Outsourcing's impact
Purchasers are buying more finished systems and subsystems and fewer components to help their companies compete.
By Jim Carbone -- Purchasing, 11/18/2004 2:00:00 AM
While the communications equipment industry is far from booming, the shift to outsourcing within the industry has dramatically changed the role of purchasing professionals.
Purchasing at communications OEMs is now less transactional and more strategic. Many buyers are reviewing suppliers' capabilities to make sure their parts and processes comply with the European Union's ban on the use of lead in electronics equipment beginning in 2006.
Purchasers are also involved in design and, in some cases, work with bid teams to make sure the appropriate suppliers are included from the onset when the company bids on a project.
Communications equipment OEM buyers are not purchasing as many components, but they are buying more finished systems that get integrated into communications equipment. The day-to-day purchasing of components and the management of low-value components has been assigned to EMS providers although OEMs will maintain control of the approved vendor list (AVL).
But, at the same time, communications equipment purchasers are managing the buy of higher value strategic components such as application specific integrated circuits (ASICs) and leading edge memory ICs.
What triggered the change? The downturn in 2001 and 2002 resulted in plummeting profits and revenue. As a result, communications OEMs got lean by downsizing, divesting and outsourcing. For example, Lucent Technologies divested itself of several business groups including its microelectronics and power systems divisions. It also went from being a highly vertically integrated company in which most of its equipment was manufactured in-house to a company that now outsources the bulk of its manufacturing.
Lucent isn't alone. Alcatel outsources most of its manufacturing. And Nortel has inked a deal with electronics manufacturing services (EMS) provider Flextronics to manufacture most of its systems and announced that it is getting out of the manufacturing business.
Another good example is Marconi, which outsources manufacturing, but keeps a tight rein on its supply base.
"We are 90% outsourced," says Jeffrey Blose, director of supply chain materials for Marconi's broadband routing and switching group based in Pittsburgh.
"We build switches and we outsource printed circuit board assemblies, enclosures, and some level-three integration," which involves placing backplanes, power supplies and fan trays in enclosures. Final integration and testing is done at Marconi's Pittsburgh facility.
While Marconi outsources, it maintains complete control of its AVL and buys about $60 million of production materials. Marconi commodity teams work closely with the company's EMS suppliers to manage upsides or downsides of material requirements. Such requirements can be volatile due to short leadtimes.
"Our customers are requesting products with shorter leadtimes," says Blose. "They place an order and they want something in two weeks. Being able to deliver that is a challenge we undertake."
It does so by working closely with its suppliers, especially its EMS providers who keep Marconi commodity teams aware of any supply issues concerning production materials.
While communications OEMs may control the AVL, they don't necessarily obsess about it.
"We spend far less time worrying about which passive component suppliers we should be managing," says Joe Carson, vice president of supplier management at Lucent Technologies. "A lot of that was moved to EMS providers."
Managing suppliers
While EMS providers may handle management of lower value production materials, communications equipment company buyers are involved in the selection and management of suppliers of key OEM subsystems that are integrated into communications equipment. Those OEM products could include voice for IP (Internet protocol) boxes, servers, power amplifiers, and filters among others.
Communications equipment industry buyers must also manage the relationships with EMS suppliers and work with product development and bid teams to assure their companies go to market with the products that customers want.
Carson says choosing the right OEM supplier is critical to helping the company achieve a competitive advantage in the marketplace.
"Our ability to pick OEM suppliers that the company can work with and integrate them into our business process is key," says Carson. "If we do that wrong, we will go back to where we were before, which is having far too many suppliers to manage, no synergies, and needing too many people and too much infrastructure to manage them," he says.
OEM suppliers must not only have subsystems that enhance the value of Lucent's systems, but also meet cost and time to market targets to satisfy Lucent's customer requirements.
To meet those targets, Lucent's strategy has been to work with fewer suppliers more closely. Over the past four years, Lucent has reduced its supply base from 3,000 to 1,500 and concentrated more business with fewer suppliers. Eighty percent of Lucent's $4.5 billion annual spend is with about 60 suppliers, says Carson.
Anticipating needs
Carson says part of meeting customer requirements involves anticipating the customer's needs sometimes even before the customer has a clear idea of what equipment it will want.
"We are looking to do a lot better at anticipating the trends in the marketplace and translating that back into the supply chain," says Carson.
To help identify market trends Lucent uses an anticipation and solutions planning group. "The anticipation group allows us to get closer to the customers product teams and understand management trends and what is happening in the marketplace and product," he says. "From a supply chain perspective, we want to have the best and most crisp understanding of what those forecast groups see."
The group, along with supplier management, works with Lucent's bid teams. Part of their job is to bring in key suppliers to the bidding process.
"When we have a bid with one of our customers, we bring suppliers in. We want to have visibility into the bid not only to plan the supply chain from a capacity standpoint, but also from a pricing standpoint," says Carson.
The advantage is that key suppliers see the cost targets that customers are looking for.
In addition, by being involved in the bid process, suppliers see the solution the customer is looking for and how much the customer expects to pay. Key suppliers can be involved in the design of the solution and can give valuable input on whether cost targets can be met. "Sometimes what customers want is not even a product that is around today. It requires innovation on our part and with our suppliers," says Carson.
Involving purchasing and suppliers in the bid process also speeds up the process.
"We want to remove the latency in the supply chain process," says Carson. "It's not just a matter of how quickly can I respond to a bid, but how quickly can I get my suppliers and their suppliers involved so we can promptly respond to market needs. We think this will be a competitive advantage for us."
He adds involving suppliers in the bid process is imperative because Lucent is no longer vertically integrated and is dependent on its partners.
"We are more leveraged in terms of the need to pull in the supply base's thoughts and perceptions," says Carson. "You have to have the ability to pull in external suppliers early in the innovation process."
Back to the future
In the future, many of those external suppliers may be regional suppliers rather than global ones. That's a contrast to several years back when most communications OEMs decided they had too many regional suppliers and opted to centralize business with a few global suppliers.
"Now there's a bit of a pushback on that," says Carson. "The thinking is that perhaps we need a voice from regional suppliers. Regional suppliers may give us a lower cost as we respond to customer needs in a particular region—be that Asia, Central America, Latin America or Europe."
For instance, it may make sense, he says, from a cost and logistics standpoint to use a regional enclosure supplier rather than use a global supplier who needs to ship components to different continents.
But using regional suppliers is not the only way communications OEMs are reducing cost. Some companies believe they can reduce total cost by signing long-term contracts with suppliers.
"Long-term contracts are good for us," says Andy Winterbottom, vice president, semiconductor procurement for Motorola. "They tell the supplier that we have indeed something they can take to the bank for more than six months."
Motorola's long-term agreements are for three years and they are evergreened so they will be extended if terms and conditions are met and both parties want them extended.
With long-term agreements, Motorola agrees to buy a percentage of its requirements from suppliers.
In other words, if Motorola needs to buy two million pieces of a certain semiconductor, the company may contract to buy 25% from one supplier, says Winterbottom. "If our requirements go up, they get more business. If they go down, suppliers share the pain."
Motorola signs long-term deals with suppliers of both leading and trailing edge technologies.
"We are wise to keep trailing edge suppliers involved," he says. "We make long-term agreements with them as well if it is important to preserve supply continuity," he says. That, in turn, reduces costs.
Mobile solutions
Communication industry buyers also work with suppliers to add value by proving module solutions rather than just discrete parts. This is especially important in mobile phone handsets where board space is at a premium.
"As you add more functionality, handset manufacturers are trying to figure out how to streamline the design and cost reduce their designs," says Scott Smyser, an analyst with researcher iSuppli. "On the RF (radio frequency) front you have more module type approaches being taken. You combine the power amplifier with the antenna switch into a module. Or combine a transceiver with filtering. There is a push for an integrated solution."
One component area where there is a need for such a solution is memory. "Memory manufactures are realizing that they need to add more value to their product so they are making multichip modules, packages that incorporate flash and SRAM ," says Smyser. Such packages take up to 30% less board space than discrete memory ICs.
Suppliers are also offering "more reference design solutions where they provide the mobile handset maker an almost complete bill of materials. Suppliers say 'here is our digital baseband processor, our analog processor our RF transceiver and some of the components qualified around it,'" says Smyser.
No shortages ahead
While buyers may have to work with suppliers to add more value, they won't have to worry about any serious parts shortages or rising prices at least over the next six months.
"Right now we don't see any supply issues with communications," says Smyser. "There is plenty of capacity out there. Based on demand we don't see any major supply issues. Prices will not go up and will likely trend downward."
The only potential fly in the supply ointment could be the perennial component obsolescence issue. A lot of communications equipment has long life cycles and can be in the field for 10 or 15 years. Electronics component technology changes quickly and component suppliers are unwillingly to continue to make parts for which there is limited demand.
One reason communications OEMs involve buyers in design is to make sure soon to be obsolete parts never get designed into new products.
"End-of-life is an issue," says Larry Howe, senior director of sourcing technology for Alcatel. "It's not only an issue on existing products that are mature. We like to leverage and reuse designs so when you look at a new product it may have 80% existing parts and 20% new. It could be that those 80% are at risk," he says.
To avoid the problem Alcatel grades bills of materials (BOMs) to assure parts to be used in a new design have life cycles that match up as well with the new product. "We need to make sure that parts don't go end-of-life before Alcatel's product goes end-of-life," says Howe. "That can be challenging because some of Alcatel's products have 10 to 15 year life cycles.
Alcatel maintains a BOM grading database for parts that is available to buyers and engineers, which identifies preferred suppliers and parts and identifies if parts are at risk for end-of-life.
Component end-of-life issues won't go away. Neither will the need for OEMs to reduce cost and be more efficient through outsourcing. Both are opportunities for buyers to contribute to the success of their companies.
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