Executive Briefings

HP Shows How to Outsource Production While Keeping Control Over Suppliers

The high-tech giant's buy-sell program ensures the best price and highest quality of parts, even though someone else is making the finished goods.

Lots of companies worry about losing control over their supply chains when they outsource manufacturing to independent producers. Hewlett-Packard Co. is doing something about it.

Like many high-tech leaders, HP has embraced the doctrine of outsourcing. It relies on multiple contract manufacturers to turn out sub-assemblies and branded product, including personal computers and printers, at sites around the world. But the strategy comes with complications, chief among them the potential loss of visibility and pricing control over the parts that go into HP's machines.

With contract manufacturers in the picture, HP runs the risk that component prices will be artificially inflated. And it has less visibility of supply and demand patterns for strategic components. Other negatives include weaker buying power, reduced enforcement of contractual agreements with suppliers, and a greater chance that lower-level components will not meet strict quality standards.

HP's solution is to retain control over the purchase and distribution of components headed for the assembly line. For the most part, its contract manufacturers do not have the power to choose or buy from suppliers. That responsibility rests with HP Global Procurement Services, which runs a buy-sell program on behalf of the company. In other words, it buys parts from suppliers, then sells them to contract manufacturers. Electronic data interchange (EDI) and Web-based communications help to automate the flow of orders and information.

In actuality, the strategy calls for a four-way relationship, among HP Global Procurement, the component supplier, contract manufacturer, and original equipment manufacturer (OEM), which most of the time is HP itself. Last year, the company ran $23bn in parts purchases through the program, out of a total production spend exceeding $43bn, according to Frieder Eckert, worldwide business process and consulting manager for HP. That translates into some 6 million line items.

Among the biggest advantages is HP's ability to hide the price of many strategic commodities. Neither contract manufacturers nor HP's competition know what the company paid for a given part. As a result, they can't put pressure on suppliers to match the price for other OEMs.

At all times, HP strives to maximize savings through its buying clout with suppliers. But price isn't the only object. HP can do a better job of balancing supply and demand at its various production sites. In the event of a market shortage, the company can allocate scarce parts to contract manufacturers who need them the most.

Contract manufacturers buying direct from suppliers tend not to adhere to contractual agreements, HP says. As a result, negotiated payment terms are often violated. What's more, the OEM has no control over how orders are distributed among suppliers of the same parts. Through the buy-sell process, the company says, "HP ensures adherence to negotiated payment terms and manages the collection process from contract manufacturers."

Certain commodities, such as memory devices, have high price volatility and are subject to frequent renegotiations. HP can lessen the impact of price changes through direct management. It also ensures that new prices are implemented in a timely fashion.

With its hand on the wheel, HP can engage in creative procurement risk-management techniques, such as forward buying. It can also oversee the proper execution of split or capped pricing. The setup makes it likelier that the selling price of a part will remain stable over long periods, the company says.

Last year, says Eckert, the buy-sell program yielded spend-related savings of more than 7 percent. Component prices were 5 to 10 percent less than if they had been set by contract manufacturers. And supply chain inventory levels have been reduced by 10 to 15 percent.

Suppliers, too, benefit from the program, says Eckert. They get paid faster than if they had sold directly to contract manufacturers. (Even better, he points out, they reduce the risk of not getting paid at all.) They sell larger amounts of product to fewer sites, simplifying the order process. And they can quietly make one deal with HP that won't affect their pricing to the rest of the market.

Currently the buy-sell process covers more than 700 suppliers and some 400 contract manufacturing sites worldwide. The program is monitored through a set of key performance indicators, says Eckert. They include on-time delivery to contract manufacturers, speed of order acknowledgments, order turnaround time, response time on change orders, and compliance with contractual provisions on accounts payable and accounts receivable.

In addition, HP relies on a semi-annual customer scorecard with key participants. The last five scorecards yielded a rating of better than 80 percent in the "exceed expectations" column.

To HP, the buy-sell program "represents a huge competitive advantage, enabling vital controls in an outsourced manufacturing environment," the company says.

Lots of companies worry about losing control over their supply chains when they outsource manufacturing to independent producers. Hewlett-Packard Co. is doing something about it.

Like many high-tech leaders, HP has embraced the doctrine of outsourcing. It relies on multiple contract manufacturers to turn out sub-assemblies and branded product, including personal computers and printers, at sites around the world. But the strategy comes with complications, chief among them the potential loss of visibility and pricing control over the parts that go into HP's machines.

With contract manufacturers in the picture, HP runs the risk that component prices will be artificially inflated. And it has less visibility of supply and demand patterns for strategic components. Other negatives include weaker buying power, reduced enforcement of contractual agreements with suppliers, and a greater chance that lower-level components will not meet strict quality standards.

HP's solution is to retain control over the purchase and distribution of components headed for the assembly line. For the most part, its contract manufacturers do not have the power to choose or buy from suppliers. That responsibility rests with HP Global Procurement Services, which runs a buy-sell program on behalf of the company. In other words, it buys parts from suppliers, then sells them to contract manufacturers. Electronic data interchange (EDI) and Web-based communications help to automate the flow of orders and information.

In actuality, the strategy calls for a four-way relationship, among HP Global Procurement, the component supplier, contract manufacturer, and original equipment manufacturer (OEM), which most of the time is HP itself. Last year, the company ran $23bn in parts purchases through the program, out of a total production spend exceeding $43bn, according to Frieder Eckert, worldwide business process and consulting manager for HP. That translates into some 6 million line items.

Among the biggest advantages is HP's ability to hide the price of many strategic commodities. Neither contract manufacturers nor HP's competition know what the company paid for a given part. As a result, they can't put pressure on suppliers to match the price for other OEMs.

At all times, HP strives to maximize savings through its buying clout with suppliers. But price isn't the only object. HP can do a better job of balancing supply and demand at its various production sites. In the event of a market shortage, the company can allocate scarce parts to contract manufacturers who need them the most.

Contract manufacturers buying direct from suppliers tend not to adhere to contractual agreements, HP says. As a result, negotiated payment terms are often violated. What's more, the OEM has no control over how orders are distributed among suppliers of the same parts. Through the buy-sell process, the company says, "HP ensures adherence to negotiated payment terms and manages the collection process from contract manufacturers."

Certain commodities, such as memory devices, have high price volatility and are subject to frequent renegotiations. HP can lessen the impact of price changes through direct management. It also ensures that new prices are implemented in a timely fashion.

With its hand on the wheel, HP can engage in creative procurement risk-management techniques, such as forward buying. It can also oversee the proper execution of split or capped pricing. The setup makes it likelier that the selling price of a part will remain stable over long periods, the company says.

Last year, says Eckert, the buy-sell program yielded spend-related savings of more than 7 percent. Component prices were 5 to 10 percent less than if they had been set by contract manufacturers. And supply chain inventory levels have been reduced by 10 to 15 percent.

Suppliers, too, benefit from the program, says Eckert. They get paid faster than if they had sold directly to contract manufacturers. (Even better, he points out, they reduce the risk of not getting paid at all.) They sell larger amounts of product to fewer sites, simplifying the order process. And they can quietly make one deal with HP that won't affect their pricing to the rest of the market.

Currently the buy-sell process covers more than 700 suppliers and some 400 contract manufacturing sites worldwide. The program is monitored through a set of key performance indicators, says Eckert. They include on-time delivery to contract manufacturers, speed of order acknowledgments, order turnaround time, response time on change orders, and compliance with contractual provisions on accounts payable and accounts receivable.

In addition, HP relies on a semi-annual customer scorecard with key participants. The last five scorecards yielded a rating of better than 80 percent in the "exceed expectations" column.

To HP, the buy-sell program "represents a huge competitive advantage, enabling vital controls in an outsourced manufacturing environment," the company says.