Operations Management: A supply chain approach University of Zurich Institute of Strategy and Business Economics Services and Operationsmanagement
Overview 1. Operation Strategy: Origins and New Directions 2. Determining Organizational Boundaries: Vertical Integration and Outsourcing 3. Designing and Managing Operating Networks 4. Creating an Edge through New Process Development 5. Sharpening the Edge: Driving Operations Improvement 3/12/2010 / 2
1. Introduction One of the most fundamental strategic decisions every company faces is which activities should be conducted in-house and which should be outsourced. Relevant questions to ask are: Under what conditions should an organization vertically integrate? Under what conditions should it outsource? 3/12/2010 / 3
2. Trends and Evidence Historically many industries were characterized by a high degree of vertical integration. Nowadays, clear trend toward outsourcing and vertical disintegration. Some regard these trends as clear indication of the superiority of extensive outsourcing and of focusing on a more narrow set of core competences. Reasoning: Vertical integration is too costly, inflexible, and distracting from companies competing in fast-paced environments. Manufacturing is often cited as a nonstrategic activity that can and should be outsourced. 3/12/2010 / 4
2. Trends and Evidence Example: Japanese automobile manufactures less vertically integrated than their American and European competitors. Suppliers take on greater responsibilities for the design and development of components and subsystems. Advantages and disadvantages of outsourcing:. 3/12/2010 / 5
3. Framing vertical integration and sourcing decisions Common terms of vertical integration are make or buy Within this approach, each component part or service is analyzed Decisions are based on costs and risks Critical strategic issues, that could not be measured purely in terms of production and delivery costs, were often not taken into account. 3/12/2010 / 6
3. Framing vertical integration and sourcing decisions Value Chain Analysis activity-based approach, which divides a firm into a set of major activities which create value. Vertical integration decisions are not viewed in terms of make or buy but in terms of the underlying set of activities to undertake internally. The purpose is to get a picture of the total system costs, and the implications that make decisions have on those costs. 3/12/2010 / 7
3. Framing vertical integration and sourcing decisions The value chain analysis takes into account that the same set of activities might support multiple products. that outsourcing one product can have cost implications for others that share resources. The value chain analysis considers the cost impact of linkages across products, as well as across activities in the value chain when making vertical integration decisions. 3/12/2010 / 8
3. Framing vertical integration and sourcing decisions Value chain analysis is limited by the fact that it is concerned almost exclusively with the configuration of activities that minimizes cost, given a firm s overall competitive strategy. as it provides little guidance about where specific activities ought to take place (inside or outside the firm). as vertical integration decisions are essentially decisions about ownership, but activities are not owned in any meaningful sense (owned are the underlying assets, resources etc.) 3/12/2010 / 9
3. Framing vertical integration and sourcing decisions Therefore, the most appropriate unit of analysis for vertical integration and outsourcing decisions are resources and capabilities. It also implies that a decision to outsource an activity is also a decision to enable a supplier or partner to invest in an own certain set of underlying asset (e.g. intellectual property). An asset-based approach to vertical integration is particularly relevant today, given the increasingly important role of intellectual property, know-how, information, reputation, and other intangible assets in achieving competitive advantage. 3/12/2010 / 10
3.1. What are the Choices? Vertical integration involves ownership of the assets Outsourcing involves some type of contractual relationship with another entity that owns the asset In reality, there is a continuum of governance structure and contractual arrangements into which firms can enter to gain access to assets. Vertical integration Virtual integration Strategic alliances Arms-length 100 percent Joint venture/ Long-term Short-term Ownership equity partner relationship contact 3/12/2010 / 11
3.1. What are the Choices? How do relationships differ along this continuum? Full ownership clearly provides some degree of freedom in terms of control. Ownership has legal implications in terms of the organization s ability to lay claim to certain physical and intangible properties, such as trademarks, patents and copyrights. Arms-length relationship do not involve ownership of assets. The mechanism of control, aside from legal action to enforce the contact, is that failing to perform as expected may result in losing future business. 3/12/2010 / 12
3.1. What are the Choices? Virtual integration encompasses many of the best features of both markets and vertical integration due to a higher degree of coordination and information exchange while avoiding organizational costs. However, it is not universally superior to those alternative arrangements. One of the challenges of assessing vertical integration strategies is that they are rarely all or nothing decisions. A company may be vertically integrated into certain assets, manage others through joint ventures and alliances and utilize arms-length market exchanges for others. Most companies vertical integration strategies operate at a fine level of granularity. 3/12/2010 / 13
4. Factors influencing vertical integration decisions Deciding among vertical integration, virtual integration or a more armslength relation requires consideration of four sets of factors: 1.Capabilities/ Resources The need to assess its resource constraints and the limits of its organizational and operating capabilities. Vertical integration is not always feasible (e.g. start-up companies). Capability limits play an important role as no company can do all things well. The time required to build or acquire a certain set of capabilities can impose a hard constraint on a company s vertical integration strategy. 3/12/2010 / 14
4. Factors influencing vertical integration decisions 2. Coordination Requirements (1/3) In designing a vertical integration strategy the objective is to choose the governance structure that best addresses the specific types of coordination that need to be provided. Coordination requires information exchange. Information exchange is efficient if it can be codified and interpreted in a relatively unambiguous way. Information is often not easy to capture in codified format, or to interpret properly, because it is idiosyncratic and tacit (e.g. the interface between R&D and manufacturing). 3/12/2010 / 15
4. Factors influencing vertical integration decisions 2. Coordination Requirements (2/3) Two examples of an R&D and manufacturing interface: Biotechnology company: transferring the process from the lab to the plant requires R&D personnel to go to the plant, to set up the process and supervise initial test batches. Process problems encountered at large scale may require changes to the process, the production environment or both. Printed circuit boards: Design information can be rapidly transferred to subcontractors. Details of the production process are not critical to the design of the board. 3/12/2010 / 16
4. Factors influencing vertical integration decisions 2. Coordination Requirements (3/3) All these factors explain why many companies that sought to reduce costs by outsourcing have not received the benefits they expected. By integrating vertically a company can create specialized organizational processes and structures that facilitate coordination and information exchange. facilitate the kind of learning that occurs through repeated interactions between particular groups or functions. Such learning will be most valuable when the critical knowledge lies at the interfaces of functions and technologies. 3/12/2010 / 17
4. Factors influencing vertical integration decisions 3. Strategic Control and Risks Creating a highly efficient supply chain does not guarantee that your company will extract any additional profits.. Outsourcing major subassemblies, such as printed circuit boards and even final assembly, has often been an efficiency-enhancing strategy. One of the implications of the term strategic control is that supply chains need to be designed not just to create value, but to capture that value as well. Vertical integration also is warranted when one seeks to avoid Lock-in from specialized contracts, partnerships or assets. Physical assets or intangible assets. 3/12/2010 / 18
4. Factors influencing vertical integration decisions 4. Protecting Intellectual Property (1/2) Intellectual capital can make a dramatic difference in a company s performance over time. Vertical Integration and outsourcing strategies play an important role in a company s approach to protect its intellectual capital. If the intellectual property can be readily identified and protected contractually, collaborative arrangements and outsourcing present no particular risks of leakage. If the intellectual property is less protected or easier to copy, then organizations must be careful when entering into collaborative relations that require such knowledge to be revealed. 3/12/2010 / 19
4. Factors influencing vertical integration decisions 4. Protecting Intellectual Property (2/2) As a result, companies often prefer to rely on laws relating to Trade Secrets to protect such knowledge. Trade-secret law does protect leakage, but generally is not as strong as patent protection. If the knowledge concerns an operating process, subsequent infringement might be quite difficult to detect as the process is hidden behind corporate walls. Another issue concerns the degree to which parties can identify and delineate boundaries around who owns what ahead of time. 3/12/2010 / 20
5. Managing Disintegrated Supply Chains: An Example Powertrain Cooling Engine Cooling Modules Radiators Condensers Charge-Air-Coolers Passenger Thermal Management (HVAC-Heating, Ventilating and Air-Conditioning) HVAC Modules (Underdash) Center Stack HVAC Module Evaporators Heater Cores. 3/12/2010 / 21
5. Managing Disintegrated Supply Chains: Supply Chain Collaboration Key Facts: Number of key suppliers: 25 Area: Europe Supply frequency: from multiple times per day to monthly 3/12/2010 / 22
5. Managing Disintegrated Supply Chains: Supplier Distribution 3/12/2010 / 23
5. Managing Disintegrated Supply Chains: Supply Chain Collaboration- Tools Logistics Quality Variation-Management Daily Delay monitoring for each product Analysis of PPM* monitoring Analysis of problems of the variation management If discrepancies occur: Entry into respective database Analysis of impact Initiation of special deliveries Request of an action plan Monthly Evaluation of volumedependability (Red-Light Monitoring) Initiation of the escalation procedure Charging of costs (additional expenses) Top 3 List worst supplier If discrepancies occur: Entry into respective database Product-Leader meeting Initiation of special actions Request of an action plan ppm analysis (top 3) Analysis of external quality occurrences Analysis of quality problems based on distinctive categories Check of action plan and its effectiveness Initiation of the escalation procedure If discrepancies occur: Entry into respective database Initiation of special actions Request of an action plan Quarterly Analysis of supplier performance Supplier evaluation Definition of further escalation procedures: Request of an 8D Report Supplier site visit Invitation of the supplier for the performance discussion Supplier audit 3/12/2010 / 24 *(problems identified/delivered goods)*parts per million
5. Managing Disintegrated Supply Chains: elements of the collaboration management Input Logistic Quality Variation Monitoring and analysis Database Plan Supplier Management Implementation Escalation procedure Special audit Charge of costs Workshops Supplier meetings Supplier audits 3/12/2010 / 25
5. Managing Disintegrated Supply Chains: Claim management Problem list Data transfer from SAP Actions are effective if problem isn t repeated within 90 days Summary of the problems and graphical display Monthly notification of the data of the supplier creating problems Worst suppliers in terms of quality are displayed monthly within the plant Problem suppliers (max. 100%) First Quarter 2006 Modine Pliezhausen GmbH 40% Gate S.r.l. 41% Modine Austria GmbH 81% 3/12/2010 / 26
5. Managing Disintegrated Supply Chains: Supply Chain Coordination: Supplier Day Review of the last year Discussion of future activities and strategy Workshops on various topics for the joint process optimization Award of the supplier of the year Informal discussions and get together 3/12/2010 / 27
5. Managing Disintegrated Supply Chains: Successful practice Measuring the strategic value of sourcing: 44% of customers and 42% of service providers do not undertake formal strategic reviews of the benefits to their business or sourcing contracts. 72% of the customers report that they do not have, or do not share with their service providers, criteria for measuring the success or failure of their sourcing arrangement. Source: KPMG 2007 (sample = 650 companies in 32 countries) 3/12/2010 / 28
5. Managing Disintegrated Supply Chains: Successful practice Success in meeting expectations: Bringing experience to the business it did not have previously 47% Ensuring SLAs are met 66% Ensuring end users/user departments are satisfied with the service provided Cost targets and financial success criteria 64% 61% 0 20 40 60 80 Percentage of respondents Source: KPMG 2007 (sample = 650 companies in 32 countries) 3/12/2010 / 29
6. Summary Today, you have seen a framework that will help managers make appropriate choices about organizational boundaries and the structure of supplier relationships. The framework provides a richer and more useful way to think about vertical integration than the simplistic exhortation to focus on core competencies. The challenge is to chose the appropriate level of focus. A company, needs to distinguish between what its core competencies are today and what they should be in the future. The idea of core competence must be balanced against the problems of coordination, strategic control, and intellectual property protection. Ultimately, an organization s vertical integration strategy is an integral part of its long-term capability-creation strategy. 3/12/2010 / 30
6. Summary Vertical Integration Coordination "Messy" interfaces; adjacent tasks involve a high degree of mutual adaptation, exchange of tacit knowledge, and learning-by-doing. Requisite information is highly idiosyncratic Strategic Control Very high: significant investments in highly durable relation-specific assets needed for optimal execution of tasks. Investments cannot be recovered if relationship terminates (Co-location of specialized facilities; Investments in brand equity; Large proprietary learning curves; Long-term investments in idiosyncratic Intellectual property R&D programs). Unclear or weak intellectual property protection; easy-to-imitate technology; messy interfaces between different technological components Arms-length relationships Standardized interfaces between adjacent tasks; requisite information is highly codified and standardized (prices, quantities, delivery, schedules, etc.) Very low: assets applicable to businesses with a large number of other potential customers of suppliers Strong intellectual property protection; difficult-to-imitate technology; clean" boundaries between different technological components 3/12/2010 / 31