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Up Close and Virtual

Want to join EMC Corp.'s supply chain?
Kris Frieswick, Others
April 1, 1998

To high-tech companies, outsourcing and alliances are old hat; the pace of technology makes going it alone difficult for even the largest businesses. But EMC Corp., in Hopkinton, Massachusetts, is pushing these strategies to new lengths. Since 1990, the maker of enterprise data storage systems has drawn closer and closer to its 25 top-tier suppliers--so close that it's sometimes hard to discern where EMC stops and the suppliers begin.

"Hardly a day goes by that there isn't an EMC person in our design facilities, and vice versa," says Charles Pope, CFO and senior vice president of finance at Seagate Technology Inc., in Scotts Valley, California. Seagate makes the multigigabyte disk drives that are the guts of EMC's flagship product, Symmetrix. Seagate recently unveiled the Elite 47, a drive that was designed in close collaboration with EMC engineers. "We probably would not have done the product if EMC had not wanted it," says Donald J. Kelly, senior vice president, worldwide product-line management.

But EMC wants more from suppliers than custom-designed products. In return for its business, the company expects suppliers to keep their costs and prices rock-bottom low. To that end, EMC keeps close tabs over suppliers' financials and often monitors the prices and availability of raw materials. EMC will even broker discounted prices with its suppliers' suppliers, which it then uses to negotiate margins and prices. And the company will follow up by setting continuous cost-cutting and quality-improvement goals, which suppliers are expected to meet.

EMC, in short, is the brain of a many-limbed organism, which functions as one to conceive, create, test, and market products. It has essentially transferred the costs of manufacturing and continuous technological advancement to its suppliers. The company maintains design, specification, material sourcing, testing, and marketing control, and it works hand-in-hand with suppliers to perfect production techniques. But it carries no inventory other than finished final product, thanks to just-in-time (JIT) delivery arrangements.

How effective is this business model? It has enabled EMC, a mere upstart with $190 million in sales in 1990, to outmuscle giant IBM in the market for data storage systems. The company, boasts CFO William J. Teuber, can ship product faster than its competitors, consistently satisfy its customers, and fill orders as quickly as they come in. In addition to product capability, Teuber proudly credits this fleet-footedness for EMC's phenomenal growth. Sales rose from $386 million in 1992 to $2.9 billion last year, and net income rose from $29.5 million to $539 million in the same period. Inventory turns climbed to 4.5 this past February, the highest level in company history, while inventory levels decreased by $44 million in the last quarter alone. EMC, which now has 6,300 employees, had a gross margin for 1997 of 46.5 percent--one of the highest in the industry, according to Teuber.

Sound too good to be true? There are, in fact, potential drawbacks to these collaborative customer-supplier relationships, which have been variously dubbed virtual corporations, keiretsu, or, perhaps more persuasively, micronetworks (see "Micro-networks," page 90). Micronetworks may fall apart because one or more of the participants can't deal with the intimacy. Suppliers may resent the intrusion of big customers breathing down their necks, and the bargaining for mutually acceptable prices can become heated. Failing health of one or more suppliers can put inconvenient kinks in the supply chain.

But EMC has shown that these highly integrated, trust-based relationships can be a win-win proposition for all involved. Here's how.

A RISKY DECISION
EMC was still a small memory-board manufacturer when it was ready in the late 1980s to go into production with Symmetrix, a high-capacity enterprise data storage system. According to Gerry McAndrews, EMC vice president of supply-based management-technical, the decision to create a micronetwork wasn't hard. All founder and chairman Richard Egan and president and CEO Michael Ruettgers had to do was look around at the Massachusetts minicomputer companies--Wang, Prime Computer, Apollo Computer, Digital Equipment Corp.--that were slowly sinking under the weight of huge manufacturing facilities and large work forces.

Once the decision was made, EMC moved fast. By 1990 it had set up its new micro-network partnerships, and later closed the Puerto Rico facility at which it had started assembling boards for Symmetrix. The first batch of Symmetrix systems, made completely within the micronetwork, shipped in December 1990.

In hindsight, the decision to create a micronetwork was sound, but at the time it was risky and almost untried. Finding healthy suppliers was crucial; any weak links in the supply chain would mean missed deadlines and loss of quality, and the resulting financial exposure. EMC, therefore, set up a system for rigorously analyzing a potential supplier's finances and production processes, going far beyond the standard reference and background checks that most customers require.

For instance, EMC reviews a supplier's overall financial position, evaluates its relationships with its other customers, examines its margins and production overhead, charts internal metrics, and, in some cases, conducts a physical review of the supplier's factory. "We know what the costs of production are," says Teuber, "so it's not hard to see if a company is doing things right."


PLAYING BY EMC'S RULES
In addition to supplier stability, EMC needed strict cost containment on its out-of-house manufacturing costs. On this front, EMC takes a two-pronged approach.

First, it attacks the cost of raw materials. For some components, such as Symmetrix cabinets, the company specifies the raw materials to be used. In those cases, EMC goes directly to its suppliers' suppliers and negotiates prices and volumes. On commodity-based parts, such as disk drives, the company monitors industrywide pricing and availability via market research reports. "We'll obviously go with whichever pricing structure will save us the most money," says McAndrews. "To do anything else would be irresponsible."

Second, EMC attacks production overhead. It tracks industry subcontractor prices and production costs, using its market research sources. When it finally sits down at the negotiating table with its suppliers, it already knows what they are paying for raw materials, what their costs of overhead should be, and what other subcontractors are charging to do the same work. All that is left on the table is the cost of facility overhead and profit. At that point, if the supplier wants to play ball with EMC, it plays by EMC's rules.

Bob Schneider, vice president and site manager of Electronic Manufacturing Systems Inc. (EMS), in Westbrook, Maine, was a little taken aback when EMC originally sat down to negotiate prices and costs at that level of detail. "It was new territory," recalls Schneider. "But we were very aggressive about winning the business." EMS makes the cabinet and does subassembly for Symmetrix. "[EMC was] trying to make sure they were getting a competitive price," says Schneider. "They weren't trying to squeeze us, but it's up to us to run efficiently."

Today, a large percentage of EMS's $200 million-plus in annual sales comes from EMC. EMS agreed to a fixed rate of markup on its production raw materials, and provides costed bills of material so that EMC can see how much each cabinet costs to make. EMS further agreed to continuous cost reduction. If it can reduce the cost of making the cabinet, it shares that cost difference with EMC.

"We want to keep [our suppliers] healthy and profitable," comments McAndrews. "Some of our suppliers have grown with us over the course of 11 or 12 years. We don't want to squeeze every cent out of them. That would be our failure." Yet, EMC will not hesitate to change suppliers if it perceives it isn't getting the most value from the relationship. "If they don't work with us," says McAndrews, "then the competition comes in and they lose the slot."

KNOWLEDGE SWAPPING
Another major risk of EMC's strategy is losing firsthand contact with storage technology expertise, the company's bread and butter. It addresses this risk by making personnel- and knowledge-swapping with its suppliers a key component of the micro-network, to ensure product quality and to keep itself in the game.

For example, EMC personnel not only helped Seagate design the Elite 47, they helped test the disk drive during the design and production stages, which enabled Seagate to bring it to market faster. "EMC gets involved in the disk drive at its beginning stages of development, much more so than most other customers we do business with," says Seagate's Kelly. "Their involvement helps us achieve our time-to-quality targets quicker, and it helps us get to our time-to-volume quicker, which means faster realization of revenue on the product."

To minimize the risk of inventory shortfalls, yet another hazard of micronetworks, EMC uses manufacturing resource planning (MRP II) documents to alert its suppliers to production needs. MRP II, which EMC considers the backbone of its micronetwork, is a highly detailed sales forecast that is translated into a current-quarter production forecast based on projected sales numbers, and into a subsequent-quarter forecast based on market requirements, explains CFO Teuber. The forecasts, adds McAndrews, have proven to be accurate to within 5 to 10 percent. (Symmetrix is a high-ticket, sophisticated item with a list price of between $260,000 and $3 million, and EMC execs admit that current-quarter forecasts aren't as difficult as they would be with a product with volatile demand cycles.) The supply loop is closed when some suppliers ship their products to warehouses near EMC's final assembly facilities in Massachusetts and Ireland to facilitate JIT delivery.

QUARTERLY REVIEWS
Micronetworks don't work unless there is a "partnership" mentality, point out EMC executives. To foster this, EMC has changed the way it reviews its suppliers. It now uses a quarterly supplier review process not only to monitor the financial health and happiness of the micronetwork, but to keep tabs on delivery, cost-cutting, and quality benchmarks. Senior supplier executives meet with EMC counterparts to discuss each other's strengths and weaknesses and to swap best practices.

"It used to be that companies would have report cards on which we would be evaluating the supplier's performance," says McAndrews. "They'd get a score, and that was that." Now, he says, the report cards are co-written. "We look at the state of the business. We ask: How did you do in revenue dollars? How did we collectively do in revenue and cost reduction, and where are our resources redundant?"


For some companies, all this togetherness is a bit too much. EMC has changed at least 2 of its 25 top-tier suppliers because of cultural differences or quality issues, according to McAndrews. But the remainder of the supplier relationships have been mutually satisfying, he adds. For the most part, suppliers agree. "Our close relationship has been very beneficial to both companies in every regard," declares Kelly of Seagate.

SUPPLIER-SIDE CONCERNS
But even close relationships can favor one party, and micronetworks are no exception. From EMC's perspective, micronetworks are a great deal. For suppliers, however, the partnership may be somewhat less fulfilling. According to Beth Enslow, senior analyst specializing in supply-chain management at Gartner Group, in Stamford, Connecticut, micronetwork relationships are based on trust and the promise of continued mutual success, not on binding, sole-sourcing agreements. For all the talk of partnerships, micronetworks still place the supplier in a subservient position in most cases. Opinions vary on whether that position is better or worse than in traditional customer-supplier relationships.

Seagate CFO Pope points out that for suppliers, the JIT component of these relationships is more difficult to manage than a traditional delivery system, especially if the supplier relies on its own JIT arrangements with subsuppliers. Price erosion, like that in the disk drive industry, makes JIT agreements even more hazardous. Under JIT delivery, customers usually don't order an inventory buffer. The customer takes delivery of smaller orders in batches, as needed. Price erosion and the resulting shorter (sometimes weekly) pricing cycles mean that each JIT batch fetches a slightly lower price than the previous batch.

"If you didn't change how you were doing business, it would be a financial negative," says Pope. "But the increased volume from key customers may have a positive margin impact if you adjust the rest of your business." Seagate is doing just that. To cut manufacturing costs, it is standardizing the design of many of its products. In addition, it's beginning to implement some of the same supply-chain management techniques that EMC uses to evaluate, weed out, and integrate more closely with its own suppliers.

EMS, too, has had some issues with its partnership with EMC, issues the two companies are trying to work out. "JIT to us means keeping our work-in-progress as low as possible, so when change comes, there isn't a lot of work out there," says Schneider. "And we've had some years when EMC missed the mark on forecasting, and then with two months left in the quarter, they realize they are going to need more and we have to go into an overtime situation."

On the plus side, suppliers, specifically in the disk drive industry, benefit from the micronetwork's increased focus on production forecasting. Traditionally, disk drive manufacturers have built units in anticipation of purchase orders, explains Pope, but they did so without benefit of detailed forecasts. In addition, customers that canceled purchase orders at the last minute were rarely penalized.

"Drive suppliers have borne a disproportionate amount of the risk all along," says Pope. "In many respects, this arrangement has been better for us. The companies are giving a lot of attention to forecasting and bringing us into the loop far earlier."

Aside from increased revenue, one of the biggest benefits of micronetworks for suppliers is that they are pushed to streamline, cut costs, adopt best practices, and improve product quality, which makes them more attractive to other customers.

"We enjoy the business because we are keeping [EMC] successful," says Schneider, "and if you have a customer that's ready to work with you to take you to the next level--and EMC does that--it makes you stronger. We've changed our organization and our methods, and we're a better company for it."

For better or worse, Gartner's Enslow expects micronetworks to catch on big in the near future.

"The whole issue of collaborative supply-chain processes is going to be a big focus very soon," predicts Enslow. "Once companies are over the Year 2000 [problem], they'll be looking for the next big opportunity, and they're probably going to be looking externally."

Kris Frieswick is special projects editor at CFO.

    MICRONETWORKS
------------------------------------------------------------------------ ------------------ EMC isn't the only company that has formed a micronetwork.  Companies as diverse as Nike, AlliedSignal, Sara Lee, and Sun Microsystems have also decided that designing and marketing products, not making them, are their core competencies. Some analysts compare these micronetworks to the Japanese keiretsu, in which a number of companies are tightly linked (usually holding equity positions in each other), sharing a common goal and motivated to make decisions that result in mutually beneficial outcomes.

Micronetworks generally feature most of the following elements: personnel- and knowledge-swapping between supplier and customer; degrees of access to each other's financials, operations, and often, proprietary processes; commonly recognized goals and metrics; common business processes; just-in-time inventory management; compatible or integrated computer systems; and a long-term relationship or primary supplier status for chosen vendors.


Beth Enslow, a senior analyst specializing in supply-chain management at Gartner Group, in Stamford, Connecticut, says micronetworks are catching on fastest in industries that are under duress--forced by outside influences to effect drastic change. In the apparel industry, for instance, micronetworks have become the norm because of the comparatively high price of U.S. labor. In high tech, the rapid pace of technological change is forcing companies to try the micronetwork approach. In the utility industry, deregulation is the impetus. Industries with highly volatile supply chains and demand cycles are also prime candidates for micronetworks, says Enslow.

The benefits of micronetworks are not necessarily cost savings, adds Enslow, but flexibility and revenue enhancements. "You can be more agile," she says. "Everyone in the micronetwork is focused on being the best at his or her own functions. If you can optimize the functions across the organization so that you're synchronizing activities, you can outcompete another company that's trying to do everything itself. It's a 'How can I make more money?' strategy rather than a 'How can I save money?' strategy." -- K.F.




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