Pacific Systems Corporation Case Questions: 1. What is your recommended sourcing strategy in this ca

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Systems Corporation Case


1. What is your recommended
sourcing strategy in this case? Please support your decision with quantitative
and qualitative evidence gathered during the case analysis. Also, present your
plan to reduce any risks associated with your sourcing decision.

case provided the data necessary to perform a cursory supplier financial
analysis. In reality, cross-functional sourcing teams must often obtain this
data during their assessment of potential suppliers. Discuss possible sources
of supplier financial information. What may impact a purchaser’s ability to
obtain supplier financial data?

sourcing decision of the magnitude highlighted in this case requires a serious
commitment of resources and time. Do all sourcing decisions require similar
commitments of time and effort? If not, describe the types of sourcing
decisions that justify this effort. Describe the types of sourcing
decisions that do not justify or require the level of effort and
analysis required in this case.

4. How important is the issue
of supplier capacity in this case? How did your group evaluate supplier
capacity? What level of attention or importance should supplier capacity
receive during the sourcing decision? Why?

selection decisions, such as the one presented in this case, usually require
many weeks or months of analysis and discussion before reaching final agreement
with a supplier(s). Creatively identify ways that the buying company can
shorten the time from recognition of a purchase need to reaching
agreement with the selected supplier.(Hint:Consider performing
certain required activities concurrently or in anticipation of a purchase

Systems Corporation, Inc. (PSC) is a medium-sized high technology company
located north of San Francisco. In its early years PSC produced component parts
and subsystems for personal computers and engineering workstations. In 2000,
PSC added its own line of engineering workstations to its product offering.
Recently, the company decided to expand its product line to include fully
assembled personal computers (PCs). The company, recognized as a
well-established component and subsystem manufacturer, has grown from a single
product manufacturer with annual sales of $2.5 million, to a multi-product $3
billion firm in just ten years. This growth was helped in part through
acquisitions in server markets and related computer industries. Pacific Systems
Corporation has a strong reputation for manufacturing high quality products
with on-time customer delivery. The company also emphasizes state-of-the-art
technology in its product design, production, information, and delivery

PSC’s decision to enter the
personal computer market occurred during the peak of the Internet boom in late
1999. In particular, the marketing department decided to focus on the home PC
user, to exploit the booming growth in home computer use. The projected growth
rate of U.S. PC shipments to the home sector in the 1990s exceeded the business
sector, and was predicted to surpass the business sector in total share of
shipments.1 Although Pacific Systems

1 “Home
Computers”, Business Week, November 28, 1994, pp. 89-96.

was a small player in this market the company decided to pursue an aggressive
strategy of selling high quality computers at affordable prices. The new line
of computers, called the 9000x series, would come with a Pentium 600 MHz
microprocessor, 128 megabytes of memory, 8-14 gigabytes of hard disk space, a
read/write CD-ROM/DVD (digital video disc) drive, and a 17-inch flat screen
color monitor.

industry forecasts have certainly been downgraded, PCS is betting that in 2003
the computer industry will grow at a slow but steady state as consumers upgrade
their computers with the predicted slow but steady growth in the economy. This
decision poses some risks, given that there is a “mixed bag†of opinions
regarding the growth of the electronics sector in

The decision was made to pursue the home computer user, through a strategy
focused on shipping low-cost, high-quality computers directly to customers as
orders are received (make-to-order). This production model is similar to the
Dell approach, and appears to be the model that will dominate the PC industry.
Because the company does not plan to build finished PCs (i.e.,
make-to-stock) in anticipation of future sales, market demand forecasts,
supplier quality, supplier capacity, lead time, and delivery reliability are
critical factors. The company is willing to carry some units in component
inventory as safety stock as a buffer against missing customer order

Pacific Systems Corporation
will assemble the computers in its own facilities, but intends to outsource
many of the key product components and subassemblies, including the DVD drive,
a feature that will be standard on each PCS computer. The decision to outsource
the DVD drive resulted from an executive-level insourcing/outsourcing study
that concluded the cost to manufacture these drives in-house was highly
prohibitive. The product requires production capabilities that are beyond PCS’s
current expertise. Marketing estimates that first year demand for the new PC,
and therefore the DVD drives, would be approximately 500,000 units, with a 20%
growth expected for year two. Expected pricing for the computers will be under
$1000. DVD demand depends totally on final product demand, which can be

1 details the monthly sales forecast for the 9000x series. However, given the
volatility of the computer market and PSC’s limited experience with marketing
directly to end users, marketing estimates, with 95% confidence, that actual
demand will likely be between 400,000 and 600,000 units. As with most high
technology companies, adequate supplier capacity is a critical issue. Taking a
lesson from the demands placed on it by its current customers, Pacific Systems
Corporation will seek some assurance from its suppliers that they can increase
the supply of components by 25% within four weeks notice of changing market
conditions. Supplier responsiveness and ability to satisfy Pacific Systems
Corporation’s volume requirements will be critical.

DVD Market Information

recognizes that DVD demand is growing rapidly, although actual numbers are
difficult to obtain. One of the challenges PCS faces, and perhaps a major
reason why PCS may want to quickly “lock in†supplier capacity, is that other
industries use the same DVD drives as are used in personal computers. In
particular, producers of home theater systems (for digitally recorded movies
and music) are moving aggressively in the DVD supply market. There has also
been several controversies, regarding lawsuits on illegal copying of DVD’s (see
Article appendix).

risk is the potential for quality problems on new electronic components (see
Article applendix). Another consider is the growth of the consumer electronics
DVD industry:

Name: Consumer Platforms – Q1 2002: DVD Players and Recorders: Seizing a Spot
in Every Home Entertainment System
iSuppli Corporation

Description: DVD players have become the
hottest consumer electronics product in the market. With prices of DVD players
hitting sub $100 price points, OEMs are looking to add new features to DVD
players to enable them to increase their average selling prices and
consequently their profit margins. This report looks at the DVD recorder market
and the various standards and presents a forecast and strategies for specific
companies attempting to participate in this marketplace…

sum, PCS must share their market with the growing home DVD system, and assess
their relative leverage in the market given other market demands for DVD’s.

Exhibit 1
Two – Year 9000x Demand Forecast

August 2003

55,000 units

August 2004

66,000 units


50,000 units

September 2004



40,000 units

October 2004


November 2003

40,000 units

November 2004

48,000 units

December 2003

45,000 units

December 2004

54,000 units

January 2004

35,000 units

January 2005

42,000 units


35,000 units

February 2005


March 2004

40,000 units

March 2005

48,000 units

April 2004

40,000 units

April 2005

48,000 units

May 2004

40,000 units

May 2005

48,000 units

June 2004

40,000 units

June 2005

48,000 units

July 2004

40,000 units

July 2005

48,000 units

Systems Corporation is targeting the price of its PC line from $900 – $1100,
depending on the model and configuration. This means that the DVD’s unit price
would need to be in the $125 – 150 range. This is not unreasonable given
current market pricing (see Appendix).

the market for DVD’s extends well beyond the computer industry, and is not
without its share of uncertainty and disruptions (see Appendix).

Another key consideration
in the supplier selection decision is that Pacific Systems Corporation expects
to control the transportation link from the supplier(s) to its facility in California.
The company has decided to assume responsibility for transportation, but not
ownership of inventory, from the supplier’s facility. The company plans to
support its inbound logistics with carriers that offer corporate-negotiated
rate discounts.

While early personal
computers were notorious for quality-related problems, today’s customers demand
defect-free products. With intense price competition and narrow profit margins,
a single product defect, particularly when the PC is in the customers’ hands,
can “wipe out” any profit from the sale. Poor quality will also
adversely affect market reputation and future sales. Although exact numbers are
difficult to obtain, financial analysts at Pacific Systems Corporation
calculate, based on experience and assumptions, that each with a defect will
result, on average, in $300 in non-conformance costs that Pacific Systems
Corporation must bear (including lost customer goodwill).

The company plans to
introduce the new line of computers directly to the marketplace in August 2003.
It must have inventory by June to begin process proving and pilot production.
The August date coincides with back-to-school sales, which is the busiest time
of year for PC makers. It is now early January 2003.

Pacific Systems Corporation
relies on cross-functional commodity teams to develop sourcing strategies for
key purchased items. Executive management views the DVD supplier selection
decision as a critical part of the 9000x series development. The commodity team
has spent the last several weeks visiting four DVD suppliers, and is currently
evaluating various supply options. The team expects to begin negotiation with
one or more suppliers within the next several weeks. Information regarding the
suppliers under consideration is presented in the following section.

The team developed a market
analysis of DVD drive manufacturers, and narrowed their search to four specific
suppliers. These four suppliers were selected as final contenders based on: a)
cost competitiveness given Pacific Systems Corporation initial target cost,
and/or b) location proximity to PCS’s assembly sites. The team was somewhat
divided, as some members felt that PCS should globalize its sourcing
initiatives, while others felt that local suppliers would be a better choice in
terms of working arrangements. Engineering supported the commodity team’s
preliminary efforts by purchasing off-the-shelf DVD’s for testing. This helped
determine if the suppliers had a product that initially satisfied PSC’s
expectations. Relying on product samples, while providing preliminary insight
into the capability and technology of each supplier, was not sufficient to
support a final supplier selection decision. Hence, the need for direct visits
by the commodity team became apparent.

team decided to visit four suppliers directly to collect detailed information.
The visits ranged from one to two days each, with all four visits completed
within a three-week period. These visits were time-consuming and exhausting,
particularly since two suppliers were located in Asia. Unfortunately, Pacific
Systems Corporation does not have an International Purchasing Office (IPO) to
support its international procurement activities. Furthermore, no one on the
team spoke Korean or Japanese. Fortunately, the other two suppliers, located in
the U.S., were much easier to visit. In fact, one supplier was located only ten
miles from the PCS assembly facility. The following sections summarize data
collected during the commodity team’s visits to the four suppliers.


Technologies, located in Nagasaki, Japan, was the largest supplier the team
visited (sales of $6.5 billion). The plant covered ten acres, with a wide
variety of computer and electronic components produced in the facility. DVD
drives represent a large segment of

Elecom’s production (Elecom
commits 50% of total capacity to DVD drive production and derives 60% of its
revenues from DVD drives). Because of its size, however, the company seemed
most interested in large contracts ($150 million or more annually). Elecom
currently controls approximately 30% market share of global DVD sales.
Geographic distance from California, along with the need to accommodate the
needs of some large customers, made

Elecom’s quoted lead time
the longest of the four suppliers being evaluated.

The highest-ranking manager
that met with the PCS team was a sales manager, who took the team to visit
various departments. The division vice-president and plant manager were in conference
with a large DVD customer, who the PSC team found out had formed a strategic
supply alliance with Elecom. The PSC commodity team felt a bit
“snubbed” at the facility, particularly the group’s female members.
The facility was efficient, spotless, and modern.

When the team visited
engineering, they spoke with a manager in DVD design. The engineer estimated,
based on previous experience, that the ramp-up time to begin production that
would satisfy PSC’s specifications would be about 4 months. Furthermore,
tooling costs would likely be $3 million.

sales manager was particularly proud of Elecom’s new Internet-based electronic
data interchange (EDI) system. This system allowed direct communication with
customers. He was also proud that Elecom Technologies was “the price
leader” for the industry, and was producing DVD drives for several of the
major brand name PC companies. He also talked about the company’s extensive
investment in research and development. When the sales manager heard that the
DVD order, based on 500,000 units in year one, would likely not exceed $75
million per year, he hesitated, saying that he would need to discuss the order
with management. Moreover, he indicated that the company typically was not
interested in orders of less than $150 million per annum, but that exceptions
might be possible. The economics associated with large orders is what made
Elecom a low-cost producer. Relevant Elecom Technologies data include:

n Quoted price = $127 per
unit (quoted at 120 yen to $1 U.S.)

n Delivery
lead time = 8 weeks

n On-time
delivery record = 95% on-time (for large customers)

n Quality
= 9,500 PPM defects

n Transportation
costs from Asia to Pacific Systems Corporation = $18 per unit

n Current
installed capacity for DVD production2
= 98%
n Duties
and customs = $9.50 per unit

n Insurance
= $2.00 per unit

n Frequency
of shipment = Monthly

n Tooling
costs = $3 million

n Ordering,
inbound receiving, and quality inspection costs = $4.50 per unit

n Ramp-up
time = 4 months

n Denomination
of contract = Yen

installed capacity indicates that portion of the supplier’s DVD production
capacitythat is currently utilized. For example, if current installed
capacity is 98%, then this supplier is utilizing 98% of its production capacity
and therefore has 2% of its capacity available for new business.

exist some country-specific risks associated with sourcing in Japan. The WorldFactBook

2002 notes that “developing
trends presage more divergence between the United States and key East Asian
countries and more difficulties for US policy and interests. . . . Greater
friction will also arise as a result on an expected downturn in the US economy,
anticipated difficulties in US-China relations, and greater debate between the
United States and Japanese and South Korean allies over military bases, host
nation support, and other alliance arrangements. . . East Asian policies toward
the United States will be driven strongly by the uncertain regional security environment,
the nascent revival of regional economies after the Asian economic crisi, and
trends in international politics and norms that affect East Asian authoritarian
and democratic governments differently but underline strong regional
nationalistic pride and assertiveness.†3

SureTech Company

A second candidate for the
contract is SureTech Company, a small manufacturer located in Colorado Springs,
Colorado. The company focuses exclusively on the design and production of PC
disk drives including floppy disk, CD-Rom, and DVD drives. The team discovered
this company almost by accident. A team member was browsing a trade journal and

advertisement. When the team visited the facility, the team was surprised at
its small size and by the fact that it is located in an old warehouse.
SureTech’s president met with the team in person. He explained that he was a
graduate of Stanford in electrical engineering and had decided to start his own
company after working for IBM for 15 years. The company entered the disk drive
market four years ago and has produced DVD drives for just over a year. During
this time, however, SureTech has established a reputation for delivery
reliability and innovation. The president explained that SureTech’s success was
based largely on its commitment to develop new technology, especially
technology that enhanced product reliablity. He also claimed that he knew every
customer personally. PC Week had praised the company’s products in
several recent editions. However, the company was definitely a small growing
entity (with less than 4% of global market share), but they expressed their
intent to focus more on the PC industry as opposed to the home consumer DVD

Everyone in the plant
seemed highly motivated, and, except for the president, the team did not see
any person who appeared over the age of 35. The president was particularly
excited about the possibility of working with Pacific Systems Corporation, and
promised to work with them closely on this contract and for any new product
lines. In particular, he emphasized that DVD technology was improving for
laptop computers, and that the laptop market was another sector that would
continue to expand in the future. Ramp-up time for the new DVD drive would be
approximately 5 months.

When asked if his firm
would have any problem in meeting demand should they receive the contract, he
hesitated before answering. He admitted that this contract would be the largest

SureTech’s relatively short
history. He also indicated that several other buying teams were also going to
be sending teams to evaluate SureTech within the next week. However, he assured
the team that he would do whatever it took to maintain reliable delivery
schedules if SureTech received the contract. Interestingly, it appeared that
the production lines were experiencing some problems during the team’s visit,
as they were shut down for nearly four hours! Relevant SureTech data include:

n Quoted price = $144

n Delivery
lead time = 3 weeks

n On-time
delivery record = 97% on-time

3 The
World Factbook, 2002, (

n Quality = 10,500 PPM

n Transportation
costs from SureTech Company to Pacific Systems Corporation = $6.00 per unit

n Current
installed capacity for DVD production = 92%

n Duties
and customs = $0.00 per unit

n Insurance
= $1.50 per unit

n Frequency
of shipment = weekly

n Tooling
costs = $3.5 million

n Ordering,
inbound receiving, and quality inspection costs = $4.00 per unit

n Ramp-up
time = 5 months

n Denomination
of contract = Dollars

E-Drive Systems

The third supplier, a
fairly large and reputable manufacturer of computer equipment, including

drives, was located less than ten miles from PSC’s facilities. About half the
company’s $2 billion sales came from the sale of DVD drives. In fact, the firm
was the second largest producer of these drives worldwide (with 20% market
share). In addition, the plant manager pointed out that the company has
committed significant resources to setting up a JIT production system for the
DVD drive line. Indeed, the PSC team was impressed with the performance of the kanban
signals and flow-through workstations. The plant manager also emphasized that
because of their close proximity to Pacific Systems Corporation, they would
have no problem delivering the product in two-day lot sizes,
“just-in-time,” to PSC’s facilities. The manager was able to show the
team reports that backed this claim. E-Drive Systems also had a solid
reputation within the industry for working with its customers on future product

visiting the quality department, the quality manager seemed particularly
preoccupied and “on edge.” When the plant manager left for a few
minutes to answer a phone call, the group asked the quality manager if the
company had experienced any significant problems recently. He confessed that
the last shipment of drives had several quality problems, and the number of
returns from large distributors had increased dramatically. This was creating
some fairly severe disruptions to production scheduling and delivery. The most
serious problem was an annoying “clicking” sound made by the drive as
it engaged the disk. However, he assured the PSC team that the design engineers
were working full-time on the problem and that it would be solved well before
PSC placed an order. When the plant manager returned, the quality manager made
no further mention of the problem. The plant manager estimated that the ramp-up
time for the first shipment would be very short, approximately 3 months.
Relevant E-Drive Systems data include:

n Quoted price = $140

n Delivery
lead time = 2 weeks

n On-time
delivery record = 99.5%

n Quality
= 7,500 PPM defects

Transportation costs from
E-Drive Systems to Pacific Systems Corporation = $14 per unit (due to frequent
deliveries of small quantities)
n Current
installed capacity for DVD production = 96%

n Duties
and customs = $0.00 per unit

n Insurance
= $3.00 per unit

n Frequency
of shipment = Every other day

n Tooling
costs = $3.25 million

n Ordering,
inbound receiving, and quality inspection costs = $3.25 per unit

n Ramp-up
time = 4 months

n Denomination
of contract = Dollars


The fourth supplier, Park
Technologies, is a Korean company with 12% of global market share in DVD sales.
Park provided the second lowest bid at $132 per unit. During the team’s visit
the plant manager claimed that capacity was not an issue, and that the company
would be willing to commit the required production capacity to the Pacific
Systems Corporation contract. DVD drives accounted for about half of Park’s
$1.3 billion in 2002 sales.

The commodity team felt
much more comfortable at Park Technologies than at Elecom. While this supplier
has minimal experience doing business with North American firms, the company
seemed quite anxious for the contract. The company has several large Taiwanese
and Japanese PC makers as customers. At this time Park Technologies has no U.S.
facilities or support staff. The team had some concerns about becoming Park’s
first major North American customer.

company’s product was excellent. Every DVD drive went through an extensive
testing procedure that assured few problems would occur. In fact, Park’s
process control and testing were more thorough than any other supplier the team
visited. However, the combination of the testing process and geographic
distance meant that delivery cycle times were much longer, up to 10 weeks per
order, although the on-time delivery performance for the facility was
excellent. The team was not sure if current Asian delivery performance would be
indicative of delivery performance to the U.S. The facility appeared well
maintained, clean, and orderly. The team noticed that the DVD drive facility
was extremely busy and wondered if the plant manager’s claim about adequate
capacity was accurate. All employees worked closely together in work cells and
knew each other by name. Industry experts viewed Park as one of the most
promising and dynamic companies in the industry. The ramp-up time for the
delivery of the first shipment was quoted as 4 months. Relevant Park
Technologies data include:

n Quoted price = $132

n Delivery
lead time = 10 weeks

n On-time
delivery record = 99.0%

n Quality
= 4,000 PPM defects

n Transportation
costs from Park Technologies to Pacific Systems Corporation = $18 per unit

n Current
installed capacity for DVD production = 92%

n Duties
and customs = $9.50 per unit

n Insurance
= $3.50 per unit

n Frequency
of shipment = Monthly

n Tooling
costs = $2.75 million

n Ordering,
inbound receiving and quality inspection costs = $2.25 per unit

n Ramp-up
time = 4 months

n Denomination
of contract = Dollars

As noted earlier, regional
instabilities, particularly with North Korea, pose a threat to US interests in
the area. The The World Factbook 2002 notes that “China will work against US
efforts to strengthen its position in the region. Notably, Beijing will press
against and challenge US support for Taiwan, US efforts to build missile
defenses in the region, and US efforts to strengthen the alliance with Japan..
. . Japan and South Korea strongly support their respective alliances with the
United States and are currently cooperating closely with Washington in
trilateral efforts to deal with North Korea. Yet, like many other US allies,
both Tokyo and Seoul chafe over the asymmetry in their alliance relationship
with the US superpower. They seek adjustments in the US military presence that
would accommodate their nationalistic or local concerns.â€

The team also gathered
financial data for each supplier. While the team believes the data for the U.S.
suppliers to be reliable, several assumptions and estimates had to be made
regarding the Asian suppliers. The team had to convert Japanese and Korean
currency into dollars. In some cases, the desired figures were not available,
or the supplier showed no interest in providing the team with the requested
information. In particular, this was an issue with Elecom Technologies.
Exhibits 2 and 3 summarize selected supplier financial data.

Exhibit 2

Selected Supplier Balance Sheet Data
(U.S. $ in millions)

For Period Ending December 31, 2002
















Accounts receivable










Total current assets





Investments at










Total investments
and other






Property, plant, and

















Accounts payable





Taxes due on income





Accrued payroll and





employee benefits

Total current





Long-term debt
















Exhibit 3

Statement of Income Data (U.S. $ in

Year Ended December 31, 2002





Net sales





Cost of
goods sold





general, and











Costs and





before income taxes





taxes on income










Although Pacific Systems
Corporation is buying a standard DVD drive, extra production demands and a
small level of design customization will result in additional tooling
requirements at each supplier.

company expects the 9000x series to have a two-year life cycle. The commodity
team will allocate all supplier-related production costs, such as tooling, on a
per unit basis over a two-year period. The company fully expects to introduce
its next generation of personal computers at the end of two years.

The US dollar has shown signs
of weakening in the last months of 2002. The outlook for the US dollar is that
it may further weaken against many of the Asian currencies in 2003. The team
has not done enough research in this area to determine the extent of this

Systems Corporation plans to maintain some level of safety stock inventory for
the drives, at least for the first year. Due to long material pipelines,
Pacific Systems Corporation expects to maintain a one-month safety stock inventory
if it utilizes Asian suppliers. For domestic suppliers, the company expects to
maintain an inventory equal to two weeks worth of demand as safety stock.

Inventory carrying costs,
which include storage, handling, obsolescence, taxes, and cost of capital, are
18% of the inventory’s unit cost. The company assumes carrying costs for safety
stock material.

n Assume the
unit price quoted by each supplier is what Pacific Systems Corporation would
pay for the drive from each supplier. Subsequent negotiations will likely alter
the quoted price.

While tooling depreciation
could be a cost consideration, this case does not consider depreciation.

While PSC takes an active
role in coordinating inbound transportation shipments, company policy states
that PSC will not assume title to material until the material arrives at the
company’s receiving dock.

The team realized this
supplier selection decision, which was one of the most critical involving the
new product line, was also going to be difficult. Until the team analyzed the
numbers and discussed the findings from the field visits, it was clear that no
consensus existed among team members concerning which supplier(s) to select. To
reach a decision, your group must do the following:


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