The Alpha Omega Corporation

The Alpha Omega Corporation, one of the world’s largest computer manufacturers, faced increasing challenges from a number of competitors for the market share needed for profitability and success. In recent years, the company had undertaken several efforts aimed at improving its profit margin and increasing sales.

One such effort was the centralization of a group of talented procurement and component engineering personnel from around the country to one site. This new organization, known as CXO, had its humble beginnings in 1982 with a mere six procurement people and twenty component engineering personnel. Being the “darling” of the corporation, CXO added employees at a rate exceeding any other organization in the company; the head count now exceeds 150-20 of whom are employed in supply management functions.

Within the supply management department of CXO, there are seven commodity managers, eight supply managers, and five support personnel. The organization has responsibility for the procurement of all integrated circuits used throughout the corporation as well as for negotiation of corporate pricing agreements in effect for most other repetitive purchases. The number of part numbers that CXO procures is approximately 2,000, of which all are received at CXO, tested, warehoused, and ultimately shipped to manufacturing plants worldwide. Other components used in Alpha Omega products are purchased and received directly by the system plants, against corporate pricing policy agreements negotiated by CXO.

CXO procurement, in negotiating all pricing agreements, utilizes a materials requirements forecasting system created and installed by a team of in-house management system specialists at every manufacturing plant in the United States. This forecasting system collects data from each plant’s own master schedule system-extracting the data in such a way that when data from all plants are combined, the information is homogeneous. The data collected are the basis of the forecast for the next eighteen months.

CXO buys against plant forecasts and requires its customers (the manufacturing plants) to place delivery orders against CXO contracts to cover the next five to nine weeks’ requirements. On an individual plant basis the orders seldom match the forecasts, which are obtained monthly and are probably outdated almost immediately; however, on an aggregate basis the total quantity ordered for any given part number roughly approximates the total forecast for all plants.

CXO procurement negotiates future contracts with qualified suppliers using aggregate forecasts. Typically, an RFQ is sent out to all potential suppliers, many of whom respond with a bid. When the bids are received, supply management manually compiles the data in the first step of the award process. Second, supply management queries engineering and procurement personnel from all plants in an effort to obtain a service rating of the prospective suppliers. Test data likewise are collected from the test database and massaged to eliminate erroneous data. All this is a very time-consuming process and renders supply management almost incapable of processing any new purchase requisitions during the pre-award period.

Eventually the contract is awarded to one or more suppliers based on several factors: qualification by engineering, price, past service, and quality ratings. Suppliers who have not yet been qualified are tentatively awarded a portion of the contract, but no deliveries will be requested or accepted until the supplier is qualified.

Once the contract is awarded, supply management hopes that suppliers will perform up to the wording of the contract. Unfortunately, in spite of agreeing to make on-time deliveries of the right quantity and the right quality level, suppliers are often late or early, often deliver below what was ordered, and frequently ship parts that subsequently fail testing. 166 Guy Craig, commodity manager for memory and microprocessor devices, was quite concerned. His supply managers spent hundreds of hours determining which suppliers should be awarded contracts. In spite of this effort, the suppliers performed at an acceptable level only so far as price was concerned.

Guy shared his dissatisfaction in quarterly reviews with the suppliers. He had nothing quantitative to back up his claims, with one exception: test histories were available, but were skewed on the negative side by lots purchased as “standard product” due to orders that were not forecasted. These parts were tested to Alpha Omega specifications and results had been erroneously counted against the supplier’s quality rating. (Normally when a supplier supplied to an Alpha Omega spec, it special-tested the parts in-house at the same parameters used by Alpha Omega.) Consequently, before test data could be shared with potential suppliers, manual manipulation of the data was required to properly document quality levels.

The supply management database used by CXO contained all information pertinent to a purchase order and subsequent receipt of material. Guy, while not a computer whiz by any means, was knowledgeable enough to realize that with the help of management systems, he could obtain information on supplier performance by purchase order (i.e., on-time versus early or late delivery, and receipt in full versus partial receipt of the quantity ordered).

The finance and materials departments both shared supply management’s concerns about supplier performance. Safety stock inventory levels had increased to guard against suppliers who did not deliver to contract. The desired inventory level was three weeks of material at an estimated cost of $3 million per week. CXO inventories had climbed to five weeks, clearly a detriment to a company with cash flow difficulties. The cost of this idle inventory was enormous; however, the potential costs associated with lower inventories (production disruptions and possible lost sales) were even greater.

In recent supplier reviews, some of the suppliers expressed the idea that if parts were sampletested rather than 100 percent tested, the test cycle could be shortened, resulting in lower work in process inventory levels. The Alpha Omega quality department was not ready to go to sample testing except on parts that consistently achieved test failure rates of no more than 500 parts per million. The suppliers then suggested that if commercially standard products were specified, no additional testing should be required at either the supplier’s site or Alpha Omega’s. This would result in lower-cost purchased material and shorter lead times as well. Guy agreed with their ideas. He established an additional objective of obtaining engineering concurrence with the adoption of standard products in lieu of specially tested parts when possible. Engineering was less than enthusiastic about Guy’s involvement in “its area.”

As Guy sat in a deserted building late one Friday evening, he looked at the list of objectives to be accomplished by CXO supply management this year. One jumped out at him: CXO had stated that it would save the corporation $10 million this year in favorable material price variance. Guy also knew that the corporation expected CXO to become 10 percent more productive this year. He felt that there was a significant amount of money to be saved throughout the organization if suppliers met their contractual obligations with regard to quality, quantity, timeliness, and service. His estimate was that 25 percent savings could be achieved if suppliers performed as stipulated. But how could be get there from here?

1. What is the basic reason that suppliers have consistently failed to meet their contractual obligations?

2. What can be done to ensure adequate supplier performance in the future?

3. On what basis should contracts be awarded?