Pacific Systems Corporation Case

Questions:

1. What is your recommended sourcing strategy in this case? Please support your
decision with quantitative and qualitative evidence gathered during the case
analysis. Also, present your plan to reduce any risks associated with your sourcing
decision.

2. This case provided the data necessary to perform a cursory supplier financial
analysis. In reality, cross-functional sourcing teams must often obtain this data
during their assessment of potential suppliers. Discuss possible sources of supplier
financial information. What may impact a purchaser's ability to obtain supplier
financial data?

3. A sourcing decision of the magnitude highlighted in this case requires a serious

commitment of resources and time. Do all sourcing decisions require similar
commitments of time and effort? If not, describe the types of sourcing decisions
that justify this effort. Describe the types of sourcing decisions that do not justify or
require the level of effort and analysis required in this case.

4. How important is the issue of supplier capacity in this case? How did your group
evaluate supplier capacity? What level of attention or importance should supplier
capacity receive during the sourcing decision? Why?

5. Supplier selection decisions, such as the one presented in this case, usually require
many weeks or months of analysis and discussion before reaching final agreement
with a supplier(s). Creatively identify ways that the buying company can shorten the
time from recognition of a purchase need to reaching agreement with the selected
supplier. (Hint: Consider performing certain required activities concurrently or in
anticipation of a purchase requirement).

6. The issue of single versus multiple sourcing is an important consideration during

supplier selection. Using the following table, identify the potential advantages and
disadvantages of single and multiple sourcing (not only as they relate to this case).

OVERVIEW

Pacific Systems Corporation, Inc. (PSC) is a medium-sized high technology company located
north of San Francisco. In its early years PSC produced component parts and subsystems for
personal computers and engineering workstations. In 2000, PSC added its own line of
engineering workstations to its product offering. Recently, the company decided to expand its
product line to include fully assembled personal computers (PCs). The company, recognized as
a well-established component and subsystem manufacturer, has grown from a single product
manufacturer with annual sales of $2.5 million, to a multi-product $3 billion firm in just ten years.
This growth was helped in part through acquisitions in server markets and related computer
industries. Pacific Systems Corporation has a strong reputation for manufacturing high quality
products with on-time customer delivery. The company also emphasizes state-of-the-art
technology in its product design, production, information, and delivery systems.
PSC’s decision to enter the personal computer market occurred during the peak of the Internet
boom in late 1999. In particular, the marketing department decided to focus on the home PC
user, to exploit the booming growth in home computer use. The projected growth rate of U.S.
PC shipments to the home sector in the 1990s exceeded the business sector, and was
predicted to surpass the business sector in total share of shipments.1 Although Pacific Systems
Corporation was a small player in this market the company decided to pursue an aggressive
strategy of selling high quality computers at affordable prices. The new line of computers,
called the 9000x series, would come with a Pentium 600 MHz microprocessor, 128 megabytes
of memory, 8-14 gigabytes of hard disk space, a read/write CD-ROM/DVD (digital video disc)
drive, and a 17-inch flat screen color monitor.

Although industry forecasts have certainly been downgraded, PCS is betting that in 2003 the
computer industry will grow at a slow but steady state as consumers upgrade their computers
with the predicted slow but steady growth in the economy. This decision poses some risks,
given that there is a “mixed bag” of opinions regarding the growth of the electronics sector in
2003. The decision was made to pursue the home computer user, through a strategy focused
on shipping low-cost, high-quality computers directly to customers as orders are received
(make-to-order). This production model is similar to the Dell approach, and appears to be the
model that will dominate the PC industry. Because the company does not plan to build finished
PCs (i.e., make-to-stock) in anticipation of future sales, market demand forecasts, supplier
quality, supplier capacity, lead time, and delivery reliability are critical factors. The company is
willing to carry some units in component inventory as safety stock as a buffer against missing
customer order commitments.

Pacific Systems Corporation will assemble the computers in its own facilities, but intends to
outsource many of the key product components and subassemblies, including the DVD drive, a
feature that will be standard on each PCS computer. The decision to outsource the DVD drive
resulted from an executive-level insourcing/outsourcing study that concluded the cost to
manufacture these drives in-house was highly prohibitive. The product requires production
capabilities that are beyond PCS’s current expertise. Marketing estimates that first year
demand for the new PC, and therefore the DVD drives, would be approximately 500,000 units,
with a 20% growth expected for year two. Expected pricing for the computers will be under
$1000. DVD demand depends totally on final product demand, which can be volatile.

1 "Home Computers", Business Week, November 28, 1994, pp. 89-96.

Exhibit 1 details the monthly sales forecast for the 9000x series. However, given the volatility of
the computer market and PSC's limited experience with marketing directly to end users,
marketing estimates, with 95% confidence, that actual demand will likely be between 400,000
and 600,000 units. As with most high technology companies, adequate supplier capacity is a
critical issue. Taking a lesson from the demands placed on it by its current customers, Pacific
Systems Corporation will seek some assurance from its suppliers that they can increase the
supply of components by 25% within four weeks notice of changing market conditions. Supplier
responsiveness and ability to satisfy Pacific Systems Corporation’s volume requirements will be
critical.

DVD Market Information

PCS recognizes that DVD demand is growing rapidly, although actual numbers are difficult to
obtain. One of the challenges PCS faces, and perhaps a major reason why PCS may want to
quickly “lock in” supplier capacity, is that other industries use the same DVD drives as are used
in personal computers. In particular, producers of home theater systems (for digitally recorded
movies and music) are moving aggressively in the DVD supply market. There has also been
several controversies, regarding lawsuits on illegal copying of DVD’s (see Article appendix).
Another risk is the potential for quality problems on new electronic components (see Article
applendix). Another consider is the growth of the consumer electronics DVD industry:

Report Name: Consumer Platforms - Q1 2002: DVD Players and Recorders: Seizing a Spot in Every Home
Entertainment System
Company: iSuppli Corporation
Description: DVD players have become the hottest consumer electronics product in the market. With prices of
DVD players hitting sub $100 price points, OEMs are looking to add new features to DVD players to enable them to
increase their average selling prices and consequently their profit margins. This report looks at the DVD recorder
market and the various standards and presents a forecast and strategies for specific companies attempting to
participate in this marketplace...

IN sum, PCS must share their market with the growing home DVD system, and assess their
relative leverage in the market given other market demands for DVD’s.

Exhibit 1
Two - Year 9000x Demand Forecast

August 2003 55,000 units August 2004 66,000 units

September 2003 50,000 units September 2004 60,000 units
October 2003 40,000 units October 2004 48,000 units
November 2003 40,000 units November 2004 48,000 units
December 2003 45,000 units December 2004 54,000 units
January 2004 35,000 units January 2005 42,000 units
February 2004 35,000 units February 2005 42,000 units
March 2004 40,000 units March 2005 48,000 units
April 2004 40,000 units April 2005 48,000 units
May 2004 40,000 units May 2005 48,000 units
June 2004 40,000 units June 2005 48,000 units
July 2004 40,000 units July 2005 48,000 units

Pacific Systems Corporation is targeting the price of its PC line from $900 - $1100, depending
on the model and configuration. This means that the DVD’s unit price would need to be in the
$125 – 150 range. This is not unreasonable given current market pricing (see Appendix).
However, the market for DVD’s extends well beyond the computer industry, and is not without
its share of uncertainty and disruptions (see Appendix).
Another key consideration in the supplier selection decision is that Pacific Systems Corporation
expects to control the transportation link from the supplier(s) to its facility in California. The
company has decided to assume responsibility for transportation, but not ownership of
inventory, from the supplier's facility. The company plans to support its inbound logistics with
carriers that offer corporate-negotiated rate discounts.

While early personal computers were notorious for quality-related problems, today's customers
demand defect-free products. With intense price competition and narrow profit margins, a
single product defect, particularly when the PC is in the customers' hands, can "wipe out" any
profit from the sale. Poor quality will also adversely affect market reputation and future sales.
Although exact numbers are difficult to obtain, financial analysts at Pacific Systems Corporation
calculate, based on experience and assumptions, that each with a defect will result, on average,
in $300 in non-conformance costs that Pacific Systems Corporation must bear (including lost
customer goodwill).

The company plans to introduce the new line of computers directly to the marketplace in August
2003. It must have inventory by June to begin process proving and pilot production. The
August date coincides with back-to-school sales, which is the busiest time of year for PC
makers. It is now early January 2003.

Pacific Systems Corporation relies on cross-functional commodity teams to develop sourcing

strategies for key purchased items. Executive management views the DVD supplier selection
decision as a critical part of the 9000x series development. The commodity team has spent the
last several weeks visiting four DVD suppliers, and is currently evaluating various supply
options. The team expects to begin negotiation with one or more suppliers within the next
several weeks. Information regarding the suppliers under consideration is presented in the
following section.

THE SUPPLY ALTERNATIVES

The team developed a market analysis of DVD drive manufacturers, and narrowed their search
to four specific suppliers. These four suppliers were selected as final contenders based on: a)
cost competitiveness given Pacific Systems Corporation initial target cost, and/or b) location
proximity to PCS’s assembly sites. The team was somewhat divided, as some members felt
that PCS should globalize its sourcing initiatives, while others felt that local suppliers would be a
better choice in terms of working arrangements. Engineering supported the commodity team's
preliminary efforts by purchasing off-the-shelf DVD’s for testing. This helped determine if the
suppliers had a product that initially satisfied PSC’s expectations. Relying on product samples,
while providing preliminary insight into the capability and technology of each supplier, was not
sufficient to support a final supplier selection decision. Hence, the need for direct visits by the
commodity team became apparent.

The team decided to visit four suppliers directly to collect detailed information. The visits ranged
from one to two days each, with all four visits completed within a three-week period. These
visits were time-consuming and exhausting, particularly since two suppliers were located in
Asia. Unfortunately, Pacific Systems Corporation does not have an International Purchasing
Office (IPO) to support its international procurement activities. Furthermore, no one on the team
spoke Korean or Japanese. Fortunately, the other two suppliers, located in the U.S., were much
easier to visit. In fact, one supplier was located only ten miles from the PCS assembly facility.
The following sections summarize data collected during the commodity team's visits to the four
suppliers.
Elecom Technologies

Elecom Technologies, located in Nagasaki, Japan, was the largest supplier the team visited
(sales of $6.5 billion). The plant covered ten acres, with a wide variety of computer and
electronic components produced in the facility. DVD drives represent a large segment of
Elecom’s production (Elecom commits 50% of total capacity to DVD drive production and
derives 60% of its revenues from DVD drives). Because of its size, however, the company
seemed most interested in large contracts ($150 million or more annually). Elecom currently
controls approximately 30% market share of global DVD sales. Geographic distance from
California, along with the need to accommodate the needs of some large customers, made
Elecom’s quoted lead time the longest of the four suppliers being evaluated.

The highest-ranking manager that met with the PCS team was a sales manager, who took the
team to visit various departments. The division vice-president and plant manager were in
conference with a large DVD customer, who the PSC team found out had formed a strategic
supply alliance with Elecom. The PSC commodity team felt a bit "snubbed" at the facility,
particularly the group's female members. The facility was efficient, spotless, and modern.

When the team visited engineering, they spoke with a manager in DVD design. The engineer
estimated, based on previous experience, that the ramp-up time to begin production that would
satisfy PSC's specifications would be about 4 months. Furthermore, tooling costs would likely
be $3 million.

The sales manager was particularly proud of Elecom’s new Internet-based electronic data
interchange (EDI) system. This system allowed direct communication with customers. He was
also proud that Elecom Technologies was "the price leader" for the industry, and was producing
DVD drives for several of the major brand name PC companies. He also talked about the
company's extensive investment in research and development. When the sales manager heard
that the DVD order, based on 500,000 units in year one, would likely not exceed $75 million per
year, he hesitated, saying that he would need to discuss the order with management.
Moreover, he indicated that the company typically was not interested in orders of less than $150
million per annum, but that exceptions might be possible. The economics associated with large
orders is what made Elecom a low-cost producer. Relevant Elecom Technologies data include:

 Quoted price = $127 per unit (quoted at 120 yen to $1 U.S.)

 Delivery lead time = 8 weeks
 On-time delivery record = 95% on-time (for large customers)
 Quality = 9,500 PPM defects
 Transportation costs from Asia to Pacific Systems Corporation = $18 per unit
 Current installed capacity for DVD production2 = 98%
 Duties and customs = $9.50 per unit
 Insurance = $2.00 per unit
 Frequency of shipment = Monthly
 Tooling costs = $3 million
 Ordering, inbound receiving, and quality inspection costs = $4.50 per unit
 Ramp-up time = 4 months

2 Note: Current installed capacity indicates that portion of the supplier’s DVD production capacity
that is currently utilized. For example, if current installed capacity is 98%, then this supplier is
utilizing 98% of its production capacity and therefore has 2% of its capacity available for new
business.
 Denomination of contract = Yen

There exist some country-specific risks associated with sourcing in Japan. The WorldFactBook
2002 notes that “developing trends presage more divergence between the United States and
key East Asian countries and more difficulties for US policy and interests. . . . Greater friction
will also arise as a result on an expected downturn in the US economy, anticipated difficulties in
US-China relations, and greater debate between the United States and Japanese and South
Korean allies over military bases, host nation support, and other alliance arrangements. . . East
Asian policies toward the United States will be driven strongly by the uncertain regional security
environment, the nascent revival of regional economies after the Asian economic crisi, and
trends in international politics and norms that affect East Asian authoritarian and democratic
governments differently but underline strong regional nationalistic pride and assertiveness.” 3

SureTech Company

A second candidate for the contract is SureTech Company, a small manufacturer located in
Colorado Springs, Colorado. The company focuses exclusively on the design and production of
PC disk drives including floppy disk, CD-Rom, and DVD drives. The team discovered this
company almost by accident. A team member was browsing a trade journal and saw
SureTech’s advertisement. When the team visited the facility, the team was surprised at its
small size and by the fact that it is located in an old warehouse. SureTech’s president met with
the team in person. He explained that he was a graduate of Stanford in electrical engineering
and had decided to start his own company after working for IBM for 15 years. The company
entered the disk drive market four years ago and has produced DVD drives for just over a year.
During this time, however, SureTech has established a reputation for delivery reliability and
innovation. The president explained that SureTech’s success was based largely on its
commitment to develop new technology, especially technology that enhanced product reliablity.
He also claimed that he knew every customer personally. PC Week had praised the company’s
products in several recent editions. However, the company was definitely a small growing entity
(with less than 4% of global market share), but they expressed their intent to focus more on the
PC industry as opposed to the home consumer DVD industry.

Everyone in the plant seemed highly motivated, and, except for the president, the team did not
see any person who appeared over the age of 35. The president was particularly excited about
the possibility of working with Pacific Systems Corporation, and promised to work with them
closely on this contract and for any new product lines. In particular, he emphasized that DVD
technology was improving for laptop computers, and that the laptop market was another sector
that would continue to expand in the future. Ramp-up time for the new DVD drive would be
approximately 5 months.

When asked if his firm would have any problem in meeting demand should they receive the
contract, he hesitated before answering. He admitted that this contract would be the largest in
SureTech’s relatively short history. He also indicated that several other buying teams were also
going to be sending teams to evaluate SureTech within the next week. However, he assured
the team that he would do whatever it took to maintain reliable delivery schedules if SureTech
received the contract. Interestingly, it appeared that the production lines were experiencing
some problems during the team's visit, as they were shut down for nearly four hours! Relevant
SureTech data include:

 Quoted price = $144

 Delivery lead time = 3 weeks

3 The World Factbook, 2002, (http://www.odci.gov/cia/publications/factbook).

 On-time delivery record = 97% on-time
 Quality = 10,500 PPM defects
 Transportation costs from SureTech Company to Pacific Systems Corporation = $6.00 per
unit
 Current installed capacity for DVD production = 92%
 Duties and customs = $0.00 per unit
 Insurance = $1.50 per unit
 Frequency of shipment = weekly
 Tooling costs = $3.5 million
 Ordering, inbound receiving, and quality inspection costs = $4.00 per unit
 Ramp-up time = 5 months
 Denomination of contract = Dollars

E-Drive Systems

The third supplier, a fairly large and reputable manufacturer of computer equipment, including
DVD drives, was located less than ten miles from PSC's facilities. About half the company’s $2
billion sales came from the sale of DVD drives. In fact, the firm was the second largest
producer of these drives worldwide (with 20% market share). In addition, the plant manager
pointed out that the company has committed significant resources to setting up a JIT production
system for the DVD drive line. Indeed, the PSC team was impressed with the performance of
the kanban signals and flow-through workstations. The plant manager also emphasized that
because of their close proximity to Pacific Systems Corporation, they would have no problem
delivering the product in two-day lot sizes, "just-in-time," to PSC's facilities. The manager was
able to show the team reports that backed this claim. E-Drive Systems also had a solid
reputation within the industry for working with its customers on future product development.

Upon visiting the quality department, the quality manager seemed particularly preoccupied and
"on edge." When the plant manager left for a few minutes to answer a phone call, the group
asked the quality manager if the company had experienced any significant problems recently.
He confessed that the last shipment of drives had several quality problems, and the number of
returns from large distributors had increased dramatically. This was creating some fairly severe
disruptions to production scheduling and delivery. The most serious problem was an annoying
"clicking" sound made by the drive as it engaged the disk. However, he assured the PSC team
that the design engineers were working full-time on the problem and that it would be solved well
before PSC placed an order. When the plant manager returned, the quality manager made no
further mention of the problem. The plant manager estimated that the ramp-up time for the first
shipment would be very short, approximately 3 months. Relevant E-Drive Systems data
include:

 Quoted price = $140

 Delivery lead time = 2 weeks
 On-time delivery record = 99.5%
 Quality = 7,500 PPM defects
 Transportation costs from E-Drive Systems to Pacific Systems Corporation = $14 per unit
(due to frequent deliveries of small quantities)
 Current installed capacity for DVD production = 96%
 Duties and customs = $0.00 per unit
 Insurance = $3.00 per unit
 Frequency of shipment = Every other day
 Tooling costs = $3.25 million
 Ordering, inbound receiving, and quality inspection costs = $3.25 per unit
 Ramp-up time = 4 months
 Denomination of contract = Dollars

Park Technologies

The fourth supplier, Park Technologies, is a Korean company with 12% of global market share
in DVD sales. Park provided the second lowest bid at $132 per unit. During the team's visit the
plant manager claimed that capacity was not an issue, and that the company would be willing to
commit the required production capacity to the Pacific Systems Corporation contract. DVD
drives accounted for about half of Park's $1.3 billion in 2002 sales.

The commodity team felt much more comfortable at Park Technologies than at Elecom. While
this supplier has minimal experience doing business with North American firms, the company
seemed quite anxious for the contract. The company has several large Taiwanese and
Japanese PC makers as customers. At this time Park Technologies has no U.S. facilities or
support staff. The team had some concerns about becoming Park's first major North American
customer.

The company's product was excellent. Every DVD drive went through an extensive testing
procedure that assured few problems would occur. In fact, Park's process control and testing
were more thorough than any other supplier the team visited. However, the combination of the
testing process and geographic distance meant that delivery cycle times were much longer, up
to 10 weeks per order, although the on-time delivery performance for the facility was excellent.
The team was not sure if current Asian delivery performance would be indicative of delivery
performance to the U.S. The facility appeared well maintained, clean, and orderly. The team
noticed that the DVD drive facility was extremely busy and wondered if the plant manager's
claim about adequate capacity was accurate. All employees worked closely together in work
cells and knew each other by name. Industry experts viewed Park as one of the most promising
and dynamic companies in the industry. The ramp-up time for the delivery of the first shipment
was quoted as 4 months. Relevant Park Technologies data include:

 Quoted price = $132

 Delivery lead time = 10 weeks
 On-time delivery record = 99.0%
 Quality = 4,000 PPM defects
 Transportation costs from Park Technologies to Pacific Systems Corporation = $18 per unit
 Current installed capacity for DVD production = 92%
 Duties and customs = $9.50 per unit
 Insurance = $3.50 per unit
 Frequency of shipment = Monthly
 Tooling costs = $2.75 million
 Ordering, inbound receiving and quality inspection costs = $2.25 per unit
 Ramp-up time = 4 months
 Denomination of contract = Dollars

As noted earlier, regional instabilities, particularly with North Korea, pose a threat to US
interests in the area. The The World Factbook 2002 notes that “China will work against
US efforts to strengthen its position in the region. Notably, Beijing will press against and
challenge US support for Taiwan, US efforts to build missile defenses in the region, and
US efforts to strengthen the alliance with Japan.. . . Japan and South Korea strongly
support their respective alliances with the United States and are currently cooperating
closely with Washington in trilateral efforts to deal with North Korea. Yet, like many
other US allies, both Tokyo and Seoul chafe over the asymmetry in their alliance
relationship with the US superpower. They seek adjustments in the US military presence
that would accommodate their nationalistic or local concerns.”
SUPPLIER FINANCIAL DATA

The team also gathered financial data for each supplier. While the team believes the data for
the U.S. suppliers to be reliable, several assumptions and estimates had to be made regarding
the Asian suppliers. The team had to convert Japanese and Korean currency into dollars. In
some cases, the desired figures were not available, or the supplier showed no interest in
providing the team with the requested information. In particular, this was an issue with Elecom
Technologies. Exhibits 2 and 3 summarize selected supplier financial data.

Exhibit 2
Selected Supplier Balance Sheet Data (U.S. $ in millions)
For Period Ending December 31, 2002

Elecom SureTech E-Drive Park

ASSETS

Cash $95.9 $35 $85 $54.3

Marketable securities $122.5 $9 $105 $27.7

Accounts receivable $889 $45 $380 $174.5

Inventories $1057.7 $75 $165 $135.4

Total current assets $2,165.1 $164 $735 $391.9

Investments at equity $738.4 $21 $70 $95

Goodwill $300 $40 $145 $80.4

Total investments and other $1,038.4 $61 $215 $175.4

assets

Property, plant, and $1,734.5 $125 $450 $412.5

equipment

TOTAL ASSETS $4,938 $350 $1,400 $979.8

LIABILITIES AND
SHAREHOLDERS' EQUITY

Notes payable $525.5 $11 $48 $35

Accounts payable $525.9 $75 $225 $125

Taxes due on income $245 $23 $70 $48

Accrued payroll and $484.2 $13.5 $202 $139

employee benefits

Total current liabilities $1,780.6 $122.5 $545 $347

Long-term debt $1,243.5 $55 $241 $165

Shareholders' equity $1,913.9 $172.5 $614 $467.8

TOTAL LIABILITIES AND $4,938 $350 $1,400 $979.8

SHAREHOLDERS' EQUITY
 Exhibit 3
Statement of Income Data (U.S. $ in millions)
Year Ended December 31, 2002

Elecom SureTech E-Drive Park

Net sales $6,500 $550 $2,300 $1,355

Cost of goods sold $5,500 $407.5 $1,495 $948.5

Selling, general, and $475 $65 $570 $250

administrative expenses

Interest expense $300 $12 $65 $55

Costs and expenses $6,275 $484.5 $2,130 $1,253.5

Income before income taxes $225 $65.5 $170 $101.5

Estimated taxes on income $100 $28 $66.5 $55

NET INCOME $125 $37.5 $103.5 $46.5

ADDITIONAL INFORMATION AND ASSUMPTIONS

 Although Pacific Systems Corporation is buying a standard DVD drive, extra production
demands and a small level of design customization will result in additional tooling
requirements at each supplier.

 The company expects the 9000x series to have a two-year life cycle. The commodity team
will allocate all supplier-related production costs, such as tooling, on a per unit basis over a
two-year period. The company fully expects to introduce its next generation of personal
computers at the end of two years.

 The US dollar has shown signs of weakening in the last months of 2002. The outlook for the
US dollar is that it may further weaken against many of the Asian currencies in 2003. The
team has not done enough research in this area to determine the extent of this weakening.

 Pacific Systems Corporation plans to maintain some level of safety stock inventory for the
drives, at least for the first year. Due to long material pipelines, Pacific Systems Corporation
expects to maintain a one-month safety stock inventory if it utilizes Asian suppliers. For
domestic suppliers, the company expects to maintain an inventory equal to two weeks worth
of demand as safety stock.

 Inventory carrying costs, which include storage, handling, obsolescence, taxes, and cost of
capital, are 18% of the inventory's unit cost. The company assumes carrying costs for
safety stock material.
 Assume the unit price quoted by each supplier is what Pacific Systems Corporation would
pay for the drive from each supplier. Subsequent negotiations will likely alter the quoted
price.

 While tooling depreciation could be a cost consideration, this case does not consider
depreciation.

 While PSC takes an active role in coordinating inbound transportation shipments, company
policy states that PSC will not assume title to material until the material arrives at the
company’s receiving dock.

CASE REQUIREMENTS

The team realized this supplier selection decision, which was one of the most critical involving
the new product line, was also going to be difficult. Until the team analyzed the numbers and
discussed the findings from the field visits, it was clear that no consensus existed among team
members concerning which supplier(s) to select. To reach a decision, your group must do the
following:

1. Develop a process that provides a logical order evaluating the market data and reach a
recommendation regarding how to proceed with the supplier selection process. For
example, the first step of this process may include organizing the data in a logical formal.
Subsequent steps should follow from the organization of this data, and may also include
additional information that is needed to make an informed recommendation, as well as the
sources of information that may be available to do so. Present this process in the form of a
flow chart with key decision points clearly identified.

2. Perform various analyses designed to support the supplier evaluation and selection
decision. These analyses, with supporting worksheets or templates provided, include

 Financial Risk Analysis While this case assumes that the cross-functional team visited
four suppliers, organizations often perform a preliminary financial risk analysis to identify
the suppliers that may not warrant further consideration due to excessive financial risk.

 Total Cost Analysis Unit price rarely, if ever, equals the total cost of doing business
with a supplier. This analysis requires each group to identify relevant additional costs
beyond unit price. This involves considering a combination of actual and estimated
costs. Consider potential currency issues in your analysis.

 Supplier Evaluation and Selection Analysis As organizations continue to rely on

fewer suppliers, the supplier selection process takes on greater importance. The
Supplier Evaluation and Selection Analysis is a robust tool used during supplier
assessment.

 Sourcing Risk Management Plan Sourcing decisions invariably involve risk. This
analysis requires each group to (1) identify the potential risks associated with a sourcing
decision, (2) assess the possible magnitude of each risk to operations, and (3) identify
ways to manage or reduce risk exposure.

Single Sourcing: Single Sourcing: Multiple Sourcing: Multiple Sourcing:

 Potential Advantages Potential Potential Advantages Potential
Disadvantages Disadvantages

7. The issue of short versus long-term contracts is also an important consideration during
supplier selection. Using the following table, identify the potential advantages and
disadvantages of short and longer-term contracts (not only as they relate to this case).

Short-Term Short-Term Longer-Term Longer-Term

Contracts: Potential Contracts: Contracts: Potential Contracts: Potential
Advantages Potential Advantages Disadvantages
Disadvantages

8. Consider the following statement: Supplier evaluation and selection, which is really a
process of risk management, is one of the most important activities performed today. If
your group agrees with part or all of this statement, provide arguments and evidence as to
why your group agrees. If your group disagrees, provide arguments and evidence as to
why your group disagrees.

9. Instead of conducting supplier evaluations through formal assessment, some firms rely on
product samples as a means to validate supplier capability. What are the risks associated
with relying only on supplier samples when making a supplier selection decision? How can
a company minimize this risk?
Appendix 1: Supplier Financial Analysis

Purchasers assess supplier financial health for several reasons. The most important reason
involves managing supply base risk. The analysis may highlight difficulties that will interfere
with the smooth and timely flow of material. A supplier may be experiencing capacity constraint
problems, have difficulty meeting its payables, have too many receivables, have poor inventory
management as revealed by low inventory turns, or have cash flow problems as noted by
current liabilities exceeding current assets.

A supplier financial analysis is likely whenever a purchaser is attempting to reduce a pool of

potential supply sources. If a supplier does not meet certain thresholds as defined by the
purchaser, then the supplier will likely not move to the next level of consideration.

Financial ratios are a key part of a supplier financial analysis. Of course, the key to a supplier
financial analysis is a purchaser's ability to obtain reliable and complete financial data, which
can be a challenge when evaluating closely or privately held corporations.

Besides calculating and attempting to interpret the meaning of financial ratios, comparing ratio
data can provide even greater insight into a supplier's financial condition. While no correct
answers exist for financial ratios, a comparison of a supplier's ratios to published industry norms
can help identify if further financial analysis is necessary. An analyst should also compare
several years of supplier financial data, if available, to identify favorable or unfavorable trends.
Another comparison involves comparing a supplier's ratios with specific competitors, which is
likely when a purchaser has collected data from more than one supplier.
Supplier Financial Analysis

Please use the following template to calculate selected financial ratios for the four suppliers
being considered for the PC DVD contract.

Supplier Financial Analysis Worksheet

Selected Financial Ratios Elecom SureTech E-Drive Park

Asset Utilization:

Asset Turnover = Sales/Assets

Inventory Turnover = Cost of Sales/Average

Inventory

Receivable Days = Accounts Receivable/Sales X

360

Payable Days = Accounts Receivable/Sales X 360

Capitalization:

Leverage = Assets/Equity

Return on Equity = Net Income/Equity = Profit

Margin X ATO X Leverage

Long-term Debt to Equity = Long-term Debt/Equity

Long-term Debt to Assets = Long-term

Debt/Assets

Current Ratio = Current Assets/Current Liabilities

Quick Ratio = (Cash + Short-term Inventory +

Accounts Receivable)/ Current Liabilities

EBIT Coverage = Earnings Before Interest and

Taxes/Interest Expenses

Reinvestment Ratio = Capital

Investment/Depreciation

Profitability Ratios:

Contribution Margin = (Sales - Variable

Cost)/Sales

Operating Margin = (Contribution Margin - Base

Cost)/Sales

Profit Margin = Net Income/Sales

Note: Shareholders equity includes stock and retained earnings. This value is also referred to as Net Worth.

Conclusions and Interpretation:

Appendix 2: Total Cost Analysis

This template requires each group to quantify costs that are in addition to the quoted unit price.
Using cost information provided in the case for each supplier, calculate the estimated per unit
total cost from each supplier for year one.

Total Cost Analysis Worksheet--Year One

Cost Category Elecom SureTech E-Drive Park

Quoted Unit Price

Transportation

Tooling

Quality non-conformance costs

Duties/customs, insurance, and

tariffs

Inventory safety stock carrying

charges:

Ordering, inbound receiving and

inspection costs

Estimated Per Unit Total Cost

Conclusions and Comments:

Appendix 3: Supplier Evaluation and Selection Analysis

The development of a supplier evaluation and selection analysis follows a sequence of steps:

 Step One: Identify Key Supplier Evaluation Categories

Supplier evaluations must include those performance categories that are relevant to the
sourcing decision under consideration. Examples of supplier evaluation categories that a
team or individual may evaluate include (but are not limited to):

• Management and personnel capability • Cost competitiveness

• Information systems capability
• Process and technological capability
• Delivery performance
• Flexibility
• Previous history and performance
• Responsiveness to customer needs
• Quality performance
• Environmental compliance
• Longer-term partnership potential
• Volume capacity
• Supplier's supply management efforts
• Information system capability

While including the relevant performance categories is critical, each additional category
adds a greater degree of assessment complexity.

 Step Two: Weight Each Relevant Evaluation Category

The performance categories included within the analysis receive a weight proportional to
the relative importance of that category. With any combination of weights, the weights
must sum to 100%.

 Step Three: Identify and Weight Subcategories

Step 2 defines the broad performance categories included within the evaluation. This step
requires the user to identify performance subcategories, if they exist, within each broader
performance category. Each subcategory receives a weight, the total of which equals the
weight of the broader performance category. For example, assume that supplier quality
performance is 20% of the total score. Within that category, a team may create
subcategories related to process control systems (5%), total quality commitment (8%), and
parts per million defect performance (7%). Please note that the subcategories sum to 20%.

 Step Four: Define Scoring System for Categories and Subcategories

This step involves defining what each score means within a performance category. A
clearly defined scoring system takes criteria that may be subjective and develops a
quantified scale for measurement. The scoring metrics are reliable if different individuals
interpret and score similarly the same performance categories under review.

 Step Five: Evaluate Supplier Directly

This step requires that a review team or individual visit a supplier's facilities to assess
supplier performance capabilities. It is common for a reviewer to meet with a supplier
shortly after the initial evaluation to discuss findings, and to point out opportunities for
improvement. The visit may also help identify future supplier development opportunities.
 Step Six: Review Evaluation Results and Make Selection Decision

The primary output from this step is a recommendation concerning which supplier(s) should
receive a purchase contract. As with any tool, the outcome from this analysis is only as
good as the planning and effort put forth.

 Step Seven: Continuous Review of Supplier Performance

After supplier selection, a purchaser's emphasis must shift form initial evaluation to
evidence of continuous supplier performance improvement.

When developing an instrument to support supplier evaluation, keep in mind that effective
instruments have certain characteristics. Effective supplier evaluation instruments should be

 Comprehensive The evaluation considers all the performance categories or criteria

considered important to the selection decision.

 Objective Objectivity requires the use of a quantitative scoring system, such as a

weighted point scale, with the meaning of each value on the measurement scale clearly
defined. Objectivity requires the creation of quantitative scales to evaluate performance
items and categories, some of which may be inherently subjective.

 Reliable Reliability refers to the degree to which different individuals or groups

reviewing the same supplier performance category using the same measurement scales
would arrive at the same conclusion. Evaluated items and scales must be clearly
defined and unambiguous so users understand what each means.

 Flexible Flexibility means the user can modify the performance categories,
subcategories, and assigned weights depending on the sourcing decision. For example,
selecting a supplier to provide a key jet engine component may require a higher
emphasis or weight placed on quality compared with other performance categories. On
the other hand, an evaluation of a distributor that provides industry-standard items (with
well accepted quality standards) will likely emphasize performance categories such as
depth of inventory, cost, and delivery.

 Mathematically Straightforward The use of weights and points during the evaluation
should be simple enough so that those involved in the assessment (including suppliers)
understand the mechanics of the scoring and selection process.

Weighted-Point Supplier Evaluation Assignment

Using the GE Scorecard as a model, create and complete a scorecard for your each supplier
that your group can use as an evaluation tool. A sample of the GE scorecard is provided to
assist your group's effort in developing this tool.
Appendix 4: Sourcing Risk Management Plan

Please complete this exercise after the group has made its selection decision. For the selected
supplier, identify any concerns by Potential Concern Area and make note of your plan t reduce
the potential risk.

Sourcing Risk Management Plan

Supplier: __________________

Potential Concern Risk or Concern Risk Reduction Plan

Area

Management Capability

Delivery Performance

Quality Performance

Process Capability

Capacity

Cost

Technical Ability
Logistics

Financial Issues

Other Commercial Issues

Appendices:

DVD Industry Fights Back

Suing Web Sites that Distribute DVD Copying Program

L O S A N G E L E S, Dec. 28 — A DVD industry

group said today it has filed a lawsuit against
dozens of Web site operators for allegedly posting
a DVD copying program it says is illegal and
could destroy the fast-growing new format.
At the heart of the complaint is a program written by
a Norwegian programmer that foils the encryption that
prevents DVDs, or digital video disks, from being
copied.
The program has stirred up concern in Hollywood
because it can be used to make a perfect copy of a DVD
on a computer hard drive. The movie can then be sent
over the Internet or copied to a blank DVD.
“The wholesale copying and distribution of
copyrighted motion pictures destroys the motion picture
industry’s ability to protect its intellectual property and
destroys the market for the computer and consumer
electronics industries’ DVD-based products,” the lawsuit
said.

Likens the Program to Theft

The lawsuit charges the program constitutes theft of
proprietary technology and seeks to stop its
dissemination.
The suit was filed in state Superior Court in Santa
Clara County in California’s Silicon Valley on Monday
by the DVD Copy Control Association, formed by the
movie, computer and consumer electronics industries to
oversee licensing of DVD technology.
In postings on the Internet, defenders of the program
said no theft was involved because of an oversight by
software company Xing Technologies, now part of
RealNetworks Inc. that left a key to the DVD code
unprotected in its DVD player software for personal
computers.
“There’s a lot of issues that go into something like
this, like freedom of speech and all that, but those
freedoms are limited when you know what you are doing
is wrong and you’re hurting people,” said Ronald
Coolley, an independent intellectual property attorney
with law firm Arnold White & Durkee in Chicago.
Industry analysts have said widespread Internet piracy
of movies is unlikely because of their huge size—nearly
5 gigabytes, or about 7 times that of a compact disk. That
means a movie would take days to download over the
Internet using a regular dial-up connection.
Also, the machinery to record on blank DVDs is
expensive and the current capacity of blank disks for
consumer use is about half the size of studio releases.
“They have to make a statement,” said Claude Stern,
an intellectual property attorney with Fenwick & West.
“All those companies that have major amounts of content
can’t afford to have some moron hacker post something
because he thinks it’s cool.”

Sales Growing
DVD is a bright spot in the industry, with sales of
players expected to top 5 million units this year, more
than double last year’s number. An estimated 30 million
devices are expected to be in homes by 2003.
Although a legal warning from the industry prompted
the program’s author to pull it off his Web site, it was too
late to check its spread in the frictionless world of
cyberspace.
The complaint names 26 people in the United States,
several European countries and Australia, and 46 other
Web sites it said posted or linked to the program. It said
it could name up to 500 more defendants as their
identities came to light.
It seeks a temporary restraining order and permanent
injunctions against publishing the program on the
Internet or elsewhere, as well as recovering legal fees
and “other relief as is found just and proper.”
“Their unchecked illegal activities will chill future
technological innovation in the motion picture, consumer
electronics and computer industries and discourage other
industries from making their content available to the
public in new formats,” the filing said.
It said the program already had chilled the roll-out of
a new product, DVD audio, that had been slated for a
December launch but would now be delayed for at least
6 months while a new encryption system was worked
out.
Copyright 1999 Reuters. All rights reserved. This
material may not be published, broadcast, rewritten or
redistributed.

SEARCH ABCNEWS.com FOR MORE ON …

dvd SEEK

Making the right component decisions

By Chris Henry
EBN
(09/04/2002 12:45 PM EST)

As the economic downturn continues, companies are retooling and searching for the latest
operating methodologies to position themselves for the next upswing. In search of this Holy Grail,
they continue to look for the secrets to greater effectiveness in electronic product design and
efficiencies in manufacturing.

This voracious appetite for improvement has driven many to consider information databases.
Engineers who are able to learn about the manufacturing viability of an electronic component at
the same time learn its technical parameters will make better choices. With better device
selection comes accelerated design success, steady production, and market share gain.

There are a number of information databases available today. They range in size from a few
million devices (Aprisa) to nearly 20 million (i2's Aspect), (PartMiner CAPS iContent), and
(Ubiquidata from Arrow's Global Information Business). Some cover only semiconductors. One
focuses primarily on military-standard tested devices. And a few attempt to cover the electronic
component horizon, from semiconductors to passive and electromechanical devices.

Most provide the technical parametrics of the devices they support. One or two offer some level
of lifecycle calculation and information on how to contact a supplier. Another offers lifecycle,
breadth of use, lead time, product change notifications, and column resale pricing, along with the
technical parametrics. While some information database providers work to include recently
introduced devices, others built several years ago benefit from a large quantity of older obsolete
products.

As you can see, there are various sizes of information databases and varying amounts of
information within each. But even with all these options, the key question to ask is: How can you
ensure that the information you're using is really accurate?

It's all about measuring the quality and reliability of information. Providers that claim 90%
accuracy, or providers that can't provide a description of their quality programs, could likely cause
as much harm as good. It will take a reasonable effort to get engineering and material
management teams to begin referencing this database of choice. It will only take a few
disappointments for them to go back to their old ways.
Is 90% accuracy good enough? Well, let's calculate it. Assume four million devices, each with 25
parameters. That totals 100 million data elements. At a 90% accuracy level there are 10 million
accepted errors. That's right, 10 million! Even if you have a relatively limited AVL, you are likely to
bump into an error. And when you do, there is grief ahead. Designs are completed that don't
function at the prototype stage, possibly due to race conditions or functional inconsistencies.

Worse yet, you get quantities for the prototype build. Your product passes with flying colors. On
you go to the production floor only to find that a key component within your design is impossible
to get a steady supply of. Or, even worse: EOL. Now we can be talking $100,000 per day while
the production line sits waiting for you to redesign. Information quality is very important, and can
keep you out of the big boss' office.

Here are the items to look for as you select an accurate, high-quality information database:

1. Look for an information provider that has a formal quality assurance program established.
Does it have a quality assurance manager and team? Also, verify that this manager does not
report to the same organization that is building the data. This avoids any conflict of interest.

2. The quality program must be integrated within the data build and data maintenance processes.
This guarantees that quality is built into the database, not just tacked on afterward.

3. Within the quality process, what is the standard to which quality is being tested? Military
Standard 105E establishes a quality sampling program at an acceptable quality level of 99.95%.
That's the type of accuracy your team requires.

4. Finally, look for a provider that has a corrective action report process. This provides you with
the assurance that, should you experience a quality problem, your provider will find the root
cause and correct the problem throughout the existing database, and not generate the same
problem in the future.

Information database quality is critical. It takes a fair amount of personal equity to drive
acceptance and usage of an information database. Engineering departments will begin to use it
reluctantly, as it forces them to change their device discovery and education process. Momentum
will be gained over time.

However, it only takes a few quality problems, and then a lack of follow-up process by the
provider, to put you back to square one. Follow the four steps above to ensure that your company
gets the best possible information database experience.

Chris Henry is vice president and general manager for Global Information Business, an Arrow
Electronics Inc. unit in Melville, N.Y., focused on the creation and selling of information to the
electronics industry.

Tuesday, January 21, 2003 EBN

EBI inches ahead in December, but Leading Index heads Recent Headlines

other way
Bolaji Ojo NEC appoints new
president and vice
EBN
chairman
(01/06/2003 12:01 PM EST)
ASIC vendors tackle
SOC hurdles
Processor makers
eye security issues
Lattice debuts mixed-
signal PLDs
Distributors appoint
new executives
The EBN Electronics Buyers' Index (EBI) ticked upward in December, after
reaching a low in November not seen since late in 2001. The significance of the
movement was offset, however, by a decline in the EBI Leading Index, which
fell 5.4% from November, to 50.8.

The EBI crept to 36.8 last month from 36.2 in November, which was the lowest
level since December 2001. The index failed to surpass the September level of
39.3 or the October figure of 37.7, indicating that weak year-end business
conditions will likely persist into early 2003. November's modest improvement
was in keeping with a trend seen much of last year in which the EBI failed to
break 40.

Moreover, the drop in the EBI Leading Index, after posting sequential gains
since September, supports the opinion of industry executives that the outlook
for this year remains unsettled. The Leading Index precedes the EBI by about
six weeks.

Procurement professionals polled for the December EBI cited several

macroeconomic and political factors as causes for concern, including a dearth
of corporate spending, signs of slowing business in some Asian countries, the
continued possibility of war with Iraq, troubling revelations regarding the
resumption of North Korea's nuclear weapons program, and an oil strike in
Venezuala that is causing fuel prices to rise.

"Month to month, quarter to quarter, we continue to see a lack of capital

spending, which continues to hinder any kind of recovery in the electronics
industry," said a buyer at one major contract manufacturer.

Indeed, production fell in December to 36.4 from 39.5 in November, while

inventory levels climbed to 36.4 after dropping to 28.3 in the prior month. While
prices showed a four-month growth trend to 36 and export orders rose to 39.1
from 37.4 in November, new orders overall in December rose just half a point,
to 40.5

The outlook was not entirely gloomy, however, with a mixed bag of reactions
from the executives polled.

"The economy has not recovered sufficiently to bring us back to levels seen
two years ago; however, the outlook is brighter and improving daily," said one
procurement executive who works for a document management firm.

Pockets of strength also reside in the military/aerospace and industrial sectors,

where contract manufacturers in particular cited an improving business climate.

"All sales are on an upswing at this time," said one respondent to the EBI
survey, "and this is expected to continue through February 2003."