The Virtual Factory -- A Tale of Two Extremes
September 2000 - By Drew Robb

Info you can use:
- Why outsourcing is a growing trend in manufacturing
- Which functions should you outsource?
- Maintaining control of outsourced functions

During the past few years, outsourcing has been sweeping across the manufacturing landscape. Core competency has become the byword, with such functions as human resources, information technology, warehousing, transport, and logistics commonly passed on to partners who perform these duties better and at lower cost.

But driven by increases in efficiency, manufacturers have been facing another dilemma: how to keep plants and assembly lines busy. As technology advances, two camps appear to be gradually taking shape.

For some, it makes sense to focus on strictly manufacturing-based strengths, dispensing with research and development (R&D), design, distribution, marketing, and sales. These companies are adopting a model of serving original equipment manufacturers (OEM) by taking care of the production of parts, sub-assemblies, or even finished goods. Such firms offer OEMs economies of scale in day-to-day manufacturing chores, making outsourcing a more cost-effective solution.

Others, however, have chosen the opposite route. When forced to take an honest look at their own operations, many recognized that manufacturing itself actually fell outside of their core competencies. Instead, R&D, design, marketing, and distribution have staked their claim as true specialties. Such companies come up with the ideas, design them, and have others prototype and produce them before taking over to sell them to consumers or corporations.

Ericsson, Nortel, and Hewlett-Packard (HP), for instance, recognized that they were paid for design and distribution, not for manufacturing. But others, such as high-tech giant Solectron, have gravitated to electronics manufacturing services (EMS), purchasing facility after facility from OEMs in order to better service their clients and reduce their costs.

According to Technology Forecasters (www.techforecasters.com), an independent industry analyst firm, annual EMS revenue exceeds $90 billion and is expected to reach close to $300 billion by 2003.

"Companies like Solectron, Celestica, and others that focused on their manufacturing competencies, had to shop those capabilities around to others," says Joel Reed, director of industrial marketing at J.D. Edwards, an enterprise resources planning (ERP) software provider. "They let their partners take care of most other functions and exist primarily as a fulfillment engine."

Solectron, based in Milpitas, Calif., manufacturers for Alcatel, Acer, HP, Nortel, and IBM, to name a few. In many cases, it has purchased plants that formerly belonged to these companies and provided the same components or equipment for a fraction of the cost. It is now a $10 billion a year company with facilities in 44 countries and a growth rate of close to 50 percent.

"In order to stay competitive in today's global marketplace, OEMs need a partner that can drive speed, efficiency and cost containment," says Dr. Ko Nishimura, Solectron's chairman, CEO, and president.

The company works with hundreds of OEMs in fields as diverse as electronics, computers/peripherals, telecommunications, networking, avionics, and Global Positioning Systems. To cope with tens of thousands of components/assemblies that are frequently changing in design and configuration, Solectron uses a combination of e-business applications from several vendors.

A BaanERP system from Baan works hand in hand with software from Extricity to deal with the many variables involved in customer orders. This arrangement is further supplemented by an Agile Software procurement and product collaboration suite. The end result: an almost infinite array of components and equipment passes rapidly in and out of its plants and onto the shelves, marked as brand-name products.

The Opposite Extreme

But what about the other end of the spectrum: those who are now shying away from traditional manufacturing, harnessing instead core competencies in design and distribution? What made them choose such a course, and what does it take to make it in this demanding field?

Liberty Richter, a specialty food importer in Saddle Brook, N.J., no longer physically manufactures any of the brands it carries, not even the name brands that are commonly associated with the company. Liberty has grown steadily by acquiring other food producers, selling their manufacturing facilities to others, and focusing on product marketing and distribution.

"We own the brands and use third parties to manufacture the goods," says John McLennan, Liberty Richter's vice president of finance. "As our expertise is in marketing, we don't want to bog ourselves down in the production of foodstuffs, an area we lack the knowledge to do well in." Instead, Liberty relies on bakeries and manufacturing plants in Illinois, Alabama, Pennsylvania, California, and throughout Asia for finished goods.

For instance, Liberty Richter bought the Sesmark brand of sesame crackers from a company that wanted to focus strictly on food manufacturing. Liberty signed a long-term co-packaging agreement, allowing that company to continue manufacturing Sesmark goods, as well as foodstuffs for other clients. "Our business philosophy is good, solid products and on-time delivery," says McLennan. "If our manufacturing suppliers perform, we stick with them."

Liberty Richter excels at the marketing and distribution of a brand, an area that many others in the food manufacturing business find difficult to do. For its Healthy! nutrition bar, for instance, the company first conducted extensive market research to verify the perceived need for a low-calorie, good-tasting soy protein bar. Next, it identified potential manufacturers that could deliver the right taste profile and devised the brand concept and packaging. It then launched an aggressive campaign that took its product into the top five in its category.

While many clients are attracted to Liberty Richter's distribution capabilities, the company actually outsources this function to Ultimate Distribution Inc. of Edison, N.J., saving about 20 percent on total distribution expenditure. McLennan believes that his company has advanced to the point where management of distribution and brand marketing have become his company's prize assets. It leaves just about everything else to others.

At the backbone of its management capabilities is Blinco Systems' 3rdwave®, a suite of integrated software solutions for international supply chain management. Liberty Richter uses this application to manage global import lines, as well as national and international exports. It consists of purchasing, inbound logistics and trucking, inventory control, order entry, accounting and finance.

"3rdwave® is basically an ERP/supply chain system that helps us obtain information that is leaps and bounds ahead of where we used to be," says McLennan. "It helps us deal with over 2,000 customers who order frequently and often in small quantities. Since implementing it, we have been able to significantly reduce our out-of-stocks and excess inventory, resolve currency conversion challenges, as well as streamline the management of our supply chain."

Virtual Electronics

Liberty Richter's approach is mirrored in just about every segment of manufacturing. In the automotive industry, for instance, Ford outsources subsystem assembly to Visteon, retaining only final assembly in-house. This is quite a change from the heyday of Henry Ford, when just about every component and subassembly was manufactured in-house.

Sun Microsystems' high-end E 10000 servers also present a fine example of virtual manufacturing. According to Jonathan Poe, vice president, executive direction service of the META Group (www.metagroup.com), "Only one person within Sun actually works on the E 10000, performing a purely project management role." Behind the scenes, i2 Technologies takes care of manufacturing and final product compilation.

"There has been a change from the vertical stovepipe towards virtual manufacturers who actual offload the lower level and routine production to supply chain partners," says Poe. "This provides greater speed to market, lowered costs, and the time to concentrate on what they are best at, such as innovation or distribution."

Take Pericom Semiconductor in San Jose, Calif. Unlike Liberty Richter, Pericom does not rely on marketing and distribution know-how. Rather, it has found a niche as a supplier of integrated circuits (ICs) that interface between the CPU and memory. Instead of shipping them to OEMs, however, it interacts primarily with contract manufacturers, which, in turn, serve the likes of Cisco, Dell, Apple, and Lucent. Its core competencies? Design and logistics.

Pericom offers as many as 13,000 items that can be ordered in quantities as large as 6 million. It negotiates with OEMs and contract manufacturers, designs the specified ICs, procures front-end tooling, and supplies everything to various subcontract foundry manufacturers in Asia. Pericom then arranges to ship these ICs to different Asian facilities to be mounted into plastic encapsulated packages. These products return to San Jose for electrical testing and final shipment.

Pericom uses J.D. Edwards' OneWorld ERP suite to oversee distribution, finance, and manufacturing. "As a result of implementing this system, we have integrated a variety of databases into one global database," says Dan Wark, vice president of operations. "OneWorld makes it possible for us to manage seven or eight subcontractors on the other side of the planet and as many as 400 different routes that our products might take before they arrive at their final destination."

Virtual Responsibility

Though such a hybrid model means that others directly handle large chunks of the manufacturing cycle, the abandonment of responsibility for the end product is a sure route to failure in a virtual world. "For outsourced manufacturing to work well, even design and marketing houses had better fully understand manufacturing process," says Eric Marks, PriceWaterhouseCooper's principle consultant, supply chain practice.

Marks, however, thinks that the core competency pendulum can sometimes swing too far. He notes that many companies are racing to emulate virtual manufacturing pioneers such as Cisco and Intel. Yet, having captured the imagination of industry and sparked an outsourcing trend, these trailblazers may actually be turning back toward a more traditional framework. That paragon of the virtual model, Cisco, for example, has recently added its own manufacturing campus in Salem, N.H.

The best approach, then, is to ignore fashion and instead go where the value is. By talking to customers and understanding their specific needs, as well as your own economics, it is possible to locate the sweet spot that exists in every industry between outsourcing and vertical integration.

The same value-seeking philosophy also applies to the implementation of the ERP and enterprise application integration (EAI) systems that form the backbone of today's convoluted supply chain relationships. A few years ago, companies were content to participate in long projects with ill-defined concepts of bottom-line return. These days, fast turnaround and immediate return on investment are the name of the game.

By piloting ERP and EAI initiatives carefully before implementing them broadly across the supply chain, greater overall results are assured, provided the lessons learned are used to tailor software to strike an ideal balance between the needs of the company and its suppliers and customers.

For related information, please go to:
3rdwave Food
3rdwave CGD (for Consumer Goods Distribution)