Case: Pacific Systems Corporation. John Blevins 430 West Fifth Street Perrysburg, OH

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1 Case: Pacific Systems Corporation John Blevins 430 West Fifth Street Perrysburg, OH John Blevins Shauna Munroe James Sunderhaus John Blevins is currently a senior in Supply Chain Management and Management Information Systems at Bowling Green State University, Bowling Green, OH. Toledo Chapter APICS ID# Full Time Undergraduate

2 Page 2 of 20 Abstract- This paper is responding to a case given to the class about a company Pacific Systems Corporation based in San Francisco, CA. PSC builds personal computers and needs a DVD supplier. Described are the different supply options, the sourcing strategy, a supplier scorecard, financial analysis, and total cost analysis. A. Executive Summary Pacific Systems Corporation is located in San Francisco, CA and is looking to contract with a supplier for DVD drives, which will be in every computer that PSC builds. PSC has been looking at four different suppliers that all have different attributes. Elecom is the price leader in the DVD industry and has developed a good reputation with their customers. Since the company is so large, PSC felt that we could become underappreciated, especially since Elecom is located globally. SureTech is a small company that is located in an old plant, which could create possible breakdowns in the equipment, and PSC is unsure if SureTech would be able to handle the large contract size. Park Technologies has quality relationships throughout their company with all employees and extensive procedures that each product has to go through. E-Drive has encountered some quality issues with their products, which has caused late deliveries, but they have engineers working to fix the problem and guarantee its correction. In order to find the best supplier PSC uses a supplier scorecard, which has clear descriptions of each area and the expectations entailed, that focuses on all the suppliers cost, quality, delivery, capacity, and risk. Suppliers are awarded points for each category based on how well suppliers meet PSC s expectations. Weights are given to each category, which are multiplied by the points awarded and totaled. These scores determine if the supplier is unacceptable, acceptable or preferred, which exemplifies their performance.

3 Page 3 of 20 Through our calculations we found that E-Drive was the only company with a 1.0 or higher quick ratio and the highest current ratio. E-Drive had the lowest TCO by $3.00, the best delivery record and the second best PPM. The only problem that E-Drive has is their average collection period, but this will be further investigated. Overall, E-Drive had the best financial data and would be the best candidate to be a supplier for PSC. B. Introduction & Objective Statement Our consulting team here at Bowling Green State University, has taken on the challenge of finding a quality supplier for Pacific Systems Corporation. PSC has recently entered the personal computer market and plans to outsource many of the components, one being the DVD drive, which will be standard on each computer they build. Pacific Systems is a medium-sized company whose base is north of San Francisco. PSC has grown from annual sales of $2.5 million to $3 billion in ten years and doesn t plan to stop growing any time soon. PSC has chosen a made-to-order strategy where PC s are shipped directly to their customers when orders are received. The company is not going to build finished PC s to meet market demand forecasts, future sales, or even supplier capacity, but it will carry some PC s in inventory to avoid missing customer orders. Therefore, PSC needs to contract with an effective and efficient supplier. From past knowledge and experience, there are always many benefits when forming an alliance within a buyer-supplier relationship. When an alliance is made between two parties, there is an institutional trust built, and a failure to develop and manage the trust is one of the main reasons that so many alliances fail. With an alliance, total costs are often lower, because there are reductions of direct and indirect costs associated with labor, materials and overhead. Quality can be improved because PSC will not have to inspect for errors in the DVD systems as they would if they build them. Instead, the supplier who is determined and efficient at making

4 Page 4 of 20 quality DVD drives is responsible. Also, improved technology flow from suppliers would be present, as PSC should trust their partner. Therefore, strategic alliances often lead to many successful new products. DVD demand is growing at an accelerated pace, and PSC wants to find a supplier as quickly as possible because other companies are going to use the same DVD drives in their personal computers. They want to extend a contract to the supplier that suits them best and will share their market with that company in hopes of building a strategic alliance. The four suppliers that PSC is considering are: Elecom Technologies in Nagasaki, Japan, SureTech Company in Colorado Springs, Colorado, E-Drive Systems in California, and last but not least Park Technologies in Korea. All four of these suppliers quoted different prices with Elecom being the cheapest at $127 per unit and SureTech being the highest at $144 per unit. The lead times range from two weeks at E-Drive to ten weeks at Park Technologies. These factors and many others must be considered before determining with which supplier to make a contract. C. Sourcing Strategy PSC should pursue a strategic sourcing strategy with their chosen supplier. Due to the current market conditions they should single source their DVD drives in order to leverage their sales and build a collaborative relationship with their supplier. They have identified DVDs as a critical part of their product and should take efforts to minimize supplier risk. The three main supply risks identified by PSC are lack of supply, quality issues, and delivery issues. By creating a strategic alliance with their supplier and guaranteeing them our business with a long-term contract they in turn would guarantee us supply in a competitive market. We plan to contract with the supplier for two-years and to renew the contract based upon satisfactory service. There are many advantages to collaborative relationships. Typically they have lower total costs, more

5 Page 5 of 20 open communication leading to less delivery or design issues, and less quality problems. All of these are seen as vital to PSC. Lower total costs are due to target costing and the buyer understanding and allowing for the supplier to earn a reasonable profit. This prevents suppliers from using hidden costs as well as allowing for innovation and investment in dedicated resources. Also supplier involvement in the design and suggestions as to processes and materials to use typically lower the costs. Supplier knowledge is leveraged as an asset to the buying company. Quality is also increased for these reasons. Suppliers are designing the product and therefore should be able to adequately manufacture it without many defects. More investments in technology also reduce quality issues. Fully developed specifications would be contradictory to this and are often used for transactional-based relationships. We used delivery performance and quality as part of our basis to determine our supplier scorecard as well as using total cost analysis and financial risk analysis to determine our sole supplier. Lastly when determining supply risk location was a deciding factor. There were two international suppliers and two domestic suppliers. One of the domestic suppliers was within ten miles of PSC allowing for a JIT delivery schedule to be set up if desired. With the international suppliers lead times could have become an issue as PSC plans to build to order computers rather than stock and their safety stock levels would be double that of domestic suppliers. Also there were some currency concerns when dealing with foreign suppliers as well as possible political issues and lack of experience and cultural and linguistic knowledge within PSC. Company Overview Elecom Elecom is located in Japan and is the largest of the suppliers. They are the low-cost leader in the industry and typically do not deal with buyers that are the size of PSC. This could

6 Page 6 of 20 lead to problems in trying to create a strategic relationship in that they would have no interest in the investment of time and resources for such a small contract. PSC s orders could be deferred to give preference to other large customers as occurred during the plant visit. SureTech The SureTech Company of Colorado Springs, CO is a new competitor in the DVD drive market. PSC s contract would be the largest in the company s history and there is some concern as to their ability to handle such an order. They might not have the resources to invest in the desired relationship and the ability to grow and invest in new technologies as the market evolves. Their plant is old and very small compared to some other competitors, which creates the possibility of down time on the production lines that could hinder their demand schedule. SureTech has a reputation for innovation and reliability, which is why this company is a potential supplier for PSC and they share the same ethics. The company employees from top down seem energetic and motivated, which helps communication to be more open and active throughout the potential strategic alliance. E-Drive Systems E-Drive Systems is located only ten miles away from PSC. Due to this they offer a justin-time delivery system, with a two-day delivery time. PSC was impressed with the open and active communication between the workstations, which proved why this company had such a solid reputation with their customers. E-Drive systems and PSC would be able to work closely with one another, particularly due to the short distance between plants. Recently there have been quality problems with shipments because of a significant increase in the amount of returns from their large distributors. The amount of returns was causing a delay in the production schedules and deliveries, which caused the quality manager to

7 Page 7 of 20 be extremely busy and on the edge. An abnormal clicking sound occurred when a disk was inserted into the drive. PSC had the quality manager s word that this problem would be resolved by the time PSC would place an order with them. Park Technologies Park Technologies is located in Korea. PSC was impressed with the extensive testing that all of the products underwent before approval. All of the employees in the facility knew each other and the manager was proud of the fact that they knew all of the names of the his customers. This showed definite potential for a collaborative relationship. Park Technologies has not done business with many North American firms and have no US facilities or support staff, which could be a potential problem. Also since they are located in Korea the average delivery cycle could take up to 10 weeks per order, which creates the possibility of stock outs or late deliveries. The problem that poses the largest risk to PSC is the regional instabilities in this Korean area that could result in threats to the United States, which would disrupt or completely terminate supply of DVD drives. D. Developing the Audit Instrument Pacific Systems Corporation uses standard criteria to rate all suppliers in order to determine their overall performance. The purpose of PSC s rating system is to identify, observe, and classify suppliers. These objective ratings help in strategic sourcing decisions and determine supplier performance. The supplier scorecard will be communicated to all suppliers, and this feedback potentially leads to continuous improvement and a better relationship. The process for the scorecard is standard to all suppliers. Suppliers are scored on 10 different performance metrics in the areas of costs, quality, delivery, capacity, and risk.

8 Page 8 of 20 Descriptions of each category are included on the scorecard (See appendix 1). Suppliers are awarded 1, 3, or 5 points based on whether they fail expectations, meet expectations, or exceed expectations in each category. Detailed expectations are listed on the scorecard under each area. There are also weights given to each metric based on importance. Total points are added up for an overall score for each supplier, which determines their rating level. E. Applying the Audit Instrument Supplier Evaluation All potential and current suppliers are evaluated based on the performance metrics on the supplier scorecard. Observations and data are taken from each supplier to determine whether they fail expectations, meet expectations, or exceed expectations in each category. After the points are given and multiplied by their corresponding weights, they are added up to determine a total score. There are three different levels in which a supplier can place as follows: Preferred Supplier Rating: Points Supplier qualifies to be a strategic partner by giving a competitive advantage Supplier exceeds expectations and supports our future goals Acceptable Supplier Rating: Points Supplier is committed to meeting basic needs Supplier meets the minimum performance criteria. Unacceptable Supplier Rating 0-74 Points Supplier fails to meet basic requirements for performance This supplier is considered risky that may prevent competitive advantage After applying the scorecard to all four potential DVD suppliers for PSC, total scores determined which level rating each supplier assumed. The following table summarizes each suppliers' total score and the supplier rating they received. Suppliers Table 1 Summary of Supplier Scores Score out of 150 points total Supplier Rating

9 Page 9 of 20 Elecom Technologies 77 Acceptable Sure Tech Company 71 Unacceptable E-Drive Systems 127 Preferred Park Technologies 99 Acceptable Total Cost Analysis Total cost analysis was performed for each of the four suppliers. The results were quite different from the quoted price and basically eliminated the low cost supplier, Elecom. Table 2 shows the quoted unit prices and estimated TCO for each of the suppliers. While Elecom quoted $127 per unit their total cost was actually over $183 per unit. This was almost $10 per unit higher than any of the other companies. The lowest TCO was E-Drive at just under $169 per Table 2 unit. SureTech and Park were comparable at almost $172 and TCO Quoted Estimated $174 per unit respectively. Year two costs were slightly Company Price TCO Elecom $ $ lower. Even though safety stock was the only change for year two, it did not affect the outcome of the TCO. Had there been more difference, an average of the two years would have been used. We could also reduce the frequency of deliveries from E-Drive and likely negotiate an even lower unit price if we contract with them again. E-Drive had the lowest delivery non-conformance costs by a significant margin, but was tied for highest in quality non-conformance costs. Many other costs remained similar. Financial Analysis SureTech $ $ E-Drive $ $ Park $ $ Financially, there were only two main choices out of the four possible suppliers. Both of them ended up being US companies. The choices were SureTech and E-Drive Systems. E-Drive

10 Page 10 of 20 Systems is the only company with a quick ratio equal to or greater than 1. SureTech was the most profitable with the highest NI as well as ROE and ROA. E-Drive was the only other company above the average for these categories. Financially, the only problems with SureTech were their gross profit margin and quick ratio which was a.7. Their gross profit margin could be increased with larger economies of scale, which is likely to occur since they are a new and growing company, and also the smallest of the four suppliers. E- Drive s only issue was their Average Collection Period of 60 days, with the average being 45 days. When using same-size income statements, E-Drive had the lowest CGS and the highest GPM. However, they also had the highest G&A expenses which lowered them to just over average NPM. All of the companies were similarly leveraged which seems typical of the electronics industries. Also, all of the companies are able to pay their current liabilities and the lowest Current Ratio was Park with a 1.1. For detailed numbers and more comparisons see Appendix 3, Financial Ratios, and Appendix 4, Income Statements. F. Recommendations Table 3 Selected Financial Ratios Ratio SureTech E-Drive Average Current Ratio Quick Ratio Debt Ratio ROA 10.7% 7.4% 6.3% ROE 21.7% 16.9% 13.8% GPM 25.9% 35.0% 26.6% NPM 6.8% 4.5% 4.2% Our recommendation is for PSC to contract solely with E-Drive Systems, eventually creating a collaborative relationship or strategic alliance. E-Drive is the only supplier who scored in the preferred range during our supplier scorecard analysis. Quoted price, PPM defects, and capacity were all rated as average during the scorecard analysis and are slight concerns. While we enjoy seeing lower quoted prices, they were lowest on TCO (Appendix 2) which is significantly more important. PPM defects could become a problem, but they were still well below two of the other suppliers, and the only supplier who had less PPM is financially

11 Page 11 of 20 unstable (see Appendix 3). Capacity was a concern with all suppliers being unable to produce the order without adding capacity; however E-Drive seemed willing and able to take the order knowing that we will increase our demand annually. Therefore, capacity should not become an issue (see Appendix 5). During financial ratio analysis, they were never worse than +/- 5% of the average of the four suppliers with the exception of average collection period. There could be many reasons for a high collection period such as longer payment terms with collaborating partners or lax collections. Another reason could be poor credit analysis and too many sales to debt-ridden customers, which might cause problems. We would want to look into the reasoning behind this before contracting with them to minimize this risk. E-Drive was the only company that had a quick ratio equal to or over 1, which tells us that they are a going concern. In addition, the average collection period should be lower assuming that we pay our accounts on time. Other faults found with E-Drive were the current clicking sound noted as a quality problem, and the head quality engineer being stressed with this issue. Current lead times are being pushed due to this quality problem and could pose a risk to PSC. However, the issue was guaranteed to be resolved before the first drive was shipped to PSC and, their ramp up time was quoted as 3 months while knowing of this problem. Lead time is the quickest being the same as our safety stock levels. They also deliver every other day which would allow for smaller orders and less inventory costs. Lastly, there are no political or inflationary risks with E-Drive as they are a U.S. based company. They also are closely located so that we could inspect their facilities if there is the slightest hint of any issues or concerns. Overall, they well surpassed all other competition, and we have come to a clear decision to contract with E-Drive Systems as they have a good

12 Page 12 of 20 reputation with their customers for delivery and quality. H. Conclusion After an in-depth analysis of the four DVD suppliers Elecom, SureTech, E-Drive, and Park Technologies, PSC has come to a decision to contract solely with E-Drive Systems. The BGSU Consulting Team has taken into account many performance criteria that measure the success of the company. They consistently exceeded expectations on the supplier scorecard, total costs, and financial measures. Their close proximity will allow PSC to monitor any potential problems and guarantees quick delivery. Since they exceed our expectations, E-Drive has the potential to eventually create a strategic alliance with PSC. Therefore, we are confident that E- Drive Systems is the best DVD drive supplier for PSC.

13 Page 13 of 20 Supplier: Elecom System: DVD drive Year: 2002 Appendix 1a Supplier Scorecards Pacific Systems Corporation: Supplier Evaluation Category Points Level 1 Level 2 Level 3 Weight Score Does not meet expectations Meets expectations Exceeds expectations (1=low (1 point) (3 Points) ( 5 points) 5=high) Costs: Quoted Price 5 Price per unit >140 Price per unit $ Price per unit < Cost: Total Costs (Year 1) * 1 > $175 Dollars per unit $ Dollars per unit $165-$170 per unit 5 5 Delivery: Lead time 1 >8 weeks 3-7 weeks < 3 weeks 4 4 Delivery: On time record 3 % on-time delivery time <95% % on-time delivery 95-99% % on-time delivery >99% 3 9 Delivery: Frequency of Shipment 1 Monthly Weekly At least every other day 2 2 Quality: Parts per million defects 3 >10,000 DPPM 6,000-10,000 DPPM < 6000 DPPM 5 15 Capacity: % for production 5 < 93% current capacity 93-97% current capacity >97% capacity 4 20 Risk: Denomination of Contract 3 Other Yen US Dollars 1 3 Risk: Political Risk 1 Extremely Risky Somewhat Risky Little or No Risk 2 2 Ramp-up time 1 > 4 months 3-4 months < 3 months 2 2 Total Score 77 * Total costs include unit price, transportation, tooling, quality non conformance costs, duties/customs, safety stock carrying charges, delivery non-conformance costs, ordering, inbound receiving, and inspection costs.

14 Page 14 of 20 Supplier: Sure Tech System: DVD drive Year: 2002 Appendix 1b Supplier Scorecards Pacific Systems Corporation: Supplier Evaluation Category Points Level 1 Level 2 Level 3 Weight Score Does not meet expectations Meets expectations Exceeds expectations (1=low (1 point) (3 Points) ( 5 points) 5=high) Costs: Quoted Price 1 Price per unit >140 Price per unit $ Price per unit < Cost: *Total Costs (Year 1) 3 > $175 Dollars per unit $ Dollars per unit $165-$170 per unit 5 15 Delivery: Lead time 3 >8 weeks 3-7 weeks < 3 weeks 4 12 Delivery: On time record 3 % on-time delivery time <95% % on-time delivery 95-99% % on-time delivery >99% 3 9 Delivery: Frequency of Shipment 3 Monthly Weekly At least every other day 2 6 Quality: Parts per million defects 1 >10,000 DPPM 6,000-10,000 DPPM < 6000 DPPM 5 5 Capacity: % of production 1 < 93% current capacity 93-97% current capacity >97% capacity 4 4 Risk: Denomination of Contract 5 Other Yen US Dollars 1 5 Risk: Political Risk 5 Extremely Risky Somewhat Risky Little or No Risk 2 10 Ramp-up time 1 > 4 months 3-4 months < 3 months 2 2 Total Score 71 * Total costs include unit price, transportation, tooling, quality non conformance costs, duties/customs, safety stock carrying charges, delivery non-conformance costs, ordering, inbound receiving, and inspection costs.

15 Page 15 of 20 Supplier: E-Drive Systems System: DVD drive Year: 2002 Appendix 1c Supplier Scorecards Pacific Systems Corporation: Supplier Evaluation Category Points Level 1 Level 2 Level 3 Weight Score Does not meet expectations Meets expectations Exceeds expectations (1=low (1 point) (3 Points) ( 5 points) 5=high) Costs: Quoted Price 3 Price per unit >140 Price per unit $ Price per unit < Cost: Total Costs (Year 1) * 5 > $175 Dollars per unit $ Dollars per unit $165-$170 per unit 5 25 Delivery: Lead time 5 >8 weeks 3-7 weeks < 3 weeks 4 20 Delivery: On time record 5 % on-time delivery time <95% % on-time delivery 95-99% % on-time delivery >99% 3 15 Delivery: Frequency of Shipment 5 Monthly Weekly At least every other day 2 10 Quality: Parts per million defects 3 >10,000 DPPM 6,000-10,000 DPPM < 6000 DPPM 5 15 Capacity: % for production 3 < 93% current capacity 93-97% current capacity >97% capacity 4 12 Risk: Denomination of Contract 5 Other Yen US Dollars 1 5 Risk: Political Risk 5 Extremely Risky Somewhat Risky Little or No Risk 2 10 Ramp-up time 3 > 4 months 3-4 months < 3 months 2 6 Total Score 127 * Total costs include unit price, transportation, tooling, quality non conformance costs, duties/customs, safety stock carrying charges, delivery non-conformance costs, ordering, inbound receiving, and inspection costs.

16 Page 16 of 20 Supplier: Park Technologies System: DVD drive Year: 2002 Appendix 1d Supplier Scorecards Pacific Systems Corporation: Supplier Evaluation Category Points Level 1 Level 2 Level 3 Weight Score Does not meet expectations Meets expectations Exceeds expectations (1=low (1 point) (3 Points) ( 5 points) 5=high) Costs: Quoted Price 3 Price per unit >140 Price per unit $ Price per unit < Cost: *Total Costs (Year 1) 3 > $175 Dollars per unit $ Dollars per unit $165-$170 per unit 5 15 Delivery: Lead time 1 >8 weeks 3-7 weeks < 3 weeks 4 4 Delivery: On time record 5 % on-time delivery time <95% % on-time delivery 95-99% % on-time delivery >99% 3 15 Delivery: Frequency of Shipment 1 Monthly Weekly At least every other day 2 2 Quality: Parts per million defects 5 >10,000 DPPM 6,000-10,000 DPPM < 6000 DPPM 5 25 Capacity: % of production 5 < 93% current capacity 93-97% current capacity >97% capacity 4 20 Risk: Denomination of Contract 5 Other Yen US Dollars 1 5 Risk: Political Risk 1 Extremely Risky Somewhat Risky Little or No Risk 2 2 Ramp-up time 1 > 4 months 3-4 months < 3 months 2 2 Total Score 99 * Total costs include unit price, transportation, tooling, quality non conformance costs, duties/customs, safety stock carrying charges, delivery non-conformance costs, ordering, inbound receiving, and inspection costs.

17 Page 17 of 20 Appendix 2 Total Cost of Analysis Worksheet Total Cost Analysis Worksheet-Year One Cost Category Elecom SureTech E-Drive Park Quoted Unit Price Transportation Tooling Quality non-conformance costs Duties/Customs Insurance Safety stock carrying charges Delivery non-conformance costs Ordering, inbound receiving, and inspection costs Estimated Per Unit Total Cost Total Cost Analysis Worksheet-Year Two Cost Category Elecom SureTech E-Drive Park Quoted Unit Price Transportation Tooling Quality non-conformance costs Duties/Customs Insurance Safety stock carrying charges Delivery non-conformance costs Ordering, inbound receiving, and inspection costs Estimated Per Unit Total Cost Quality non-conformance costs 300 per unit Unit requirements units in year one units in year two Conversion Rate 120 yen/dollar Asian Safety Stock 4 weeks Domestic Safety Stock 2 weeks Average Weekly Demand, yr units Inventory Holding Costs 18%

18 Page 18 of 20 Appendix 3 Financial Ratios For Period Ending December 31, 2002 (U.S. $ in millions where applicable) Elecom SureTech E-Drive Park Average Current Ratio Quick Ratio Average Collection Period Inventory Turnover Fixed Asset Turnover Total Asset Turnover Debt Ratio Debt-to-equity Ratio Long-term debt to equity Times Interest Earned Return on Asset 2.5% 10.7% 7.4% 4.7% 6.3% Return on Equity 6.5% 21.7% 16.9% 9.9% 13.8% Gross Profit Margin 15.4% 25.9% 35.0% 30.0% 26.6% Net Profit Margin 1.9% 6.8% 4.5% 3.4% 4.2%

19 Page 19 of 20 Appendix 4 Same Size Income Statements Year Ended December 31, 2002 Elecom SureTech E-Drive Park Average COGS 84.6% 74.1% 65.0% 70.0% 73.4% Gross Profit 15.4% 25.9% 35.0% 30.0% 26.6% Gen & Adm. Exp. 7.3% 11.8% 24.8% 18.5% 15.6% EBIT 8.1% 14.1% 10.2% 11.5% 11.0% Interests 4.6% 2.2% 2.8% 4.1% 3.4% EBT 3.5% 11.9% 7.4% 7.5% 7.6% Taxes 1.5% 5.1% 2.9% 4.1% 3.4% Net Income 1.9% 6.8% 4.5% 3.4% 4.2% Income Statements Year Ended December 31, 2002 (U.S. $ in millions) Elecom SureTech E-Drive Park Net Sales $ 6,500 $ 550 $ 2,300 $ 1,355 Cost of Goods Sold $ 5,500 $ 408 $ 1,495 $ 949 Gen & Adm. Exp. $ 475 $ 65 $ 570 $ 250 Interest Expense $ 300 $ 12 $ 65 $ 55 Costs and expenses $ 6,275 $ 485 $ 2,130 $ 1,254 Income before income taxes $ 225 $ 66 $ 170 $ 102 Estimated taxes on income $ 100 $ 28 $ 67 $ 55 NET INCOME $ 125 $ 38 $ 104 $ 47

20 Page 20 of 20 Appendix 5 Capacity Issues Company Used Capacity Market Share Capacity* Available Elecom 98% 30% SureTech 92% 4% E-Drive 96% 20% Park 92% 12% *Capacity based upon stated market share Market determined to be units based upon Appendix 1, sales of 5m players The company with the highest available capacity only can produce units, therefore with all companies able to accept our contract for units, we do not consider capacity an issue