Enhancing Margins In High-Tech Manufacturing

To be competitive, companies need to have a global footprint in manufacturing facilities, warehouses and distribution centers.

Introduction

The high tech industry is characterized by intense competition, an increasingly complex supply chain, short product life cycles and complexities arising due to increased outsourcing. These put intense pressure on margins and most supply chain constituents survive on wafer thin margins. This makes it imperative for organizations to aggressively pursue cost reduction methods and avenues for revenue increase. To be competitive, companies need to have a global footprint in manufacturing facilities, warehouses and distribution centers. However, this may introduce risk in terms of loss of data and information, thereby resulting in longer supply lead time and delayed customer response. Simultaneous, Instantaneous, Transparent and Accurate information is the most critical issue facing the industry. Cost, speed, zero inventory, just-in-time delivery, strategic sourcing, collaboration are becoming the norm in this environment.

The key issues faced by high tech organizations are highlighted below.

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Margin impacting issues are critical to high tech industries as they face declining margins. Given these challenges, there are various industry specific practices such as indexation (exchange rate risk management), ship and debit and price protection to manage cost and revenues.

Company Gross Margin, 2009-10 Operating Margin, 2009-10
Arrow 11.91 2.57
Avnet 12.47 -6.28
Cisco 63.93 16.9
Source: Annual reports

The issues that primarily impact margin are:

1. Inventory Optimization

Cutting down inventory levels to a minimum has been an objective that manufacturers have focused on for years through initiatives such as Kanban. Inventory levels have been pared down to a minimum post these initiatives and the focus has now returned to improving customer service levels given these inventory levels.

2. Strategic Pricing

Determining the right price of a product is the outcome of analysis of market conditions, costs, position in product lifecycle and customer preferences. This analysis is critical to maximizing profits for new products and identifying the stars and underperformers amongst the current products.

3. Collaboration

There has been a strategic shift to sourcing for manufacturing and procurement and partnering with alliances for sales because of the growing tendency for most of the high-tech companies to become lean and concentrate on their core competency. Close collaborations within the organization as well as with all the partners across the supply chain are a must for responsiveness to the customer's and market's demand, to squeeze out the cost of the product, to optimize Value/Cost of the supply chain and to increase the velocity of the supply chain.

Inventory Optimization

Asset managers across all industries have to identify the optimum inventory levels required to be stocked for each item. High Tech firms have rationalized inventory to extremely low levels and have reached a situation where traditional means to cut inventory will result in deterioration in customer service levels. The crux of inventory optimization is to minimize inventory levels while maintaining customer service levels as per requirements.

Inventory turn rate is one of the most important metrics continuously monitored by manufacturing organizations. A higher turn rate implies meeting of service levels with a lower level of inventory. Firms aim for a higher finished goods turn rate through application of inventory optimization.

Organizations can have different driving forces for their inventory optimization activities. The optimization plan is based on the imperative on which the optimization needs to be hinged upon.

  1. Enforce service levels plan -- Safety stock required to achieve the target service level.
  2. Enforce budget constraint -- Safety stock permissible within the available budget determines service level attained.
  3. Enforce capacity constraint -- Available resource / material constraints determine the attainable service levels.
  4. Enforce user specified safety stocks -- User specified safety stock determines attainable service levels

The following are the areas in which inventory optimization can be applied.

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1. Plant operations / assembly lines: Components go through various production operations prior to completion of the final product. Each operation can have a different throughput rate impacting the amount of WIP existing throughout the assembly line. Optimizing the throughput of all the processes based on the bottleneck and desired customer service levels will help minimize inventory levels.

2. Transportation: The choice of transportation throughout the supply chain is primarily based on the cost of each transport option. The option chosen impacts the buffer inventory required to be maintained across the supply chain and the service levels attainable. Selection of the transportation type and inventory in transit is hence critical to inventory optimization.

3. Sourcing policies: Sourcing decisions are strategic by nature and typically not altered on a daily basis once purchase agreements have been drawn. Factoring a high level impact on inventory levels while making a sourcing decision will help in overall optimization of inventory during manufacturing processes.

4. Lot size optimization: Each step in a process can have a different optimal lot size based on resource usage. A larger lot size ensures higher resource utilization and lower unit transportation costs. However, lot size optimization also factoring storage costs, impact on upstream and downstream processes and WIP levels can help pare inventory costs.

5. Risk pooling: Inventory of a single part can exist in multiple locations and exist separately as components for different end products. The variability of the aggregate demand for the part will be less than the summed variability of the individual locations / end products. Risk pooling can help substantially reduce total investment in inventory.

6. Postponement: Components are often used for multiple end products. Postponement of use of these components in the production process enables a higher amount of risk pooling and levels of inventory required of these components. It also reduces the amount of WIP existing in the system.

ERP applications such as Oracle Applications provide the functionality to implement the optimization plan chosen by the organization and these processes.

 Optimization Area

Oracle Applications Functionality

Plant operation / assembly lines

The following are factored during safety stock calculation:

Bills of material
Routings and key resources for items
Capacity constraints including resource availability
Cost elements for resources utilized

Transportation

Transportation capacity and cost are inputs used in inventory optimization
Penalties can be defined for exceeding transportation capacity
Exception messages can be generated if transportation capacity is under loaded or overloaded.
Sourcing policies Largely a strategic decision to be factored during supplier selection.
Lot size optimization Lot size has to be adjusted based on the economy of scale existing for each resource. If not sufficiently high to dictate batch size, the capacity of the bottleneck resource will drive the lot size.  Safety stock can then be optimized in the system once this is finalized.

Postponement and Risk Pooling

Planning engine determines postponement based on costs and lead times.
'Postponement factor' allows specification of the level in BOM / Sourcing tree until which postponement should be applied.
Value addition beyond this level is delayed till a firm order is received.
Allows Postponement analysis of inventory carrying costs with or without postponement in graphical format.

Strategic Pricing

As mentioned by Andrew Carnegie: "Watch the costs and the profits will take care of themselves." Operational inefficiency, information silos, lack of visibility across supply chain, inventory holding costs, delayed order fulfillment contribute to increase in cost. Also, the bigger challenge is to protect the margins as well as be competitive in pricing, even if cost is being watched closely. This margin loss stems from inconsistent pricing across channels and regions. This compels the company to look for a pricing system which can provide flexibility in pricing for salespersons to earn commission along with protecting margins and which can uniformly price the product across regions and channels.

In Jan 2010 AMR Research interviewed 56 U.S.-based high-tech manufacturers in order to better understand current pain points in the high-tech industry. More than 50 percent view price execution and price strategy as the key drivers impacting revenue management processes and hence margin. When requested to rate their performance against the importance of processes, biggest gaps were identified in resolving special price requests and price enforcement.

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infosys-4Source: AMR Research, 2010

 

High tech industries are extremely sensitive to fluctuations in the demand curve. This increases their need to get better visibility into demand and adapt to the prices without any delay. Companies look for holistic end-to-end solution where-by they can analyze, plan, publish, execute and negotiate price. Oracle Price Management offers capabilities of managing price negotiation, adherence to pricing rule as per corporate guidelines through-out the life cycle, resolution of optimal price at the time of transaction and managing the pricing across the channels. Oracle Price management integrates set of business processes which enable organizations to determine right price based on internal and external environmental conditions.

Oracle's Price Management Solution

Oracle Advanced Pricing provides pricing controls, manages promotion pricing and provides capability to activate price/discounts based on user defined parameters of time, quantities and entities. It supports global discounts that can be applied irrespective of the currency being used. Price Book enables communication of the pricing to customers, partners and sales force. Promotional limit functionality cuts off promotional spending when it reaches predetermined level defined on the various factors like cumulative discount amount, total quantity ordered or gross revenue of products. Oracle Advanced Pricing offers an extensive security rule that provides capability to restrict view or modification of prices based on roles or users.

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Oracle Deal Management

Siebel Dynamic Pricer provides a single source system which enables sales users to administer optimal price lists and discounts used for multi-channeled global distribution. Oracle Deal Management provides the sales person with scenario simulation and decision making tools at the time of negotiation to help them achieve maximum profit from every deal. It also provides enforcement of corporate pricing policies integrated into the quote and orders.

Large portion of high tech companies are selling through indirect model. Companies must optimize channel sales by streamlining the design registration process and automating channel quotes, ship and debit, and point-of-sale (PoS) tracking processes to improve management of price protection and stock rotation.

Companies providing proprietary product line take early mover advantage through industry process like Design win and negotiate price for higher margins. It's important to link design registration automatically to the correct channel partner or sales representative to appropriately apply margin. Infosys has designed a custom workbench which supports design win registration process throughout the lifecycle of the product. It allows direct coordination of manufacturer with customer through a distributor and automates Point of Sales accumulation. It is also important to support risk based post shipment price adjustments. Indexation is an industry practice allowing transfer of buy sell exchange rate risk to customers.

Better handling of claims is prerequisite in High-Tech Industry to correct the inventory valuation costs and control the revenue by correcting supplier price. Oracle and Infosys have collaborated to provide integrated solution for Price Protection in Oracle E-Business Suite Release 12. Considering the price volatility faced in the life cycle of products in High tech industry, Price Protection offers requisite support to handle price fluctuations from suppliers. It provides capability for better claim handling by revaluing the existing stock, updating open purchase orders, computing the debit claims for differential cost amount and presenting to supplier, computing credit claims and paying back to the customer. This ensures in maximizing profitability through accurate and fast processing of claims. Adequate reporting is essential to track any claims rejected or missed.

Read the second part of the article here.

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Shruti Johri is a Lead Consultant with Oracle Practice at Infosys Ltd. Shruti has around 9 years of experience in IT with domain expertise in Distribution, Logistics and Costing areas. She has worked on large ERP transformation projects in Hi-Tech domain and has been instrumental on solution design & development.

Siddharth Ravi is a Senior Consultant with Oracle Practice at Infosys Ltd. Siddharth has over 7 years of industry and consulting experience and has worked on a host of ERP transformation projects in Order management, Distribution and Costing in the Hi-Tech and discrete manufacturing domain.

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