Make or Buy Decision - Offshoring

Make or Buy Consumer
Electronics Case Study: PhoneCo

Franco Monti,
Deloitte Consulting, Zrich

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
A
c
t
i
v
i
t
i
e
s

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
A
p
p
r
o
a
c
h

E
n
d

p
r
o
d
u
c
t
s

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
arrange-
ments
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 NOPs)
- successful Far East companies:
DBTEL (established, reliable products),
Binatone (simply does the business)
Vtech (concentration on huge markets/NOPs)
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 lsst sich kinderleicht
anschlieen und liegt besonders gut
in der Hand.
Das einzigartige Styling besticht. Die
beeindruckende Farbpalette verblfft. Und
der unglaubliche Funktionsumfang
berrascht immer wieder.
Produktfunktionen & Vorteile...
Design, vllig anders als bei herkmmlichen
Schurlostelefonen...
2 Telefonbcher fr 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
PCBs
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
PCBs
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
PCBs
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
PCBs
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
PCBs
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
C
o
m
m
i
t
m
e
n
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 100000 pieces.
Order incl. over-delivery

Make or Buy Decision - Offshoring

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Electronics Case Study: PhoneCo

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