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Wednesday • April 14 • 2004

Reference • Global Supply Chain Management

To • George Foo

From • Rogge Heflin

Recommendation Overview

To mitigate supply chain material shortages: • Forecast product and feature demand • Pre-order parts at time of sale • Synchronize material orders with supplier manufacturing cycles • Monitor all materials in supply chain • Increase number of tier one and add tier two suppliers • Design new products using generic parts and focus attention to software development

Reevaluation of Supply Chain

The sudden current shortage of key parts in the 5ESS® signaled the need to review the current supply chain. A scan of the industry using Michael Porter’s Five Forces, Appendix 1: Michael Porter’s Five Forces Scan, indicated many problems, but improving the supply chain will reduce problems with competitors, Appendix 2: Root Cause. The supply chain model has been improved over the last decade, but room for improvement still exists. The information learned during the supply chain changes can be used to integrate new changes smoother. It is important that during the new change implementation, how changes are made and why changes are made is just as important as the changes that are made [9 p104]. These changes must not hurt the two most important competitive advantages: the 5ESS® switch is the world’s most reliable and widely used switching system and a highly efficient manufacturing operation [4 p3, 11]. The hub and spoke procurement model worked well when 5ESS® demand was low, but when the demand increased, “these leading procurement arrangements were sorely testes and in some cases broke down” [4 p10].

5ESS® Demand

The fixed line teledensity in the Asian is never more than 67.5% and averages close to 30.0%. The need to connect people drove the telephone system development toward efficient voice networks. The current trend, from voice networks to data networks changes, the demands placed on the telephone system; therefore, the equipment necessary to efficiently operate the network as demands change [4 p11].

Although the wireless teledensity, never more than 80.5% and averages 44.9%, is higher than fixed lines, this market has much more potential to use the 5ESS® switch. In either sparsely of heavily dense areas, it is very expensive to install phone lines; however, one cell tower has the ability to service many people. Since the cellular phone network is a voice network, the switch has potential to be used with cellular voice networks.

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Action: Direct customers to readily available configurations. By steering customers to configurations with ample parts supply, on-time delivery rates will increase [3 p73]. In addition to promoting available configurations, continue to focus bidding on projects where the switch has cost and feature advantages over competing products [4 p9]. The sales and marketing force need to learn the production costs to help Lucent gain the most profit from each sell.

Action: Forecast the quantity and features required on 5ESS® switch orders. The forecasting of switches and switch configuration also forecasts the number of parts needed, thereby reducing potential part shortages.

Action: Forecast the need for data network products. Since the switch and switch market is nearing maturity, other products will be in demand. These products are based on packet switching technology, data networks, and light wave multiplexing.

When forecasting, it will be necessary to determine what products and features, therefore parts, can and cannot be accurately forecasted [3]: • Use historical data to help develop a forecast to increase forecast accuracy. • Use individual and independent forecasts to measure forecast accuracy. • Incorporate actual demand into forecast to fine tune current production forecasts. • Track forecast errors to better estimate future forecast estimates. • Create a production model based on demand probability to allow production desired goods.

Action: Offer reconfiguration service for 5ESS® switches from landline voice networks to cellular voice networks. Since the switch is being reused, the need for parts is reduced. Here the service, connecting the switch to lines from new cell towers and configuring the software for cellular phone use, will generate revenue with out increasing the demand for parts.

Part Shortages

Although the switch is an engineered to specification product, 91.5% of all parts are generic and can be ordered from Asian suppliers [4 Exhibit 5]. The remaining 8.5% of parts are either cheaper in non-Asian countries or truly proprietary and shipping costs become important cost drivers.

Diagram 1: New Supply Chain Ordering Changes Indicated by Emphasized Lines

Customer

Taiwan Joint Venture Lucent Partner

Additional Parts Suppliers

Additional Parts Suppliers

Oklahoma City Lucent

Parts Suppliers United States

Second Tier Suppliers

Second Tier Suppliers

Second Tier Suppliers

Parts Suppliers Asia

Second Tier Suppliers

Joint Venture Sales / Order Taker

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79.2% of the Asian built parts, 75.4% of the all 5ESS® parts, require only simple manufacturing capabilities [4 Exhibit 2]. 86.9%1 of all parts in the 5ESS® can be forecasted at the time of sale.

Action: Pre-order all generic parts necessary for any 5ESS® from suppliers and joint ventures at the time of order. While the 5ESS® is being designed, notify the suppliers about part quantity, design, and deadline changes, fine tuning the actual number of and type of parts needed. Notifying all suppliers at the time of order and throughout the design process will allow them to forecast their production and to fulfill parts requests in a timely fashion. [3]

To affect this part ordering change, the partnership nature will have to change. The current linear supply chain will move to broadcasting parts forecasts to all joint ventures and part suppliers at the time of the order. To communicate forecast data quickly, the systems and processes must be implemented throughout the entire supply chain from suppliers to joint ventures to manufacturing plants to the corporate office [2 p160].

Action: Synchronize order placement with supplier manufacturing cycles. Although communication about forecasts and needed parts help reduce inventory and costs, aligning part orders with manufacturing cycles can reduce inventory levels by 14% and reduce out of stock parts to 2%. [1 p4, 7]

Total Supply Chain Material Tracking

If concentrated demand occurs, it is possible that the local suppliers will not be able to fulfill the demand.

Action: Track all materials in the supply chain and the supplier production capabilities. When one supplier cannot fulfill its primary plant’s needs, order the part from another plant’s supplier region. This will reduce the lag time from waiting for the local supplier to fulfill its orders. The internet and internet technologies can be used as an inexpensive method to link in real-time suppliers, pants, and joint ventures. This linking will give visibility to the entire supply chain through out the supply chain to better plan manufacturing and part procurement. [6 p5]

Sole Suppliers

Parts with only one supplier typically have lead-times twice that of multi-supplier parts. These longer lead-times increased the amount of in-production switches by about 25% [4 p10]. As more manufacturing plants become advanced, they become able to manufacture complex parts. As the competition to supply complex parts for the 5ESS® increases, the lead-time, price, and quality for these complex parts improves.

Action: Partner with additional suppliers not necessarily in Asia, that can inexpensively produce parts. Change the interactions from a Lucent-supplier partnership to a Lucent-vendor relationship, which will increase the vendor’s commitment to success [8 p4]. Also, require the suppliers to have the ability to supply at least 25% of parts necessary for any order.

Action: Create partnerships with second tier suppliers. The inclusion of second tier suppliers, although increasing the complexity of the supply chain, will reduce the probability of material shortages. The more suppliers that are involved, the more likely that at least one supplier will be able to fulfill part demands.

1 95% confidence interval that any 5ESS® built can have 86.9% of its parts built in local-market plants.

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When creating partnerships and joint ventures, specific requirements need to be satisfied. The following requirements can be used to evaluate the feasibility of continuing to improve internal capabilities or outsource some production: • Manufacturing capabilities • Bell Labs certification • Additional services offered • Understanding of market needs • Manufacturing cost

• Manufacturing timeliness [10 p19] • Shipping timeliness [10 p19] • Failure percentage [10 p19] • Production accuracy [10 p19] • Shipping accuracy [10 p19]

Internal Improvements or Complete Outsourcing

Less than 8.5% of all 5ESS® parts are proprietary [4 Exhibit 5]. Considerable cost savings result from manufacturing in close proximity to the consumer. These cost savings stem from improving relationships with the consumer, steering bids to projects with the best cost benefits, and leveraging each plants benefits.

Action: Develop products using generic off-the-shelf components while focusing resources on software. By using common components, the number of suppliers is large. The large number of suppliers will reduce the change of any material shortages. Switch software can be easily implemented and upgraded, thereby generating revenue mainly by intellectual property with little influence from material costs, shortages, and hardware development.

Action: Use factory expertise to reduce manufacturing lead-time, improve product quality, and reduce costs. Send the largest orders to Oklahoma City, the most complex to Taiwan, and the least profitable to Qingdao. Twice per year, hold a symposium to discuss and transmit information on how one factory is able to specialize in one area. Sharing knowledge will help all factories improve their production capabilities. By utilizing the expertise of each factory and teaching other factories, this model will be useful and effective in future environments.

Action: Build proprietary parts in wholly owned Lucent facilities; assign the remaining production as close to the consumer as possible. However, when the forecasted production for any factory nears 90.0% of capacity, assign subsequent orders to factories with the highest forecasted capacity slack and the ability to build the parts. Distributed manufacturing assignments will balance concentrated demand across a wider supply source. The 10% underutilization is for orders requiring expedition.

Geographic Market Plant Plant Expertise

North America Oklahoma City High Volume

South America Spain

Europe Spain

Asia Taiwan Custom Products

India Qingdao Lowest cost

Table 1: Geographic Market and Plant Associations [4 p10]

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Other Problems

Employees Discomfort with Change – The employees need to positive results to obtain their buy in. Focusing on the positive results from the previous supply chain change and relationship with joint ventures and how these new changes will also have positive results, the employees will be more willing to accept the changes. In addition, employee buy in will increase if they are part of the redesign and can suggest and implement improvements to the process themselves [9 p98].

Economies of Scale in Oklahoma City – Although the Oklahoma City plant has a large capacity, economies of scale do not fully apply to parts made completely by machine. A new automated plant can produce as much as the Oklahoma City plant can.

Change from State Controlled Companies to Local or Private Control – Although this change significantly alters the market place, high levels of corruption continue to exist and affect business practices. Lucent, the joint ventures, and suppliers need to be aware of the challenges that will be raised when dealing with corruption as these ownership changes take place. [7]

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Appendix 1: Michael Porter’s Five Forces Scan

Bargaining Power of Suppliers – The 5ESS® is engineered to customer specifications; therefore, the customer determines the functionality. If the 5ESS® is not designed to meet the customer’s demands, the customer will purchase a similar switch from another company. The consumer demand and willingness of other suppliers to customize their products leaves little bargaining power with suppliers.

Bargaining Power of Buyers – A typical switch costs about $1 billion and telephone companies usually use the same switch in many locations throughout its telephone network. Due to the high cost of one unit and high probability of future purchases, the buyers can demand specific functionality from a switch. If one company will not provide exactly what the customer needs, the customer can purchase a similar switch elsewhere.

Entry into the Asian market required the formation of joint ventures. Law required these joint ventures to enter the market. If a company did not form a joint venture, then the company could not do business in Asia.

These two factors, consumer demand and required joint ventures, indicate high buyer bargaining power.

Threat of Substitutions – Only class 5 software controlled switches are direct substitutes for the 5ESS®; Alcatel, Nortel, Siemens produce competing class 5 switches. Due to the ability of competitors to supply switches, the threat of substitution is moderate to high.

Threat of New Entrants – Alcatel, Nortel, and Siemens produce software operated switches similar to the 5ESS®. Low cost and lead-time, precedents set by Lucent, are the biggest barriers for Alcatel, Nortel, and Siemens. Competing companies with the ability to supply switch products sets the threat of new entrants in the Asian switch market is very high.

Competitive Rivalry – Asia is the fastest growing market for telephone switches. Many telephone equipment providers would like to sell in the Asian market. The desire by many companies to gain market share in the Asian market increases the competitive rivalry.

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Appendix 2: Root Cause

Diagram 2: Root Cause Diagram

Appendix 3: Material Percentage Calculations

5ESS® Asia

Component type Quantity Percent Quantity

Integrated circuit Mature 508 83% 421.6 Power module Mature 21 31% 6.5

PCB Mature 69 72% 49.7 Other active Mature 131 75% 98.3 Capacitor Simple 144 81% 116.6 Resistor Simple 504 98% 493.9

Other passive Simple 268 98% 262.6 Metal parts Simple 832 95% 790.4 Backpane Mature 32 39% 12.5

Cable Simple 588 99% 582.1

Total 3097 91.5% 2834.28 95% confidence 86.9%

Table 2: Material Percentages

Local Material Shortages

Late Production

Late Shipment

Poor Forecasting Few Suppliers

Poor Material Tracking

Customers Go Elsewhere

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Appendix 4: Material Complexity Calculations

5EES® Switch Total Type Quantity Percent

Mature: 761.0 24.6% Simple: 2336.0 75.4%

Table 3: Mature Part Calculations for 5ESS® Switch

Parts Manufactured Asia Type Quantity Percent

Mature: 588.6 20.8% Simple: 2245.7 79.2%

Table 4: Mature Part Calculations for Asia

Appendix 5: Resources 1. Ashiya, Mona. Syncra Systems. Harvard Business School. 13 March 2003.

2. Broadbent, Marianne. The Implications of Information Technology Infrastructure for Business Process Redesign. MIS Quarterly. Volume 23. Number 2. Pages 159-182. June 1999.

3. Fisher, Marshall L., et al. Making Supply Meet Demand in an Uncertain World. Harvard Business Review. May-June 1994.

4. Hoyt, David. Lucent Technologies: Global Supply Chain Management. Leland Stanford Junior University. Stanford, California. January 2001.

5. Magretta, Joan. The Power of Virtual Integration: An Interview with Dell Computer’s Michael Dell. Harvard Business Review. March-April 1998.

6. McAfee, Andrew P. IBM Technology Group. Harvard Business School. 13 March 2003.

7. Shum, Martin. Executive Informational Interview. 31 March 2004.

8. Sole, Deborah. Harley Davidson Motor Company: Enterprise Software Selection. Harvard Business School. Boston, Massachusetts. 22 January 2003.

9. Spear, Steven and H. Kent Bowen. Decoding the DNA of the Toyota Production system. Harvard Business Review. September-October 1999.

10. Kulp, Susan. Metalcraft Supplier Scorecard. Harvard business School. 24 March 2002.