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  1. 1. COORDINATION WITHIN AND ACROSS THE FIRM Vish V. Krishnan The University of Texas at Austin
  2. 2. AGENDA <ul><li>Technology Applications in Procurement and Supply Chain Management </li></ul><ul><ul><li>Commercialization and entrepreneurship opportunities </li></ul></ul><ul><ul><li>E-Auctions at Motorola </li></ul></ul><ul><li>Challenges in coordinating within a company </li></ul><ul><ul><li>Fabtek Case Discussion </li></ul></ul><ul><li>Coordination Strategies and the Notion of Double Marginalization </li></ul>
  3. 3. Technology Applications in Procurement... <ul><li>Technology can help: </li></ul><ul><ul><ul><li>Reduce transaction costs of procurement </li></ul></ul></ul><ul><ul><ul><li>Aggregate orders and achieve scale economies </li></ul></ul></ul><ul><ul><ul><li>Match buyers and sellers for dynamic pricing </li></ul></ul></ul><ul><li>Different modes of E-Procurement </li></ul><ul><ul><li>Software-based, no intermediaries </li></ul></ul><ul><ul><li>Intermediated – electronic marketplace </li></ul></ul><ul><li>Electronic marketplaces can be classified along numerous dimensions: </li></ul><ul><ul><li>Horizontal or vertical </li></ul></ul><ul><ul><li>Public or private </li></ul></ul>
  4. 4. Horizontal & Vertical Portfolio of Electronic Markets Vertical market focus ( example; ) Horizontal market focus(e.g. Plastics Steel Chemicals Paper Energy Cattle Telecom Flowers Logistics management MRO procurement Capacity management Investment recovery Human resource mgmt. Project management Media buying Credit management Source: Sawhney & Kaplan
  5. 5. FreeMarkets (FM) <ul><li>FM: A Buyer-centric electronic-marketplace where global suppliers bid for a major firm’s order </li></ul><ul><li>Why did FM choose to represent big buyers? </li></ul>Fortune 100 Company FM Supplier 1 Supplier 2 Supplier 3
  6. 6. FreeMarkets Effect on Supplier Prices: Should Buyers Rejoice? Source: FreeMarkets
  7. 7. How to Evaluate E-Marketplace Vendors <ul><li>Scope: Bundled consulting activities fit the firm’s core competency and deepen customer relationships. Raise barriers to entry. </li></ul><ul><li>Scalability: Bundling of consulting and software makes the company less scalable. </li></ul>Low Barrier to Entry High Barrier to Entry High scalability Low scalability FreeMarkets ARIBA GOAL Chemdex, Vertical Net
  8. 8. What an E-Marketplace offers Firms <ul><li>Promises to increase list of global suppliers at lower cost </li></ul><ul><li>Offers technology to do reverse-auctions </li></ul><ul><li>Lower variable cost of procurement </li></ul><ul><li>Good to reduce transaction costs </li></ul><ul><li>Can perform order matching for commodity items </li></ul><ul><li>Problems with E-Markets </li></ul><ul><li>Threaten the relationships with suppliers </li></ul><ul><li>Availability not guaranteed </li></ul><ul><li>New intermediary introduced (charges a transaction fee) </li></ul><ul><li>Are they appropriate for strategic items? </li></ul>
  9. 9. The Problems with E-Markets <ul><li>Threaten the relationship between customers and suppliers. Do not create much additional value in the steady state. </li></ul><ul><li>Founders sometimes do not have deep domain expertise and lack credibility. </li></ul><ul><ul><li>Zero-sum E-Markets . </li></ul></ul><ul><li>Suppliers fear erosion of brand image. Customers worry about the disruption of supplier relationships. </li></ul><ul><ul><li>Results in Liquidity Problem </li></ul></ul>
  10. 10. Industry Consortium E-Marketplaces <ul><li>Groups of industry participants banded up with technology providers to form “E-Marketplace” </li></ul><ul><ul><li>Wanted to capture the market “upside” </li></ul></ul><ul><li>Covisint the most notable example, received FTC approval but has stumbled. </li></ul><ul><li>Not just buyers - suppliers and distributors have come together to form their own “sell-side” e-marketplaces. </li></ul><ul><li>What do these consortiums do to the first-generation, entrepreneurial e-marketplaces… </li></ul><ul><li>What are the problems associated with consortium marketplaces? </li></ul>
  11. 11. E-Sourcing at Work: The Case of Motorola
  12. 12. A company buys a lot of items… <ul><li>Can one approach to procurement be applied to all the items that a company buys… </li></ul><ul><ul><li>Branded sub-systems </li></ul></ul><ul><ul><li>Commodity components </li></ul></ul><ul><ul><li>Consulting services </li></ul></ul><ul><ul><li>Capital equipment </li></ul></ul><ul><ul><li>Commodity supplies </li></ul></ul><ul><li>How do we segment the different items? </li></ul>
  13. 13. Segmented E-Procurement Strategy Commodity Buys Strategic Buys Customer Demand-driven Budgeted Commodity components e.g. memory, fasteners (Price, quality) Branded subsystems e.g. integrated circuit Instrument panel (Quality, Availability) Capital Eqpmt. e.g. integrated circuit Instrument panel (Quality, Performance) Operating Resources e.g. office supplies (Price, transaction cost)
  14. 14. Segmented E-Procurement Commodity Buys Strategic Buys Customer Demand-driven Budgeted Commodity components Vertical E-Markets Branded subassy’s Private E-Networks Capital Equipment Extranets Operating Resources Software/Horizontal E-Market/Service
  15. 15. Lessons Learned on the Role of Technology <ul><li>Contrary to the pitch of IT vendors, e-procurement is neither a panacea nor a no-brainer. </li></ul><ul><ul><li>Technology can help reduce transaction/search costs, create economies of scale, and match buyers to sellers. </li></ul></ul><ul><ul><li>However, intermediaries may frail customer-supplier relationships; Revenue model of supply chain intermediaries is suspect. </li></ul></ul><ul><ul><li>Approach electronic marketplaces with caution. They may lower prices for commodity items, but may also compromise quality and customer relationships. A private electronic network may be suited to exchanging most branded/strategic items. </li></ul></ul><ul><li>What do you need to do if you are buyer to use this technology more effectively? </li></ul><ul><li>How do you get pricing power if you are a seller? </li></ul>
  16. 16. E-Markets versus E-Networks <ul><li>Markets are for commodity trading among anonymous buyers and sellers </li></ul><ul><li>E-Marketplace owner steals the limelight </li></ul><ul><li>E-Markets transfer value from buyer to seller in steady-state </li></ul><ul><li>Focus is on aggregation/matching </li></ul><ul><li>Networks can maintain identity and brand of buyers and sellers </li></ul><ul><li>Network service provider is an invisible channel enabler </li></ul><ul><li>Create positive value by reducing design iterations, offering decision support, and improving quality. </li></ul><ul><li>Focus is on integration/collaboration </li></ul>● ● ● ● ● ● ● B C D A Customer Customer JV Subcon Supplier Supplier Supplier
  17. 17. Takeaways <ul><li>FreeMarkets show the challenges in building internet-enabled companies. The trade-offs between scalability and sustainability/barriers to entry. </li></ul><ul><li>Why the model of public marketplaces may not be in alignment with industrial markets: less fragmentation, and relationship based markets. </li></ul><ul><li>The key benefit of internet auctions may be better preparation (upfront homework) in procurement. </li></ul>
  18. 18. Managing Supplier Relationships in the Digital Age: The Role of E-Sourcing Chris Bakotic Motorola
  19. 19. Role of E-Sourcing <ul><li>Agenda </li></ul><ul><ul><li>The Motorola Context in which E-Sourcing is Happening! </li></ul></ul><ul><ul><li>Two Uses of E-Sourcing: e-RF x & Reverse Auctions </li></ul></ul><ul><ul><ul><li>Benefits to Buyers and Suppliers </li></ul></ul></ul><ul><ul><ul><li>Decision Criteria </li></ul></ul></ul><ul><ul><ul><li>Preparation </li></ul></ul></ul><ul><ul><ul><li>Execution </li></ul></ul></ul><ul><ul><li>Where we are Going with E-Sourcing </li></ul></ul>
  20. 20. <ul><li>Stage IV </li></ul><ul><li>Operational Effectiveness </li></ul><ul><li>Joint Leverage </li></ul><ul><li>Detail Cost Analysis </li></ul><ul><li>Price Benchmarking </li></ul><ul><li>Standardization and product reuse </li></ul><ul><li>Supply Chain Value-add </li></ul><ul><li>Information integration through further development of e-tools </li></ul><ul><li>Stage I </li></ul><ul><li>Part Leverage </li></ul><ul><li>One price per part </li></ul><ul><li>Transaction based </li></ul><ul><li>Stage II </li></ul><ul><li>Cost Competitiveness </li></ul><ul><li>Leverage total supplier business </li></ul><ul><li>Cost Competitive </li></ul><ul><li>Focus on price and internal process cost </li></ul><ul><li>Stage III </li></ul><ul><li>Cost Leadership </li></ul><ul><li>Reduce Supply Base </li></ul><ul><li>Strategic Sourcing </li></ul><ul><li>Focus on external costs </li></ul><ul><li>Development and use of e-tools </li></ul><ul><li>Stage V </li></ul><ul><li>Business Competitive Advantage </li></ul><ul><li>Integrated Prod. </li></ul><ul><li>Development </li></ul><ul><li>Top-line Value Generation </li></ul><ul><li>Spec definition </li></ul><ul><li>e-Everything </li></ul>Cost Savings Impact Time Supply Management Organizational Development Process Improvement related to NPI/NTI/ESI Integration of supplier to customer Product reuse and Standardization Detailed cost analysis and modeling Reduce time to market Adapted from Michigan State University GEBN Transactional Efficiency e-Enabled Sourcing Collaborative Supply Chain
  21. 22. E-Sourcing <ul><li>Definitions </li></ul><ul><li>e-RF x – electronic Request For Quotation, Request For Information, Request For Proposal. </li></ul><ul><li>Reverse Auction – time limited event, suppliers bid lower prices to provide goods or services. </li></ul>RFI RFQ RA Award
  22. 23. Technology is merely an Enabler! <ul><li>E-sourcing technology merely supplements the current sourcing and negotiation process </li></ul><ul><li>Online tool that adds structure to managing the negotiation process </li></ul><ul><li>Compliments the Negotiation Planner. Planning is critical! </li></ul><ul><li>Can replace or complement some traditional physical meetings with virtual meetings </li></ul><ul><li>Is not intended to replace all face-to-face negotiations, and is not suited for all spend categories! </li></ul>
  23. 24. E-Sourcing – Benefits <ul><li>Benefits to Buyers and Suppliers </li></ul><ul><li>Benefits to the Buyer </li></ul><ul><ul><li>High cost savings – greater than the results of aggressive manual negotiation </li></ul></ul><ul><ul><li>Compressed negotiation cycle time </li></ul></ul><ul><ul><li>Reduced travel time and expenses </li></ul></ul><ul><ul><li>Better market pricing knowledge </li></ul></ul><ul><ul><li>Can create “time-based competition” </li></ul></ul>Check plausibility of initial quotes (2 weeks) 2 negotiation rounds: First (remote) round with 7 suppliers, second round face-to-face with 3 suppliers. (8 weeks) Decision preparation, presentation, approval (2 weeks) Auction preparation and 1 auction with 7 suppliers (2 weeks) Check plausibility of initial quotes (2 weeks) Decision preparation, presentation, approval (1 weeks) Traditional Auction-powered
  24. 25. E-Sourcing – Benefits to Suppliers <ul><li>Suppliers get: </li></ul><ul><ul><li>Introduction to new business opportunities </li></ul></ul><ul><ul><li>Low cost sales channel </li></ul></ul><ul><ul><li>Fair competition through a level playing field </li></ul></ul><ul><ul><li>Ease of quoting </li></ul></ul><ul><ul><li>Quick buyer decision </li></ul></ul><ul><ul><li>Unparalleled Market Intelligence </li></ul></ul>
  25. 26. E-Sourcing – Decision Criteria Market Attractiveness Product Attractiveness Commodity product Unique product Sole source Many suppliers Strategic Generic Auction Environment RFX Environment
  26. 27. E-Sourcing – Decision Criteria <ul><li>Three ingredients for success </li></ul><ul><ul><li>Credible switching threat </li></ul></ul><ul><ul><ul><li>Buyer is willing to switch suppliers or change business share </li></ul></ul></ul><ul><ul><ul><li>Suppliers believe that the Buyer will switch </li></ul></ul></ul><ul><ul><li>Competitive Marketplace </li></ul></ul><ul><ul><ul><li>Industry standard product </li></ul></ul></ul><ul><ul><ul><li>Excess capacity in the market </li></ul></ul></ul><ul><ul><ul><li>Many suppliers are qualified </li></ul></ul></ul><ul><ul><li>Compelling Spend </li></ul></ul><ul><ul><ul><li>Buyer’s business is important to the supplier </li></ul></ul></ul>
  27. 28. E-Sourcing – Preparation becomes Paramount! <ul><li>Using an eight step process </li></ul><ul><li>Similar to traditional negotiations, but sequence and focus changed </li></ul><ul><li>Solid preparation is key! </li></ul><ul><li>Enforces discipline and data driven decisions </li></ul><ul><li>Included in the training on software usage </li></ul>Negotiation Planner Execution 8 Lessons Learned 7 Actual Auction Preparation 6 Practice Auction 5 Supplier Conference 4 Auction Dry Run 3 Data Quality Review 2 Auction Strategy 1 First Meeting with Team Auction Milestone
  28. 29. E-Sourcing – Preparation Total Negotiated Cost Savings 70% of Total Cost Savings 30% of Total Cost Savings Example Negotiation Distribution of Cost Savings Strategy & Planning e-RFx e-Auction
  29. 30. E-Sourcing – Preparation <ul><li>Forces more careful planning and analysis earlier in the negotiations process </li></ul><ul><li>Early supplier engagement on pricing and cost structure </li></ul><ul><li>Ensures each supplier understands requirements </li></ul><ul><li>Reveals “gaps” in understanding </li></ul><ul><li>Helps ensure an “apples to apples” comparison </li></ul><ul><li>The tool is only as good as the process it supports </li></ul><ul><li>The tool can help enforce the process </li></ul>
  30. 31. Auction Execution <ul><li>Execution is critical for continued success </li></ul><ul><li>Clear communication to suppliers </li></ul><ul><ul><li>The sourcing process </li></ul></ul><ul><ul><li>The timeline </li></ul></ul><ul><ul><li>The award strategy </li></ul></ul><ul><ul><li>The awarded contract terms </li></ul></ul><ul><li>Follow through! </li></ul>
  31. 32. E-Sourcing – The Future <ul><li>Continued adoption as a standard business practice </li></ul><ul><ul><li>More “spot buys” – desktop auctions </li></ul></ul><ul><ul><li>Integration with procurement systems </li></ul></ul><ul><li>Suppliers empowered by flexibility in quoting </li></ul><ul><li>Increased discussion about total cost in the value chain </li></ul><ul><li>More online tools created to </li></ul><ul><ul><li>Automate supply chain data sharing </li></ul></ul><ul><ul><li>Enhance supply chain collaboration </li></ul></ul><ul><li>XML standards defining the language of the supply chain </li></ul><ul><ul><li>Technology industry: RosettaNet </li></ul></ul>
  32. 33. E-Sourcing – The Future
  33. 34. E-Sourcing – The Future
  34. 35. E-Sourcing – The Future
  35. 36. Fabtek Case Discussion
  36. 37. Coordination Challenges <ul><li>The Fabtek case illustrates coordination challenges even within a small company! </li></ul><ul><ul><li>Imagine a much larger and established company. </li></ul></ul><ul><li>Why is coordination so challenging? </li></ul><ul><ul><li>Managing specialists is like herding cats! </li></ul></ul><ul><ul><li>The Information Challenge : Difficulty in obtaining accurate information </li></ul></ul><ul><ul><li>Limited Resources, Unlimited Opportunities </li></ul></ul><ul><ul><li>Trade-offs Among Functions </li></ul></ul>
  37. 38. Manufacturing-Marketing Trade-offs
  38. 39. Vertical and Horizontal Scope <ul><li>Vertical scope : </li></ul><ul><li>The set of primary and support activities required for the production of a good or service that the firm performs itself rather than purchase from independent firms. </li></ul><ul><li>Choosing what to do in-house and what to buy (OR VERTICAL SCOPE) is the classic make-buy decision. </li></ul><ul><li>Horizontal scope : </li></ul><ul><li>Horizontal scope means the breadth (variety) and quantities of products and services a firm produces (offers). </li></ul><ul><li>Depends on economies of scope and scale. </li></ul><ul><li>Costco and Southwest cases illustrate the issues of horizontal scope determination. </li></ul>Is outsourcing always the optimal decision?
  39. 40. Scope Decision Making <ul><li>What determines the boundaries of a firm? </li></ul><ul><ul><li>When does a firm make/buy its raw materials and/or components? </li></ul></ul><ul><ul><li>When does a firm use partners for assembling finished products and value-added resellers for distribution? </li></ul></ul><ul><ul><li>What other complementary product businesses should the firm participate and when does it enter? </li></ul></ul><ul><li>Why do firms get formed in the first place? </li></ul><ul><ul><li>Why don’t individuals transact among themselves as entrepreneurs? Why are there firms and what is their economic function? What determines which transactions are mediated through markets and which are bought within a formal organization? </li></ul></ul><ul><ul><li>These questions were first posed by Ronald Coase, resulting in transaction cost economics. </li></ul></ul><ul><ul><li>Companies adopt the organizational mode that </li></ul></ul><ul><ul><li>minimizes transaction costs. </li></ul></ul>
  40. 41. Transaction Costs <ul><li>Coordination Costs </li></ul><ul><li>Costs incurred in </li></ul><ul><li>Determining prices </li></ul><ul><li>Bringing buyers and sellers together </li></ul><ul><li>Advertising and marketing expenses </li></ul><ul><li>Buyer search costs </li></ul><ul><li>Cost of decision making </li></ul><ul><li>Motivation Costs </li></ul><ul><li>Costs incurred in </li></ul><ul><li>Motivating employees </li></ul><ul><li>Addressing organizational inertia </li></ul><ul><ul><li>In the past the rule of thumb was, “ markets motivate, hierarchies coordinate” . </li></ul></ul><ul><ul><ul><li>When coordination needs of the products are high, bring them </li></ul></ul></ul><ul><ul><ul><li>within a firm. When inertia sets in, turn to the market. </li></ul></ul></ul>
  41. 42. Profits in a Vertically Integrated Company <ul><li>Consider the following Bundled company : </li></ul><ul><ul><li>Significant monopoly power (say Applied Materials!) </li></ul></ul><ul><ul><li>Sells a finished product made up of two component sub-systems </li></ul></ul><ul><ul><li>Faces a downward sloping demand curve: p = $100,000-500 q </li></ul></ul><ul><ul><li>Marginal costs of the two component sub-systems A and B are $20,000 and $10,000, respectively. </li></ul></ul><ul><ul><li>What is the profit maximizing price and quantity for this firm? </li></ul></ul><ul><ul><ul><li>When marginal revenue = marginal cost, profit is maximized </li></ul></ul></ul>p q demand curve 100,000 200 30,000 Marginal Cost = $30,000 Marginal Revenue = 100,000-1000 q 100,000-1000 q* = $30,000 q * = 70 p * = $65,000 Maximum Profit = 70* (35,000) = $2,450,000
  42. 43. What Happens Under Unbundling? <ul><li>Suppose the bundled company “BundCo” decides to unbundle itself; SepCo makes A and buys subsystem B from a new company NewCo </li></ul><ul><li>Would this impact the profit of the company SepCo? </li></ul><ul><ul><li>Faces same downward sloping demand curve: p = $100,000-500 q </li></ul></ul><ul><ul><li>Marginal costs of sub-systems A and B are still $20,000 and $10,000. </li></ul></ul><ul><ul><li>However, NewCo may charge a price p s different from its marginal cost. </li></ul></ul>p q Bundco’s demand curve 100,000 200 Marginal Cost = $20,000 + p s Marginal Revenue = 100,000-1000 q 100,000-1000 q* = $20,000 + p s 80,000-1000 q* = p s p s q Newco’s demand curve 80,000 Marginal Cost = $10,000 Marginal Revenue = 80,000-2000 q 80,000-2000 q* = $10,000 q* = 35 p s = $45,000 Newco’s Profit = 35*35,000 = $1,225,000 $100,000-500 q
  43. 44. Profits Under Unbundling <ul><li>Let us now compute SepCo’s profit under unbundling: </li></ul><ul><ul><li>q* = 35; </li></ul></ul><ul><ul><li>p* = $100,000-500 q* = $82,500 </li></ul></ul><ul><ul><li>p s = $45,000 </li></ul></ul><ul><ul><li>SepCo’s Profit = 35 (82,500-20,000-45,000) = $612,500! </li></ul></ul><ul><li>Total System Profit = SepCo’s Profit + NewCo’s Profit = 1,837,500 < $2.45 million made by BundCo. </li></ul><ul><li>This deterioration in profits is referred to as double-marginalization . </li></ul><ul><li>It happens when both a firm and its independent supplier have some monopoly power, which allows each of them to add a monopoly profit margin to their costs. This leads to sub-optimal quantities, prices, and profits! </li></ul>
  44. 45. Double Marginalization in the Microsoft Case <ul><li>Excerpts from &quot;An Expensive Pig in the Poke: Estimating the Cost of the District Court’s Proposed Breakup of Microsoft ”, 9/21/00. Stan Liebowitz , Professor of Economics , University of Texas at Dallas . </li></ul><ul><li>&quot; “ </li></ul><ul><li>There are several reasons to believe that the price of Windows would rise. As has been noted in a declaration by the government’s expert Carl Shapiro, and in an Amici brief by Litan, Noll, Nordhous and Scherer, there is a well-known problem that economists refer to as double marginalization. The double marginalization problem occurs when two firms, each with market power, produce complementary products. Each firm attempts to charge a markup that would maximize its profits, taking the other firm’s markup as given, and in so doing the price for the two combined goods contains a higher markup than if a single firm had set a profit maximizing markup for the two goods jointly. Thus, if one believes that both the AppCo and the OpCo will have market power, prices after the breakup would be expected to increase.&quot; [at pages 3-4.] &quot;A detailed analysis of Microsoft’s pricing clearly demonstrates that Microsoft’s behavior in application markets can be classified as that of a price cutter, or a firm following a low-price strategy. After the breakup, new leadership will exist in one or both companies and each will have to choose a pricing strategy. It is impossible to know in advance what pricing strategies will be adopted by these companies. Although it is possible that both the OpCo and AppCo will follow the same type of low price strategy used by Microsoft, it is likely that at least one, and perhaps both companies, will adopt a different, higher-price strategy, perhaps due in part to the double marginalization factor mentioned earlier.&quot; [at page 10.] </li></ul>
  45. 46. Key Takeaways <ul><li>Coordination across functions and business units is a major challenge. </li></ul><ul><ul><li>Creating incentive compatibilities is key. </li></ul></ul><ul><ul><li>Minimizing incentive incompatibilities essential for smoother functioning. </li></ul></ul><ul><li>Firms organize themselves to minimize transaction costs. </li></ul><ul><ul><li>Markets motivate, Hierarchies coordinate. </li></ul></ul><ul><li>Double marginalization is the phenomenon under which profits in a vertically integrated firm is higher than the combined profit of unbundled firms (with monopoloy power). </li></ul><ul><li>Transaction characteristics, Value chain profit patterns, and Channel structures should influence scope decisions. </li></ul>