Nortel Networks' outsourcing journey has come a long way in eight years.

In 2000, the Toronto-based communications OEM decided to outsource printed circuit board assembly. Then in 2004 it sold factories to EMS provider Flextronics. The result was that though Nortel maintained factories in Ireland and North Carolina, the company outsourced 95% of its equipment manufacturing to EMS suppliers, including Sanmina-SCI and Jabil Circuit as well as Flextronics. That equipment includes optical switches, secure routers, digital phones, telephone switches and many other communications products.

Its approach to the outsourcing of manufacturing is far more aggressive than that of others in the industry. In fact, outsourcing consultant Charlie Barnhart says it is atypical to outsource as much manufacturing as Nortel does.

Nortel's strategy has saved the company big bucks. But there has been a cost too: The company found it had lost some control of its supply chain and some visibility into its customer requirements. "We realized that we carried the outsourcing model a bit too far," says Jeff Townley, CPO who is based in Hong Kong. "We needed to take back a little control."

What the company took back was some of the strategic sourcing of components it previously outsourced to its EMS providers. Nortel still outsources 95% of its manufacturing, more than any other major OEM. It has also reduced both the number of components and suppliers it uses. And, purchasing has become more involved in product design. The efforts have paid off. Nortel has reduced component costs by about 15% and lowered leadtimes for some components by 50%.

Right now, Nortel controls about 80% of the components it purchases and EMS providers control the other 20%. About two years ago, Nortel controlled about 60%. Nortel plans to reduce supplier-controlled products to about 5%.

The reason Townley believes that Nortel is taking back strategic sourcing of more parts is that it can get lower cost as well as better overall performance from suppliers.

He says EMS providers can often get lower prices for some components because they have larger purchasing volumes than Nortel, but that doesn't mean those lower prices are passed on to Nortel.

"In the past we let EMS providers negotiate cost and then we verified that's what they paid," says Townley. "The problem with that is it didn't allow for the fact that there are kickback schemes," he says.

Townley says one of its EMS providers may negotiate with a supplier and agree to pay $1 for a part. So the part is shipped and the EMS provider pays $1. However, the supplier will later send a rebate check to the EMS provider so the actual cost of the part may be just 80¢. The EMS supplier may not share the rebate with Nortel.

"We found out that was happening and that is why we forced transparency," says Townley. "Now, we negotiate the contract with those suppliers and confirm that is the actual cost in the bill of materials—and we have the ability to make sure there are no other costs being passed on," he says.

To enhance its efforts to reduce cost, Nortel is buying fewer components from fewer suppliers. For example, about two years ago, there were one million parts in Nortel's purchasing portfolio. Today there are 300,000, says Townley. Where possible, the same parts are being designed into multiple Nortel products.

At the same time, Nortel is directing more spend to fewer suppliers. Nortel used to have 80% of it spend with about 1,000 suppliers. Today 80% of the spend is with 200 suppliers. In total, Nortel spends about $3 billion per year for direct materials and EMS providers.

Nortel purchasing's group directors and supplier relationship managers determine which parts and suppliers Nortel uses. Nortel's component portfolio is broken into seven areas: radio frequency modules, power (batteries, power supplies rectifiers), semiconductors, optical components, interconnects, printed circuit-board fab and mechanicals.

One way Nortel reduced its number of components and suppliers was by creating a "basket of parts" for designers to use in new products.

"In the past the designer would come to us and say 'I want to use this part. Go pull out a part number for it and put it in the system,' and basically we would just do it," says Townley. "We have reversed that trend to where we define the basket of parts. We say there is a part that can be used in an enterprise product and a carrier product. It helps us consolidate suppliers and the number of components and our spend," he says.

Component engineers who work in purchasing are involved in design and direct designers towards the parts and suppliers they should use. Those parts are in a Nortel-developed database called Chooza. Chooza lists the parts suppliers, technical specs of the parts and the equipment they are currently used in.

While Nortel is reducing its number of suppliers, it realizes it needs a certain number to maintain a competitive environment. "There is a balance. We would never have one application specific integrated circuit (ASIC) supplier, but five or six is too many," says Townley. "I would want at least three because with two, if one of them drops off the face of the earth, then you have a problem," he says.

He says in developing sourcing strategies for components and production materials, suppliers' performance in cost, quality, delivery and technology are reviewed carefully. However, Nortel also factors in the chance of consolidation.

"With power supplies, we had three suppliers, but one of them bought out the others so we had to develop another one," says Townley.

Choosing the right components and suppliers is also important because it makes it easier to have a "refresh" strategy for parts. Some of Nortel's products have lifecycles up to 15 years. However, electronic component technology can change quickly so the company has to refresh parts periodically.

To make refresh easier, Nortel uses ASICs in equipment because five or six parts can be combined into one. "We can refresh technology a lot easier," he says because there are fewer parts. "We can deal with hundreds of ASICs, rather than thousands of individual components and suppliers."

While Nortel has reduced its number of components and component suppliers, it is maintaining its number of EMS providers at three. When Flextronics bought Nortel's manufacturing facilities, Nortel was also using Solectron and Sanmina-SCI. However, last year Flextronics brought in Jabil to maintain a competitive environment.

Nortel may use more original design manufacturers (ODMs) in the future because ODMs specialize in certain technologies, offer a lot of design expertise and generally have lower costs than EMS providers.

"The lines are blurring between the OEM, ODM and EMS," says Jay Stearns, strategic sourcing product leader for Nortel. He is responsible for driving Nortel's overall EMS strategy and awarding business to manufacturing providers.

"ODMs are competing more with the traditional EMS business. Typically we use them when we need some real hard-core design expertise in some specific technology areas," he says.

ODMs are very competitive on cost. "They are aggressive in initial cost, but also on ongoing cost reduction," says Stearns.

Stearns says Nortel will sometimes use them for intellectual property that Nortel may need for some of its products. "However, we use them more for their design services and getting cost reduced at the low-end of the market with some of our enterprise products where cost is very important to us," says Stearns.

He says ODMs are more cost competitive than EMS providers because ODMs are typically located in Taiwan or southern China and they take much more advantage of the local marketplace.

Nortel will stipulate which chipsets are to be used by its ODMs. However, the ODMs use local suppliers for other materials such as mechanicals, cables and some semiconductors and get a lower cost, according to Stearns.

He says in some cases, ODMs are becoming more EMS-like. "They are starting to come into the traditional EMS space bidding on products and winning," he says.

Greater use of ODMs is one way Nortel has modified its EMS strategy. Another way is that while it will continue to outsource virtually all of its manufacturing, Nortel will make sure it is the last stop before one of its products is shipped to a customer.

"We have customer operations centers where Nortel is the last touch to our customer," says Sterns. "We need to maintain that direct link to customer."

The centers "marshal" products for a customer, he says. A customer may order enterprise equipment that may include three products from Nortel's optical and wireless businesses.

"Customers don't want three different shipments showing up over the course of a week," says Stearns. They want it all showing up as one shipment from Nortel.