HP sources globally to cut costs
Hewlett-Packard has slashed its direct materials cost by $1.1 billion since it merged with Compaq in 2001. Global sourcing, consolidation of purchases and price masking have been key to its success.
By James Carbone -- Purchasing, 6/17/2004 2:00:00 AM
When a company spends $43 billion per year on production materials, it wants to make sure it is getting the best price, the highest quality and the best support possible from suppliers.
That's why Hewlett-Packard over the last three years has launched initiatives to exercise greater control of its spend, consolidate its purchases where possible and identify and develop emerging sources of supply in China, Eastern Europe and India.
Such an undertaking is no easy task for a company as big and diverse as Hewlett-Packard, which had $73 billion in sales in 2003, and is perhaps best known as a computer company. However, it is also a leading supplier of copiers, printers, networking equipment and storage systems.
Its business units often have different supply requirements. HP believes it has found a way to satisfy all of its business units' supply and procurement requirements while still reducing cost and taking advantage of emerging markets.
Having revamped its approach to supplier management since its 2001 merger with Compaq Computer Corp., HP has centralized purchasing of key commodities, such as microprocessors, memory ICs and disk drives that are used by many of HP's four business units. For commodities that are unique to business units, such as chassis and power cords, it has a decentralized approach.
To support both corporate purchasing and purchasing at business units, HP has its Global Procurement Services group, which serves as an international procurement organization (IPO) and a buying arm for the company.
HP uses its Purchasing Council to help develop purchasing strategies used throughout the company. It also has "core" teams which work in new product development, and commodity teams which manage parts purchased for multiple HP business units.
Cleaning up
HP's current procurement organization is the result of the work of "clean teams" which were formed after the merger. The teams analyzed the procurement processes of both HP and Compaq and identified the best practices for each.
The teams found that Compaq's purchasing was very centralized, while HP's was decentralized because of its many business units.
"What we have now is a hybrid approach," says Greg Shoemaker, vice president of procurement for HP. "We have a certain number of commodities that are centralized and commodities that are pan HP—products such as microprocessors, disk drives and software," he says. Corporate purchasing is responsible for those commodities.
Corporate purchasing combines the volumes of all its business units for those commodities to leverage its spend with suppliers.
"Then we have commodities that are business specific. Chassis would be an example. Not too many chassis are exactly alike. A desktop chassis is different than a storage rack chassis," says Shoemaker. Business units are responsible for managing those commodities.
To help leverage commodity purchases, HP has established a Procurement Council comprised of the purchasing directors of business units and headed by Shoemaker. Those units include customer solutions, imaging and printing, technology solutions and personal systems.
The council meets monthly and, besides leveraging HP's purchasing power, the group focuses on professional development, IT toolsets and practices, and processes that can be used throughout the company. The idea is to share information about practices being used in individual business units to determine if they could be employed throughout HP.
Core teams, comprised of members of procurement, marketing and development are employed to help set supply strategies at HP.
The teams work with new product development and look at what products are going to be introduced and what parts will need to be purchased. The core teams then determine which of HP's sourcing strategies need to be in place for the parts used in the new product.
Core teams work closely with HP's strategic suppliers because HP needs the technical expertise of suppliers in its new products.
"We will invest $4 billion in research and development this year, but it doesn't account for all the R&D that needs to be done," says Shoemaker. "We don't necessarily invest a lot in memory, hard disk drives or microprocessor development. Our suppliers do that."
Fewer get more
Reliance on suppliers for technology development is one reason HP has centralized its purchasing with a small group of suppliers. Consider: Eighty percent to 85% of HP's production spend is with just 35 suppliers.
Another way HP has reduced cost from suppliers is through its Absolute Best Cost (ABC) process, says Shoemaker. "We view this as a best practice," he says. "With ABC we identify what is the best cost we can find for a part. We determine what are the feature sets we may want to add to the part, what are the costs for the features and if the customer will pay for them," he says.
HP also does risk assessment on parts. "We look backward over time at cost, supply and demand and do regression analysis on a part," says Shoemaker. The idea is to see what a part costs at a certain time given the overall supply-and-demand scenario and general business conditions at the time.
"We then look forward and predict a range for cost as well as supply and demand, and then use the data to reach a better agreement with suppliers," he says. For instance if there is a memory module that is used by multiple HP business units, "we'd do a risk assessment on the part and predict what a price will be. Based on that analysis, we might come up with a scenario where we agree to a price ceiling in return for a volume commitment to the supplier," he says. "It's a win-win situation."
Another way HP has helped control cost is through e-sourcing. "It is a tool in our tool bag and it is more than reverse auctions," says Shoemaker. "We do electronic requests for quotations (RFQs) and private offers," says Shoemaker.
A private offer is a form of an electronic RFQ, but it is sent to an individual supplier. "You may conduct a half dozen at the same time for the same part, but each one is private. You are not sharing the data among the suppliers," he says.
Bid for business
HP does reverse auctions with some suppliers but is careful about them. He says HP did a reverse auction for hard disk drives last year, but has not done one since for drives.
"Some suppliers like auctions, some hate them," Shoemaker says.
Some suppliers only participate in them because they don't want to lose business. They wonder why they should share technology with a customer if the customer is going to hammer them on price with reverse auctions.
"Reverse auctions make a lot of sense for commodities where there are low barriers to entry and there is a large installed base and it is easy to qualify new suppliers," says Shoemaker.
He adds that just because it is a buyer's market, it doesn't mean HP will do auctions. "You have to look at where the market is going to be over the next year. Is it a consolidating market? Are there barriers to entry? How key are your supplier relationships? How key is a supplier's technology?"
Reducing the cost of purchased goods, either through consolidating purchases or using e-commerce tools is important to HP because 70% of HP's revenue is used to buy parts for production. Any savings in material goes to HP's bottom line.
That is one reason why HP keeps control of its strategic purchases of components used by its electronics manufacturing services (EMS) and original design manufacturing (ODM) providers.
Like most OEMs, HP outsources much of its manufacturing to reduce its total cost and uses EMS providers and ODMs in various ways to support its different business models. For instance with its "no-touch" model for notebooks, HP's ODMs design, manufacture and ship a product with HP's name on it to HP's customers. With its low-touch model for desktops, an EMS provider builds the product, but HP performs some product configuration. With high value products, such as larger sophisticated servers, HP builds all of the product except for the printed circuit boards.
In each of these models, HP maintains control of sourcing for strategic components such as DRAMs, drives and software.
For such parts, HP corporate purchasing negotiates contracts with suppliers. HP's Global Procurement Services (GPS) buys the parts and sells them to the company's manufacturing partners in what HP calls its "buy/sell" process. Parts are sold to the EMS provider at a higher price than what HP paid the supplier.
Price masking
HP masks the price it pays for the parts from its EMS providers because it believes it gets world-class prices and wants to keep the prices confidential. The strategy makes sense for many components, especially semiconductors. HP was the world's largest OEM purchaser of semiconductors in 2003 having purchased roughly $11 billion in chips, according to iSuppli. With such large volumes it should be getting significant discounts.
Wolfgang Zenger, vice president of GPS, says that in the 1990s, when HP outsourced manufacturing, it also outsourced a lot of purchasing.
"When outsourcing started we were the biggest outsourcer. But we realized in the mid-1990s we had given too much control to contract manufacturers," he says. Zenger says HP turned over a lot of purchasing responsibility to its EMS providers. However, whenever there was a problem with sourcing a part "the contract manufacturer came back to us and said it needed help getting the part."
At the same time when the contract manufacturer got a price advantage for a part, the savings were not necessarily passed on to HP. Zenger states that, in addition, "HP lost a lot of visibility in its supply chain because it didn't have as tight a relationship with suppliers. So we took some control back in-house. That is why we are advanced in the buy/sell area," he says
HP's efforts to reduce cost have paid off. Since 2001 HP has realized about $1.2 billion in production material cost savings as a result of its initiatives and strategies, according to Shoemaker. That figure is above and beyond cost savings because of market conditions.
Parts scouting
Moving forward, HP is looking to find ways to reduce the cost of materials by identifying new emerging sources of supply. China emerged as a location for low-cost labor and much of HP's manufacturing is located there. "However, China so far has not significantly impacted HP's sourcing strategies for components," says Shoemaker. "China has become strategic from a sell point of view, but not so much from a sourcing standpoint. But we continue to evaluate that."
He says production of many components is not necessarily labor intensive. For instance a DRAM fab costs millions of dollars and is highly automated so there are no real labor savings gained by locating a fab in China. " 'Now with chassis, that's a different story, "says Zenger. "There is much more labor content so there could be savings." He adds that China will become an important source for disk drives.
Finding and developing emerging sources of supply is another function of Zenger's GPS group in addition to managing the buy/sell process.
"We are HP's eyes and ears in the markets where the action happens," says Zenger. "We own a lot of supplier relationships day-to-day because we place orders. We go out and perform factory audits, so we know what's going on. We have real-time and forward- looking information in terms of technology roadmaps," he says. Because it executes the buy/sell process, GPS knows which suppliers have the best prices for parts and where the parts can be purchased.
GPS actually functions like an international procurement organization (IPO) and comprises 300 people who are distributed around the world with roughly 60% based in Asia. "We are close to where HP's outsourced manufacturing is taking place in China, southeast Asia, Japan and Korea," says Zenger. "That is where we have people located to provide market intelligence and to perform factory audits so that HP people in the U.S. or Europe don't have to travel into those regions."
GPS provides market information and looks to identify sourcing opportunities for corporate purchasing and for HP business units as an IPO would. The IPO concept is not new to HP. It was one of the first companies to have an IPO when it formed the organization about 20 years ago. However, the role of GPS is a little different than a standard IPO.
Business units contract with GPS for certain services. "We provide commodity management services including supplier audits," says Zenger. GPS will also buy on behalf of the business units. "We are a self-funded service organization and operate like a business to provide services and business units pay us," he says.
GPS identifies new sourcing opportunities and transfers knowledge from the business units into the supply base so that HP and the potential new supplier can optimize a design. "We have engineers in India, Europe, and Mexico and they are all connected in certain commodity teams," says Zenger. "We have a mechanical team comprised of people in Europe, U.S., Mexico, and Asia Pacific for products such as power cords."
To the future
Zenger says HP is investing heavily in market development in Vietnam, "which is the future for us. We are in China and India. GPS was instrumental when we opened up in Eastern Europe. Five years ago, we didn't do any sourcing there. Now we do several billions of dollars per year there," says Zenger.
GPS is not finding new suppliers for microprocessors or DRAMs, but for other parts that may be unique to the business units. Mechanicals and power cords are good examples. "We are doing a lot of business in the mechanical space in India," he says.
GPS also monitors inventory and provides information to HP's business units. "We have an advantage in allocations when there are market shortages because we know exactly where our inventory sits," says Zenger. "We have real-time visibility and can do inventory balance between sites worldwide or in regions. It also helps us manage price volatility."
While strategies and practices are key to reducing cost, so are highly trained purchasing professionals. Moving forward, HP expects to step up its efforts on professional development.
Shoemaker says purchasers will be trained to be more knowledgeable in legal matters, logistics, cost of quality and technical aspects of the parts they buy.
"We want them to continue to progress professionally and be in a better position for advancement," he says.
One initiative HP will undertake is rotating purchasers into different positions.
"If you are stuck in a single commodity for 10 years, obviously you know that job like the back of your hand, however it closes you off somewhat to new ideas," Shoemaker says. "Every commodity is a little different. What you learn about one commodity can be an advantage in another commodity."
He adds that HP has always held purchasing in high regard and it was never a back office function. "It has been viewed as strategic in nature because up to 70% of what goes into our product is purchased," says Shoemaker. Because purchasing is strategic, there is a need for purchasing to continuously improve.
"We have a $43 billion spend, but just having the largest spend doesn't necessarily get you the best of anything," says Shoemaker. "You get the attention of everyone, but it is your people, business practices and strategies that are key to your success."
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