Forecasting methodology and supply chain management in new technology ventures

Forecasting methodology and supply chain management in new technology ventures Guido De Santis Sonetto Technologies www.sonettotech.com

Disclaimer The business case presented here was inspired by true events. However, every piece of information is directly available on internet, the rest is the writer personal interpretation of publicly known facts. Names, date and figures have been altered.

Table of content Objectives Key idea MCMC Business Case Proposed framework & toolbox Conclusions

Objectives Discuss how a new product/technology introduction affects commonly accepted approaches to business planning and decision making Propose an actionable framework and a set of tools to address the challenge

Introducing a new technology requires different approach to basic processes Process S&OP Make or Buy decisions On-going business Focus on sales forecast Focus on Cost/Financial performance New technology introduction Focus on different scenarios for product readiness Focus on flexibility/risk Supplier Selection Focus on balance between price/quality Focus on capability Purchase agreements structure Focus on price/volumes Focus on flexibility and technical support Should consider optimizing economic value over a broad range of scenarios

We will build cameras! We will build millions of cameras! confidently says George Burton, newly appointed president of MCMC in March 2011. MCMC (mems camera module corporation inc.) is a wholly owned subsidiary of IPLC (Intellectual Property Licensing Corporation) a cash rich company looking for growth opportunities. MCMC has developed a disrupting technology for Autofocus actuators to be used in smart phone cameras. MCMC will replace voice-coil actuators with MEMS based ones. The smart phone market is already close to 600M/unit per year and growing and the existing camera technology very mature. MCMC has a unique product, low power, high speed, high precision autofocus, however in the last two years has not been able to find any customer for his revolutionary component. Currently, voice coil actuators are sold by few ODM s that develop custom products for major hand-set companies. These ODM s are risk adverse and have no incentive to adopt a new component that is not requested by their end customers. Burton s strategy is to integrate vertically and produce a full camera module that will be cheaper and with superior performance that the existing ones.

The end product: Camera Module A cube of ~5x5x5mm Containing about 30+ components Camera 5 lenses that move to provide autofocus feature Very tight component and assembly tolerances The actuator moves the lens stack

MCMC technology Voice Coil Autofocus Actuator MEMS Autofocus Actuator Smaller, faster, cheaper, less power consumptions. Replacing a complex assembly of 15 parts with one component made of a single piece of silicon

our own factory! While the company has not shipped any product yet, it is engaged in promising discussions and demoing prototypes to several major Tier One customers, each of them could easily purchase 5M unit per month. These customers, among many other demands, want to see production capacity. to enter the market and scale rapidly we need to have a factory repeats George Burton to the board of directors. The IPLC M&A team is tasked to identify a target and close a transaction. After 6 months of negotiations, in April 2012 MCMC, announces the purchase of an ailing Camera Module business from a competitor in China. There are existing customers using the old technology, based on the volume projections, the facility will post single digit profit margin. The price paid is a fraction of the book value of all the assets, the facility has about 250 fully trained employees. The VP of Supply Chain is very excited the facility has extra capacity to support the production of 4M units/month of new MEMS based cameras at industry lowest costs. A very good deal that is the stepping stone for MCMC to enter a $10B market with a killer technology comments the president after the deal is closed.

MCMC supply chain (phase 1) MEMS Assembly Lens Assembly Camera Assembly Proprietary process performed at a subcon A Proprietary process performed at a own facility Standard process performed at a own facility Outsourced In House

The first troubles The forecast for the new factory in China turned out to be 30-40% too optimistic. The major customer, was down by 20% from previous year, the second largest was down by 90% being a laptop manufacturer. The first quarter the operation posted losses. After one quarter, the main customer demanded 10% discount, when MCMC refused to provide the discount the customer swiftly moved production to the 2 nd source, citing supply risk and MCMC lack of commitment to the current technology roadmap. The factory became effectively 90% idle. In the mean time, prospective customers for the flagship MEMS based product were expressing skepticism about MCMC readiness to produce in volumes. After finding some serious issue in the first set of engineering samples, all of the them abandoned the talks considering the technology not mature enough. After 9 months of losses MCMC fired Burton and the VP of supply Chain, closed the China facility and wrote off most of the assets.

Discussion: what went wrong and why? Process Key issues S&OP Misaligned Incentives: M&A, Sales Engineering not involved in the process Fake it till you make it mentality Ego: President did not want to change his mind Make or Buy decisions Focus on lowest production cost at forecasted volumes Looked at the industry with an adversarial view rather than as an ecosystem

Another opportunity In January 2013 IPLC hires Richard Gable, a veteran of the mobile phone industry, as new MCMC president. Richard asks the new VP of Supply Chain to find a company willing to build MCMC camera. Three months later, MCMC announces an agreement with LiteOn, one of the largest camera ODM in the world. LiteOn will act as EMS for MCMC early products in exchange of future access to the technology. In the mean time, MCMC had engaged with a large Chinese smart-phone maker that is eager to differentiate itself in the crowded Chinese market by adopting a new technology. Since the market had changed, MCMC needed to design a new camera: 8MegaPixel with a new lens set: very expensive and with very long development and qualification cycle. Luckily, engineering had already started working with a new lens vendor willing to quote low mass production price for the chance to expand its experience in the high-end optics market. With no time to spare, MCMC raced to build the new camera. After looking at first samples in May, the customer is ready to ramp a new phone platform in August 2013 with aggressive ramp volumes. It looks like MCMC has a new great opportunity to succeed in commercializing its revolutionary technology

MCMC supply chain (phase 2) MEMS Assembly Lens Assembly Camera Assembly Proprietary process performed at a subcon A Proprietary process performed at sub-con A Standard process performed at a best in class ODM facility EMS Model EMS/JDM model

More troubles In June 2013, MCMC is struggling to build cameras in spec. The lens design keeps changing to accommodate for downstream yield problems. The lens supplier is slow in implementing the changes and reach acceptable production yield and quality, they do not have experience with this level of precision. The agreement with the lens supplier had a very low mass production cost, but a very high sampling cost during product development. The continuous changes are prolonging the development cycle and the quantity of samples produced is very high and the costs are mounting. The same is happening at Subcontractor A. The unit cost for subcontractor A was based on a production process defined by MCMC R&D team and negotiated hard by supply chain. As the process steps change and the ramp is approaching Subcontractor A is charging very high fees for development builds, DOE s and added Quality Control. In July 2013 MCMC fails to deliver the first 5K pieces pre -production lot to the customer, that decides to exclude MCMC Camera from the BOM of its new phone. The next phone platform is planned for February 2014...

It s over In early January 2014 MCMC is ready to produce. Supply Chain and Engineering worked with one of the best lens company in the industry and, after much struggle and expenses, have built a new fantastic camera with MEMS technology. The Chinese customer has placed orders, qualified the product and is ready to accept shipments. Yields are improving rapidly and the selling is price very high. However, IPLC board of director, tired of continuous losses, delays and missed deadlines, decides to monetize the Intellectual Property by selling, stops all operations and shuts down MCMC completely.

Discussion: What went wrong and why? Process Key issues S&OP Ramp too aggressive from the beginning Did not manage well investors expectations Supplier Selection Did not select best vendors based on capabilities Purchase agreement model Purchase agreements focused on long term/steady state, not enough thoughts given to costs during a development cycle of uncertain length

Variability of prediction higher during technology development Technology TR 1 TR 2 TR 3 Product Proto EVT DVT PVT Readiness time probability during technology development T0 prediction Readiness time probability during product development T0 prediction Should consider very formal definition of PLC phases to agree on risk level

Volume forecast asymmetrically unstable Initial volumes as function of delay from planned T0 Volumes Sales forecast External forecast Operational target capacity T0 Time (Delay) The long tail of the technology readiness distribution tends to drive an estimate of early volumes that has a low probability of actually happening Volume elasticity vs. launch delay is typically high Typically there is a lot of pressure to project optimistic results Should consider decoupling external forecast vs. operational target capacity

Projected cost very elastic to changes and delays Initial costs as function of delay from planned T0 cost plan T0 Delay Should consider proactive approach to flatten the curve and minimize the cost over a broader outcome probability spectrum

Tools to reduce cost variability vs. changes Initially Overspec certain components Strong focus on Supplier CpK Negotiate a flat price/volume curve Cost Robustness Pre-negotiate change costs Over-spec certain Equipment capability Delay line integration/automation for cost reduction Understand technology risk areas to reduce impact of changes

New technology introduction lessons learnt Involve formally R&D in S&OP process Utilize formal PLC process to align stake holders on risk levels Consider decoupling financial forecast from operations forecast Choose leading suppliers more based on capabilities than cost Insert operations very early in the product development effort despite technical difficulties and R&D territorial response Over-spec around critical areas in a early phase to anticipate problems and mitigate issues Develop supply agreements that account for unforeseen changes and extended qualification period Adopting this approach requires cross functional support which is why S&OP and PLC are key tools

Common sense is not so common Voltaire Common sense is not so common because it is influenced by individual experiences and self interest Anonymous