Out of Sorts with Outsourcing

OEMs, contract manufacturers pursuing different objectives

New York  July 25, 2001  In their quest to develop virtual manufacturing and supply chain operations, many high-tech companies have found that outsourcing has provided more headaches than solutions, according to a new report released today by management consultancy Booz Allen & Hamilton.

For high-tech companies like Cisco, Sony, Palm, Compaq, Apple and Philips, outsourcing the manufacturing of key products and components has not lived up to expectations, and has contributed to their financial and performance difficulties, the report asserts.

According to the report, the failure has been not with the theory of outsourcing but with the practice. Outsourcing was designed to make manufacturing and distribution more efficient, to reduce inventory and to sharpen the focus on product design and innovation. Yet the results have been mixed at best, as shown in report cards on outsourcing effectiveness for Cisco and Compaq's Pocket PC. Each company received an overall grade of "C," with high marks for focus on innovation and customer responsiveness but poor grades for reducing inventory.

Ed Frey, vice president at Booz Allen & Hamilton, says that the current outsourcing models cannot effectively adjust the supply of products from contract manufacturers to dramatic changes in demand, leading to product shortfalls in times of high demand and, more recently, to bloated inventories as demand tapered off.

The effects of significant revenue shortfalls have been compounded as high-tech companies such as Cisco were locked into commitments to buy large quantities of new products from their suppliers. "Like Lucy and Ethel in the chocolate factory, these companies are left with a glut of product and nowhere to put it," Frey said. "Unfortunately, it's just about impossible to hold a fire sale in high-tech."

The report highlights a major flaw in outsourcing today: the basic conflict of objectives between original equipment manufacturers (OEMs) such as Cisco and Compaq, and the contract equipment manufacturers (CEMs) who actually produce the products, such as Solectron and Jabil Circuit. OEMs need flexibility so they can quickly ramp-up supply as new products become "hits." However the CEMs need predictability  not flexibility  for their production schedule, because they often operate on razor-thin profit margins and must maintain a relentless focus on cost.

The OEMs have also missed out on the informal communications and problem-solving channels that existed when the entire supply chain was still under one roof, according to Bill Lakenan, a Booz Allen principal. "Water cooler comments from the marketing department about how rapidly the new product was taking off were invaluable," said Lakenan." They kept production people closer to the market so they were able to quickly respond to changing conditions. Now this grease that used to smooth the product flow is gone  so the supply chain has been rougher."

The report offers an approach to make outsourcing more successful for high-tech companies by redefining how supply chains work. Keys for effective outsourcing include: actively managing capacity to handle a sudden surge in demand; utilizing a rolling process to reserve aggregate capacity in the long term, while specifying exact production schedules closer to production dates; improving coordination of production planning; building flexibility into product designs; and learning from mistakes and adapting the supply chain over time.