Archive for the ‘Procurement’ Category

I just created a review video of the celebrated Economic Order Quantity (EOQ). This video considers two key decisions in inventory management: how much and when to order? Starting from real data, we build a model to optimize the total cost, which is the sum of the setup (order + transport + receiving) cost and holding cost. The solution is the celebrated Economic Order Quantity. All in just 4min :). Please put any comments or questions in the YouTube comment section which I periodically check.

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Fancy, luxury handbags start off looking like this:


Not exactly the image of exclusivity and sexiness that the likes of Hermes and Longchamp want to project when trying to convince customers to pony up for a bag but leather starts with hides and hides don’t start off in fancy colors.

The image comes from a Wall Street Journal article on Tanneries Haas, an old-school Alsatian tannery (French Tannery in Demand as Source of Top-Notch Leather, Nov 6). The article walks through the production process (quick: name a use for chromium!) but the interesting part of the story is how the industry of supplying high-end hides has changed. Tanneries Haas remains independent but luxury houses are buying up tanneries.

Until just a few years ago, the tanning business was the least glamorous cog in the designer-handbag industry. But recently Tanneries Haas and other French tanneries have found themselves the object of attention from famous luxury labels jockeying for secure sources of top-notch leather. “When they saw a certain number of tanneries disappear, they had to think about protecting their suppliers,” says Jean-Christophe Muller Haas, a sixth-generation French tanner. …

By acquiring suppliers, luxury goods purveyors hope to get more control over raw material costs. Prices of calf hides have soared in recent years due to Europe’s falling veal consumption. Calves are slaughtered primarily as a source of veal and skins are a byproduct. With fewer calves slaughtered to meet shrinking demand for veal, the supply of skins available for luxury leather goods is also diminished.

This move is not just limited to European calf leather. Businessweek reports that luxury firms are also buying up crocodile farms (A Crocodile’s Bumpy Road From Farm to Handbag, Oct 24).


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The Wall Street Journal ran a series of articles on the challenges Airbus is facing. I will try to cover several of these, as each highlights a different issue, and I would like to begin with the one discussing the effort made by both Airbus and Boeing to fight the delays that plagued their operations during the last several years (“Hit by Delays, Airbus Tries New Way of Building Planes“.)

Both Boeing and Airbus have outsourced, during the last few years, not only their production, but also the design of the different parts, as well as the management of the suppliers’ sub-tiers. We have documented these in the past (“Boeing Delivers First Dreamliner“,) and the article, briefly mentions these. Manufacturing problems have left Boeing with more than 40 almost-completed Dreamliners awaiting fixes. Their main customers now expect to get their planes around four years late. The project has cost Boeing billions more than its initial $10 billion budge.  The reader must recall that Boeing has embarked on this ambitious outsourcing plan to reduce investment costs, and speed R&D and production. As we all know, things have not panned well for these two goals. What were the main reasons: loss of visibility of the progress of different suppliers, as well as incentive issues.  It took Boeing quite a while to figure it out, but they finally have:

In a major retreat, it has since bought up suppliers, brought work back in-house and integrated more closely with its remaining contractors.  “We gave away a lot of elements of work that we’d always done in the past, and then didn’t provide the kind of oversight necessary for some of the people that were doing work that they’d never done before,” said Boeing Executive Vice President Jim Albaugh, who ran its airplane division until June, at an investor conference last fall. To retrench, Boeing mobilized hundreds of engineers specialized in manufacturing and industrial issues, who have pored over every element of the program, including at suppliers. At its factory near Seattle, Boeing built a control room with video links to overseas suppliers, allowing its engineers to examine parts live on shop floors in Japan or Italy. For a second, larger version of the Dreamliner, Boeing opted to design many outsourced components itself, such as the plane’s rear section and tail wings.


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The term private equity (PE) firm not only sounds sexier than “buyout firm,” but it also better reflects the changing nature of such firm’s activities.  Before the financial crisis hit in 2009, PE firms were not unlike residential home flippers: find an undervalued house, make “the deal” (often hugely leveraged), improve it, and sell it at a profit … quickly.  The difference, however, was that the PE deal makers mainly used someone else money.  After the financial crisis, loans and leverage doesn’t come that easily anymore and the task of PE is moving towards making “true” improvements and often holding on longer.

In the good old days, the majority of PE action involved financial restructuring and beautification of the balance sheet and make a profit, sometimes in a few months, without getting deeply involved in the business.  Now, the focus is on operational restructuring and improvements.  Two typical activities involve changing the people (HR reorgs) and improving the operations.  (Changing product and brands often takes too long for a PE firm’s time scale.)

Last week, Kevin Roose reported in the New York Times on how PE firms like Blackstone “are using their size and scope to pressure suppliers, set their own prices and exert their influence in a range of industries, including health care, construction and consumer goods:“

Last year, Blackstone was part of a group of companies that collectively bought 16 million reams of copy paper, 35 million FedEx shipments and 900,000 days’ worth of rental cars from National and Avis.

“We have incredible leverage,” said James A. Quella, Blackstone’s North American head of portfolio operations. “The more volume we have, the lower our prices go.”

The private equity titans have huge economic influence and sway, largely because of the size of their portfolios. Blackstone owns all or part of 74 companies that employ 700,000 people and generate $117 billion in annual revenue. Taken collectively, Blackstone’s businesses would rank as the 13th largest company by revenue.

This seems like a welcome byproduct of the change of the times: the smaller individual companies (“entities”) get access to suppliers and services on the same terms of a 10 or 100-fold larger company.  The changing focus to providing “true value” (by which I mean improving true work, which equals operations) also increases the value of operations and supply chain management knowledge. And that is good news for operations professors and for MBA students!

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The financial troubles in southern Europe are spreading and impacting the supply chains of Airbus and Boeing (and Embraer).  Daniel Michaels and Darcy Crowe report in The Wall Street Journal that Spanish supplier Alestis was placed under court administration (the Spanish equivalent of US bankruptcy protection) earlier this month.

The interesting part is that Alestis is in the attractive business of new advanced composite materials (carbon fiber parts—as a cyclist, I love this stuff and have written about this great material before on this blog) manufacturing: it supplies

“major parts of jetliners including composite ribs, panels and skins for the hot-selling Airbus A320 and the A380 superjumbo, the world’s largest passenger jet. Its long-term contracts bring steady payments from established companies. But Spanish banks have slashed lending, so Alestis, like many skilled companies, is operating from one bill to the next.”

So why is this affecting Alestis?

“Alestis was established in 2009 from the merger of several small aeronautic companies around Spain with support from the regional government of Andalusia. It was just coming together when Spain’s real-estate industry went bust. Banks were left with piles of bad loans that have drawn scrutiny from authorities and financial markets. Last week, the government ordered all banks in Spain to raise their provisions against potential losses tied to real estate, which will reduce their capital for lending to companies like Alestis.”

Given that Alestis doesn’t disclose financial results, I don’t know exactly what’s going on but it is quite likely that they need some help in working capital and supplier relationship management. Carbon fiber and finance must go hand-in-hand. With strong long-term contracts from premier customers, Alestis should be able to manage its cash, inventory, and suppliers better.

Airbus and Boeing have learned their lessons when they burned themselves by transitioning to a system integrator business model. (Quick review from our Kellogg Operations Strategy course: They outsourced major parts manufacturing without a parallel sufficient investment in supplier relationship management. To minimize their financial risk, they were going to pay suppliers only when aircraft were finished.  Suppliers invested early but didn’t get paid with the delays in the A380 and the 787.  Subsequent supplier defaults forced A& B to buy up some key suppliers: A bought PFW Aerospace and B bought Vought Aircraft.)

The story with Alestis is different and A & B are keeping a close eye on this and are lending to Alestis.  Interestingly, Airbus must walk a fine tight rope: keep Alestis afloat yet not lend too much because that may make it liable to all of Alestis’ debt. Or will they buy Alestis?

Supplier management must combine strategic contracting and relationship management that drives continuous improvement. It is key to operations strategy and any outsourcing models.

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Finally, after many delays, Boeing delivered the first Dreamliner. The Wall Street Journal, which has been following the development closely throughout the years, had a nice article about the topic (“For Boeing, It’s Been a Long, Strange Trip“):

Boeing—eight years after it began developing the ultra-efficient jet—is still trying to prove it can make a success of both its innovative product and new approach to plane-making. For decades, Boeing designed and built its jets in-house, bearing the whole expense. In 2003, it embarked on the unprecedented step of outsourcing most of the Dreamliner’s manufacturing to far-flung suppliers.

The article is correct to point out the new approach to plane-making and the innovative product, yet, I think it is somewhat misleading to say that outsourcing the manufacturing was unprecedented. As we have been writing in several posts about the topic Boeing chose to outsource not only the manufacturing, but also the design and management of sub-component suppliers.  Many of the causes of delays can be attributed to the lost visibility brought by this model. It is true though that under the new model, Boeing has been reduced to a large-scale assembler, and suppliers will do most of the production.  The lack of visibility and miscommunication regarding production responsibilities led to absurd situations:


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Wired had an interesting article last month on the backshoring trend lead by many small and medium sized manufacturers (“Made in America: Small Businesses Buck the Offshoring Trend“).

The article makes an excellent point that for many small manufacturers, offshoring may be a costly proposition:

For US firms, the decision to manufacture overseas has long seemed a no-brainer. Labor costs in China and other developing nations have been so cheap that as recently as two or three years ago, anyone who refused to offshore was viewed as a dinosaur, certain to go extinct as bolder companies built the future in Asia. But stamping out products in Guangdong Province is no longer the bargain it once was, and US manufacturing is no longer as expensive. As the labor equation has balanced out, companies—particularly the small to medium-size businesses that make up the innovative guts of America’s technology industry—are taking a long, hard look at the downsides of extending their supply chains to the other side of the planet.


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Few things cause more operational challenges than severely peaked demand. When demand one week is 20 times higher than average demand, one needs creative ways to satisfy customers without letting costs get completely out of control. A spike 20 times higher than normal might  seem like an exaggeration, but that is what the CEO of ProFlowers claims they see when Valentine’s hits and they ship 20% of their annual sales in just a few days.

Vodpod videos no longer available. I find their approach to managing demand an interesting part of their strategy. (more…)

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Here’s a follow up to Gady’s post on component shortages for electronics firms. The Wall Street Journal reports that lead times for a variety of components have gotten fairly long (From Snowmobiles to Cellphones, a Scramble for Parts, Aug 5). Here’s the story in pictures:

Lead times have been building for the past 12 months for certain key components, according to research firm iSuppli Corp. Waits for four types of transistors, for instance, which direct the flow of electrical currents and are used in everything from cars to handsets to washer-dryers, ranged between six and ten weeks in July last year, iSuppli says. Now waits last 18 to 20 weeks—a level where they’re expected to stay for the rest of the year.


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As Gady recently posted, Toyota has run into a rough stretch.  Not exactly Chrysler-rough but still a lot of folks in Toyota City must be working long hours.  The latest wrinkle on this is that Toyota is turning to suppliers to help cut costs (Toyota Accelerates Its Cost-Cutting Efforts, Wall Street Journal, Dec 23).

The world’s biggest car maker by volume told suppliers at a meeting Monday that it wanted them to help the company reach its goal of slashing the cost of auto parts by 30% in the next three years, a person familiar with the matter said.

The Japanese company has set more aggressive cost-cutting targets under a program called RRCI, which combines two cost-reduction initiatives currently under way, the person said. RRCI stands for “Ryohin (quality), Renka (low-price), Costs and Innovation.”

First, one has to admit that it makes a lot of sense that a car manufacturer would look to its cost of buying parts as a way to save money.  The figures one usually hears put the cost of purchased parts well north of 50% of the cost of building a car.  So while eking out a little labor savings is nice, the real money is in reducing the cost of parts. Second, this starts to sound like a Big 3 move.  As I mentioned in an earlier post, GM tried a big squeeze on its suppliers back in the early 90s with mixed results at  best.  They saved some money in the near term but they certainly antagonized many suppliers in the process.  I’ve got to think that Toyota will manage this better.  They have traditionally had much tighter relationships with their suppliers.  They also have a long track record on working with their suppliers on design and cost reduction so there is reason to believe that they can pull this off fairly smoothly.

At the same time, GM is making some big changes to their purchasing processes (GM purchasing gets a re-engineering, Automotive News, Dec 14) in part by changing where purchasing sits in their org chart: (more…)

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