

display

subassembled

PCB’s

CMS

microtel

Prototyping

Mechanic

Design

Industrial

Design

Shipment

papers

Logistics

Transport

CMS parts

Sourcing Test-

equip-

ment Ware-

house

NPI

Industriali-

sation

Manuf-

acturing

Elcoteq

Hungary

Tooling Plastic

manu-

facturing

WEZ

Ware-

house

CBA CH

PhoneCo

Qualifing

R&D

HW

R&D

SW

Quality

Marke-

ting

Sales

Logistics

Project-

mgmt.


Options / Scenarios

1. Direct

Sourcings

1a) Product

direct sales

1b) Chinese

Suppliers

1c) Euro

Suppliers

2. “PhoneCo-

Asia“-Sources

2a) PhoneCo-

Asia over DH

2b) PhoneCo-

Asia direct to

Manufacturer

3. Designhouse

(DH) Sources

4. ODM Sources

FAR-EAST

SOURCING

VALUE CHAIN –

SIMPLIFIED VIEW

-PhoneCo office

-IPO Hongkong

PhoneCo-

Asia

Customer 1

DTAG

Customer 2

Swisscom

Customer 3

Retail CH

Ware-

house

CBA CH

China Manufacturer with

internal Designhouse

DH

China-Suppliers

with a product

basket

Buy in

NPI

Industriali-

sation

ASS

1a)

2)

China Manufacturer with

internal Designhouse

3)

4)

2a)

2b)

2a)

ODM

China Manufactuer

Euro-Suppliers

with a product

basket

Buy in

1b)

1c)

PhoneCo

PhoneCo


FAR-EAST

SOURCING

VALUE CHAIN –

DETAILED VIEW Options / Scenarios

1. Direct

Sourcings

1a) Product

direct sales

1b) Chinese

Suppliers

1c) Euro

Suppliers

2. “PhoneCo-

Asia“-Sources

2a) PhoneCo-

Asia over DH

2b) PhoneCo-

Asia direct to

Manufacturer

3. Designhouse

(DH) Sources

4. ODM Sources

BACKUP

-PhoneCo office

-IPO Hongkong

Sourcing

Buy in

Qualification

Quality

Supervision

Customer 1

DTAG

Customer 2

Swisscom

Customer 3

Retail CH

Shipment

papers

Logistics

Transport

Ware-

house

CBA CH

CMS

CMS

display

subassembled

PCB’s

CMS

microtel

CMS parts

Sourcing

Ware-

house

Manu-

facturing

China

Manu-

facturing

CMS plastic

manufacturing

Test-

equip-

ment

NPI

Industriali-

sation

Proto-

typing

Tooling Industrial

Design Mechanic

Design

R&D

HW

R&D

SW

DH

Qualifing

Shipment

papers

Logistics

Transport

R&D

HW

R&D

SW

DH Qualifing

China-Suppliers

with a product

basket

Buy in

NPI

Industriali-

sation

Repair

Hotline

Spare-

handling

ASS

1a)

2)

CMS

CMS

display

subassembled

PCB’s

CMS

microtel

CMS parts

Sourcing

Ware-

house

Manu-

facturing

China

Manu-

facturing

CMS plastic

manufacturing

Test-

equip-

ment

NPI

Industriali-

sation

R&D

HW

R&D

SW

Proto-

typing

Tooling Industrial

Design Mechanic

Design

DH

Qualifing

3)

4)

2a)

2b)

2a)

PhoneCo

Asia

CMS

CMS

display

subassembled

PCB’s

CMS

microtel

CMS parts

Sourcing

Test-

equip-

ment

Ware-

house

Manuf-

acturing

ODM

China

Manu-

factuer

Euro-Suppliers

with a product

basket

Buy in

CMS

CMS

display

subassembled

PCB’s

CMS

microtel

CMS parts

Sourcing Test-

equip-

ment Ware-

house

NPI

Industriali-

sation

Manuf-

acturing

Elcoteq

Hungary

End-

assem-

bling SW Branding

Box, Manual,

Labeling

1b)

1c)

PhoneCo

Qualifing

R&D

HW

R&D

SW

Quality

Marke-

ting

Sales

Logistics

Project-

mgmt.


QUALITATIVE VALUATION OF SOURCING OPTIONS 1a)

Product

direct sales

High High Medium Low High Low High

interest interest interest interest interest interest

1b)

China

Suppliers

1c)

Euro

Suppliers

2a)

„PhoneCo

Asia" Sources

via DH

2b)

„PhoneCo

Asia" direct

Sources

3)

DH

Sources

4)

ODM

Sources

Characteristics

PhoneCo source

products over an

ODM partner

PhoneCo source

products over a DH

PhoneCo has a

partner or an own

organisation which

can source direct

products in China

PhoneCo has a

partner or an own

organisation which

can source

products in China

over DH or ODM

PhoneCo source

products over a

China Supplier

which has a

product-basked

PhoneCo source

products over a

China-Supplier

which has a

product-basket

PhoneCo sources

products directly

through a chinese

manufacturer

PhoneCo

-> ODM

(-> Designhouse)

PhoneCo

-> Designhouse

-> China

Manufacturer

PhoneCo

-> PhoneCo-ASIA

-> China

Manufacturer

PhoneCo

-> PhoneCo-ASIA

-> China

Designhouse

-> China

Manufacturer

PhoneCo

-> Euro Suppl.

-> China

Manufacturer

PhoneCo

-> China Suppl.

-> China

Manufacturer

PhoneCo

-> China

Manufacturer Value Chain

Scenarios

Pros +

and

Cons -

+ ODM makes

better price

pressure on the

Designhouse

- flexibility ?

- no experiences

+ most flexibility for

product definition

+ technologie

advantage

+ Designhouse

has ODM

experience

+ more then one

ODM

- long value chain

+ local people

+ short communi-

cation path

- expensive to bulid

up a new organi-

sation

+ shorter distance

for cooperation

+ better

understanding

same culture

+ suppliers has a

product basket

- Euro-Supplier is

more expensive

then china

supplier

+ local supplier

with direct

connections

+ suppliers has a

product basket

- long distance for

cooperation

+ cheapest option

+ suppliers has a

product basket

- chinese mentality

unknown

- no experience

+ local people

+ short

communication

path

+ over Design-

house we have

more flexibility to

define product

- expensive to bulid

up a new organi-

sation

- longer value chain


CONTENTS









VALUE CAPTURED = NPV OF ADDITIONAL CASH FLOWS

NPV of

ongoing

business

Fixed

costs

Variable

production

costs

Recurring

investments

Interaction

cost

Exceptional

items

Tax impact NPV with

deal

Product

purchase

NPV of additional

interaction cost

(monitoring of

supplier, management

of the supply chain…)

Net NPV of one-off costs

and investments, i.e. asset

sale, restructuring costs,

required investments such

as IT-system upgrading

NPV of product

purchasing cost to the

manufacturer, driven by

negotiated unit billing

price and volumes

All cash costs directly related to

production are avoided in case of

outsourcing, including the

recurring investments required to

maintain the plants and lines

Value of the

deal captured

by the

outsourcing

company

Purchasing price is not the

unique driver of additional

value captured by the

outsourcing company

SCHEMATIC


BUSINESS CASE FORMULATION

The essence of DCF is to represent the cash inflows and outflows of this project at a common point of time so that they can be compared in an appropriate was

Because DCF weigths The essence of DCF is to represent the cash inflows and outflows of this project at a common point of time so that they can be compared in an appropriate was

Becaus DCF weigths

C200 Best CASE Project NPV 43

Variables

Fiscal Year 2003 2004 2005 2006

Revenue side Liquidation

Volume in '000 Units 80 200 200 0 in units

Consumer price (EUP) 80 72 65 0 in EUR Only 10% price decrease

Transfer Price per unit 42 38 34 0 in EUR

Standard cost per unit 38 32 27 0 in EUR

Standard Margin 9.8 14.8 19.5 0.0

SG&A Total 11 11 11 0 in %

Marketing 2.5 2.5 2.5 0.0 in % Sales Smaller marketing cost

Sales 2.5 2.5 2.5 0.0 in % Sales Smaller sales cost

Outsourcing Management (Swisscom) 5.0 5.0 5.0 0.0

Overhead 1.0 1.0 1.0 0.0 in % Sales

COGS Total 3,147 6,622 5,629 0

Product Procurement 3,040 6,460 5,491 0

Warranty 61 129 110 0

Logistics 16 33 28 0

Testing 30 65 55 0

Testing in % 1 1 1 0

Warranty % 2.0 2.0 2.0 0.0

Logistics % 0.5 0.5 0.5 0.0

Initial and recurring CAPEX 110 55 55 0

Initial setup cost in EUR '000 100 0 in EUR

Legal cost 10 5 5 0 in EUR

Annual costs for improvement 50 50 0 in EUR

Net Working Capital

Average days of inventory 120 120 120 120 in days

Average days of oustanding A/R 180 180 180 180

Average neccessary inventory 1,035 2,177 1,851 0 in EUR

Average necessary A/R 1,499 500 400 0 in units

Average outstanding days of inventory: 42 days sea freight + 14 days production + 42 days component lead + 7 days LC opening

Average outstanding days A/R: 120 days of product provisioning + 60 days deferred payment

Average A/R equals COGS/oustanding A/R days

Cost of Capital 5 in %

Investment Justification

Intermediate Calculations

less setup investments

Higher volumes (only year 04 and 05!!)

15% decrease of SHK

2003 2004 2005 2006

Investment Justification C200 Estimated Launch 8/2003 Liquidation

Swissvoice Revenue 3,368 7,579 6,821

- COGS (Standard Cost) 3,147 6,622 5,629

Contribution I (C1) in CHF '000 222 957 1,192

Contribution I (C1) in % 7 13 17

- SG&A 371 834 750

= Operating Profit -149 123 442

- Initial and recurring CAPEX 110 55 55

- Increase Inventory 1,035 1,143 -327 -1,851

- Increase Accounts Receivables 1,499 -999 -100 -400

= Cash Flow from Operations -1,758 1,067 487 400

Discounted Cash Flows -1,674 968 421 329

Net Present Value (NPV) 43

PhoneCo Revenue

Average outstanding days of inventory: 42 days sea freight + 14 days production + 42 days component lead + 7 days LC opening

Average outstanding days A/R: 120 days of product provisioning + 60 days deferred payment

Average A/R equals COGS/oustanding A/R days


CONTENTS









TYPES OF OFFSHORE ARRANGEMENTS

Relationship type Pros

Off-shore development

center

• Maximum value from off-shore

outsourcing

• Significant managerial

and financial

commitment

Cons

Joint venture • Risk mitigation without losing

control over partner

Exclusive outsourcing • Lower commitment to off-shore

outsourcing

• Lower upfront investment

• Easier exit strategy

• Value from offshore

outsourcing is divided

between vendor and

client

Multiple vendors • All the benefits from exclusive

outsourcing

• Competitive pricing

• No long-term commitments

• Multiple knowledge

transfer efforts

• Threat of experienced

assets leaving

Co

mm

itm

en

t

+

–

EXAMPLE

Example

• PhoneCo

Asia

• Swisscom

Testlab Asia

• VTech

arrangement

• DRS,

VTech,

Binatone


CONTENTS









SELECT THE RIGHT PARTNER: SCREENING PROCESS

Define long list of

candidates

Select shortlist

based on basic

criteria

Shortlist

Activity

Main criteria

for selection • Experience in the

manufacturing of

products similar to

the one to be

outsourced

• Suitable geographic

location

• Trust worthiness

• Fit on broad criteria:

– Response to RFQ

respecting the desired

Service Level

– Cost efficiency

– Suitable size

– Financial performance

• Fit on detailed criteria, such as:

– Lack of strategic / competitive conflict

– Capacity to absorb the different

outsourcing contracts

– Reputation of reliability

– Flexibility of forecast and engagement

mechanism

– Breadth of capabilities

– Adaptability to future needs

– Technological potential

• Long list (5-10

companies)

• Reduced list (3-4

companies) • Short list

(2 companies)

End products

EXAMPLE

Send a Request for

Quotation (RFQ)

Direct contact to evaluate fit

on detailed criteria

Final decision based on

negotiation result (sharing of

the deal value)

The 'right

partner'


CONTENTS









FAILURE CAN HAVE SERIOUS RAMIFICATIONS

Potential ramifications

• Miss one-time and year-on-year financial goals

• Delays in outsourcing timeline

• Lowered workforce morale and productivity

• Customers become dissatisfied

• Consume greater share of management's mind

• Large switching costs should operations need to be brought back in-

house


AFTER SALES SERVICES (ASS) CONCEPT FAR EAST

supplier Stock

PhoneCo Distr. POS

Service

Desk

End

User

ASS

Center

Hot-

line

Substitution

Local

ASS-Center

Distribution Channel

Key Points

• Our warranty obligations will be satisfied through over-delivery. Warranty conditions will be identical to those of the supplier

• The service desk is restricted to exchange of Handset or Basestation in warranty cases.

• PhoneCo offers neither repair nor spare parts.

• The supplier makes an over-delivery of about 4% at the rate of 1:4 Basestation / Handset

• If the return rate can be proved to be higher than appr. 6%, substitution will be made 1:1 by the supplier. The distribution

channel is responsible for the corresponding statistic.

• An extended ASS-concept could be taken in account with a distribution channel with more than 100’000 pieces.

Order incl. over-delivery

make or buy decision - offshoring

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