MGT Group: Reconstructing the Supply Chain After a Cross-Border Factory Relocation (A Written Analysis of the Case)

 I.            INTRODUCTION

Two years after being acquired by MGT Group, LSD is still poorly performing. It suffers from low on-time delivery of orders, low inventory turnover, vague market segmentation and product overlap with another MGT owned company resulting to costly wastage of resources.

MGT is a global company established in 1945 and headquartered in Lille, France. It specializes in design and manufacture of high-precision control systems for aviation, aerospace, medicine, electronics, transportation and energy industries. On the other hand, LSD, a company based in Rouen, France, specializes in design, manufacture, and sale of high-precision valves for aviation, navigation, and energy industries. MGT’s acquisition of LSD enabled it to expand its product lines and market.

However, by the second quarter of 2007 and $13M spent on LSD, MGT still sees no sign of improvement. Recognizing market saturation in Europe and an opportunity in the newly rising market in Asia, MGT decided to close its LSD factory in France and relocate it to MGT Fuzhou Co., Ltd. in China. Fuzhou is a wholly owned subsidiary of MGT focused on design and production of high-precision electronic systems.

Kevin Lurton, Vice Chief for Operation at MGT’s Control Systems Division, was charged with closing and relocating LSD factory from France to China. Lurton is faced with the challenge of setting up a new supply chain strategy system in China while effectively managing the supply risks during the transition period.

In setting up the new supply chain system, Lurton studied customer demands, the complexity of supply and production processes and came up with an agile strategy. This strategy is anchored on the need to respond quickly to customers’ changeable, diverse and unpredictable demands without leading to high risk supply disruption.

II.            PROBLEM STATEMENT

How would Kevin Lurton build an efficient supply chain system for LSD in China?

III.            OBJECTIVES

  1. To create a flexible, adaptable and consistent supply chain system in order to cut procurement lead time and achieve customer responsiveness.
  2. To be able to minimize supply shortage and distribution risks.
  3. To be able to enhance LSD’s profit margin by reducing manufacturing costs.
  4. To be able to accelerate time to market of LSD’s products.
  5. To maintain LSD brand’s global competitiveness.

IV.            AREAS OF CONSIDERATION

1.      Time Constraint

After pouring millions of dollars to revive LSD, MGT still saw no sign of improvement and has grown to become a financial burden to the Group. Eager to extricate itself from the awkward situation, MGT decided to close down LSD French factory and relocate it to MGT Fuzhou Company’s China factory within one year.

With the overriding need to substantially cut operating costs quickly and steadily given the MGT’s declining ability to attract outside investments due to the financial crisis, making the transition to China must be swift or further losses will mount which could hurt MGT’s reputation as an industry leader and respected brand.

2.      Instability of French Supply Chain

Closing LSD factory in France would naturally create disturbance and unrest among the stakeholders of the French factory. The suppliers in particular will be hit harder as LSD scales back supply orders and prepares to move to China. As a result, certain suppliers will demand shorter payment periods, higher prices, larger minimum orders or even terminate supply contracts as they may also look on cutting similar losses from overstocking of raw materials and components.

3.      Complexity of French Supply Chain

LSD’s French supply chain was complex to manage. There are bottlenecks that pose negative influence on the supply chain resulting to longer procurement period for key raw materials and components. In addition, the minimum orders for these raw materials and components tended to be very high. There’s also the very low concentration of suppliers. LSD has 481 high-precision valve products involving 4,329 types of raw material inputs. However, supplier concentration is very low, only 113 in all, resulting to poor bargaining power. The complexity of the French supply chain resulted in long supply cycle, high controlling difficulty, and high system’s costs.

4.      Material Procurement Cycle and Purchase Cost

The procurement lead times for raw materials and components sourced from French suppliers are very long. Supplier production time for machining material is 8 weeks and another 2 weeks for air transport including customs inspections or a total of 10 weeks. Materials for casting take longer to produce at 12 weeks. Other metal processing’s production time is 6 weeks and non-metal items take 2 weeks. All in all, casting takes 14 weeks purchase time, 8 weeks for metal processing and 2 for non-metal processing materials. The result is a procurement team always under heavy pressure to meet production deadlines and relevant freight and customs expenses drive the total purchase cost up by 10% to 25%.

5.      Inventory Pressure

LSD factory has accumulated a large amount of raw materials inventory in the warehouse worth approximately $2.6 million. This is due to the low production efficiency of LSD prior to 2007. These raw materials inventory are needed to be transferred to China and poses to be a logistical burden not to mention high cost of freight and customs duties.

6.      Fuzhou Company’s Imperfect Supply Chain

The raw materials needed to manufacture Fuzhou’s products are all provided by internal suppliers and the company was responsible for purchasing only low-value, non-important materials from local suppliers, accounting for approximately 30% in its total procurements. Manufacturing LSD’s high-precision valves would make Fuzhou responsible for the procurement of all needed raw materials, thus setting a higher demand and pressure on its ability in supply chain management.

7.      Risk from Macro-economic Fluctuation

Macro economic factors might pose great impact on the management and operation of a global supply chain. LSD transfer was carried out amid international economic fluctuations which could shake regional trade agreements, tax policies, import and exports tariffs, force labor costs up and even limit the ability of companies like MGT to attract outside investments.

8.      Understanding Customer Demand for LSD’s products

Accurate understanding of customer demand is essential towards designing and implementing an efficient supply chain system. Every link of the system is geared towards customer satisfaction otherwise the supply chain will be unsuccessful.

An analysis was conducted in order to understand LSD’s niche market and identify other industry players, LSD’s products were not intended for refuelling ordinary vehicles and all its suppliers are from transportation industry that uses LSD’s high-precision valve products for special purpose equipments or projects. In terms of geographical distribution, LSD has its major market in the US but its products were also widely used in developed and developing nations.

Profit driven sellers typically put harsh demands on delivery dates without lowering expectations for high quality. These sellers typically ask for short delivery time after placing an order therefore placing higher pressure on a manufacturer’s supply chain management.

9.      LSD’s Supply and Production Process

The value flow of LSD’s high-precision valve products starts with metal and non-metal upstream raw material suppliers. These materials are then picked up by component suppliers, forming them based on LSD’s specifications and contract demands. Upon delivery to LSD, these are assembled, tested and packaged for delivery to LSD’s customers.

However, bottleneck constraints pose a negative influence on the upstream supply chain as procurement period for key raw materials and components tended to be very long. Non-regular materials, which are about 40% of the total orders, needed to be ordered on special basis and takes 6-8 weeks to manufacture and suppliers demand large minimum order quantity resulting to higher inventory risk. Some key raw materials components are also imported. Transportation and customs clearance takes about 2 weeks and transported by air which is very expensive. In sum, the supply chain featured a long supply cycle, high controlling difficulty, and high system costs.

10. New Supply Chain’s Strategic Objectives

The old supply chain was prone to “bullwhip effect” because of its overall uncertainty and complexity. Bullwhip effect is an occurrence in the supply chain where order sent to the manufacturer creates a larger variance than the sales to customers. To counter this effect, the most appropriate strategy for the new factory’s supply chain system should be an agile one. The strategic objectives of an agile supply chain are fast and flexible response to customer demands with minimal supply shortages and distribution risks with the help of an inventory buffer and the pooling of other resources. This can be done through the monitoring of rate of on-time delivery and average delivery time. This could be achieved by mainly cutting the procurement time.

11. Merger and Acquisition

The 60-year history of MGT is also a history of acquisitions and mergers and the company has stepped up its efforts since 1998. Between 1998 to 2007, it acquired over 20 design and manufacturing companies. With these acquisitions, MGT has accumulated substantial knowledge about the processes and milestones involved in this kind of business transaction. MGT management and its board also understand that mergers and acquisitions are essential strategic business policies geared towards sustaining the company’s growth through synergy, diversification and even elimination of competitors.

12. Supplier Evaluation and Accreditation Policy

MGT has worked hard at finding and developing suppliers that meet its own needs and even building a scientific system for supplier evaluation and accreditation. MGT has a three-step supplier evaluation system usually carried out on a monthly, quarterly or annual basis. This evaluation calls for real performance measures based on four major dimensions of delivery time, service, cost and quality. This supplier evaluation system took into consideration the company’s strategic needs and its subsidiaries actual operational requirements. This evaluation policy, while not very efficient, has succeeded in ensuring quality and fairness.

V.            ALTERNATIVE COURSES OF ACTION

1.      Build a Centralized Supply Chain in China

Building a centralized supply chain system will mean a common, localized supply chain for Fuzhou and LSD where the central authority responsible for decision-making is made at the management level of Fuzhou’s supply chain team. Fuzhou Company will also be responsible for building upstream supply chain relationships for LSD.

This supply chain organizational structure will leverage on Fuzhou’s excellent management team and a high performing staff that has cultivated a unique corporate culture focused on professionalism, excellence and devotion to their respective duties and responsibilities.

The centralized supply chain system will also leverage on standard sourcing of raw materials, processes, and even technology decisions resulting in economies of scale and improve bargaining power with suppliers while enhancing internal operational efficiencies and knowledge sharing.

Advantages:

a. Cost savings from increased purchasing power and economies of scale

b. Substantial cost reduction from a single, streamlined supply chain unit.

c. Fast implementation of supply chain for LSD leveraging on Fuzhou’s established supply chain system.

d. Lower inventory risk by leveraging on increased bargaining power to lower down minimum order quantities for raw materials and components.

e. Consolidation of supplier base that will help buffer supply disruptions.
f.  Fuzhou Company boosts an excellent pioneering management team and a high performing staff.
g. Localized supply chain helps eliminate raw materials and supply chain bottlenecks, high system costs and accelerates time to market.

Disadvantages:
a.  Cultural differences from LSD and Fuzhou management teams could get in the way of creating a common supply chain.
b. Fuzhou’s expertise is not with high-precision valve products.
c. Fuzhou has imperfect supply chain.

2.      Build a Decentralized Supply Chain in China – Integrate Quick Response (QR) and Quality Control (QC) Systems

LSD will control its own supply chain by linking with new, localized upstream raw materials and component suppliers. Learning from the complexity and instability of French supply chain system, the new China supply chain will integrate two important systems: Quick Response and Quality Control systems designed to respond quickly and accurately to customer orders while maintaining LSD’s strategic competitive advantage through high quality products.

MGT has worked hard at finding and developing suppliers that meet its own needs even using scientific system for supplier evaluation and accreditation. LSD can leverage on MGT’s three-stage supplier evaluation process in order to select and accredit new suppliers that will fulfil LSD’s strategic needs.

A QR system is designed to work throughout the supply chain system in order to produce a closer relationship between supply and changes in demand. QR is particularly effective in highlighting any change in customer requirements, which will enable LSD and its suppliers to develop new methods of meeting these changing demands.

QC is relevant in increasing customer satisfaction and reducing manufacturing waste. This will also ensure that throughout the manufacturing process of LSD’s high-precision valves, product quality is constantly monitored and improved.

Advantages:

a. Speed in implementing supply chain processes and resolution of issues.
b. Flexible and fast response to customer demands with minimal supply shortages and distribution risks.
c. Less resistance from Fuzhou Factory’s management because its supply chain system will not be disrupted.
d. Improves satisfaction at the site and business unit level at LSD.
e. Minimizes risk of deploying low quality products to customers.
f. Localized supply chain helps eliminate raw materials and supply chain bottlenecks, high system costs and accelerates time to market.

Disadvantages:
a. Decentralization means little sharing of information and coordination between LSD and Fuzhou’s on supply chain matters.
b. Could not leverage on economies of scale.
c. High controlling difficulty and supply cost due to reduced bargaining power with suppliers.

3.      Form Strategic Partnership with Chinese Suppliers

There is a need to foster longer-term and co-operative relationships in the supply chain system. This is due to the increasing competition, changing customer preference and demands. LSD’s successful cross-border relocation entails the management of fundamental processes involved in the satisfaction of its customers. One of this is forming strategic partnerships with suppliers in China. This partnership will allow LSD to take advantage of the resources and expertise of its suppliers in the hope of satisfying its own customers.

Advantages:

a. Minimal supply disruption and shortage risks resulting in faster and flexible response to customer’ changeable, diverse and unpredictable demands.
b. Promotes production efficiency and product quality
c. Reduces production costs
d. Reduces time to market
e. Facilitates information sharing that improves overall corporate strategy.
f. Cuts ordering and procurement time therefore achieving average product delivery time.
g. Improve customer satisfaction.
Disadvantages:
a. Since most of the benefits goes to the buyer, suppliers are hesitant to form strategic partnerships with manufacturers.
b. Suppliers may have to increase investments in equipment and new technologies, putting a strain on its cash flow and affecting its relationship with the manufacturer.
c. Different cultures of supplier and manufacturers-buyers will lead to frictions in the supply chain.

4.      Vertically Integrate

Implement backward integration strategy by gaining ownership or control of strategic upstream raw materials and component suppliers in China through mergers and acquisitions. This will align external supply chain capability based on LSD’s long term strategic needs and manage an extended enterprise that behaves as if internal to the company. This will secure stable input of raw material and component resources. Furthermore, MGT has a long history of successful acquisitions and has the resources to control or own strategic suppliers.

Advantages:

a. Minimal supply shortages and distribution risks resulting to fast and flexible response to customer’ changeable, diverse and unpredictable demands.
b. Promotes efficiency and reduces transaction costs.
c. Production is more efficient
d. Improved profitability and cash flow
e. Facilitates information sharing that improves overall corporate strategy.
f.  LSD increases power in the marketplace
g. Minimal risk of supply disruption and shortages
h. Cuts ordering and procurement time therefore achieving average product delivery time.

Disadvantages:
a. High cost of acquisition and mergers.
b. Higher costs if the company is incapable of managing new activities efficiently.
c. Implementation and integration is not easy.
d. New competencies may result in culture clashes and increased bureaucracy will result to reduced flexibility.

5.      Build a Supply Chain Anchored on the Principle of Just-in-time (JIT) Manufacturing Model

JIT production model is designed to meet demands, producing high-precision valves based on a given number of customer orders. Products are only manufactured once there is demand, not manufacturing them in advance. The overriding principle of JIT is to increase production efficiency while avoid wastage, overproduction, waiting and excess inventory.

While JIT is a manufacturing strategy, this model in an integral component in helping efficiently manage the supply chain system of LSD by giving increased emphasis on supplier relationships. Supplies come at regular intervals throughout the day and are synchronized with production demand and the optimal amount of inventory is on hand at any point which is then moved directly to customers.

Advantages:
a. Very low inventory risk since products are only produced when there is demand for it.
b. Reduces inventory costs while improving flow of goods.
c.  Increases efficiency on supply chain system.

Disadvantages:
a. Susceptible to Bullwhip effect
b. Eliminates inventory buffer causing inventory shortages in case of sudden demand surge
c. High supply shortages and distribution risk.
VI.            RECOMMENDATION

The success of LSD’s cross-border transfer from France to China hinges on the ability of MGT to implement a successful China supply chain swiftly and minimize supply disruptions as possible.

Based on the analysis of the issues facing Kevin Lurton and MGT’s as a result of cross-border factory relocation to China from France and the alternative courses of actions enumerated, I therefore recommend that Kevin Lurton implement alternative courses of action number 2, Build a Decentralized Supply Chain – Integrate Quick Response and Quality Control Systems and number 3, Form Strategic Partnership with Chinese Suppliers

These alternatives will be keys towards implementing an efficient new supply chain system for LSD in China.

VII.            IMPLEMENTATION

The implementation of the alternative courses of action selected will be divided into short-term and long term strategies.

Short-Term Strategy Implementation

 The short-term strategy will be the implementation of a decentralized China supply chain for LSD, and at the same time embedding the Quick Response and Quality Control systems into the supply chain management. It has 4 phases which will be carried out in 2008, leading towards the realization of a localized supply chain.

Year 2008

Phase 1

Phase 2

Phase 3

Phase 4

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Strategy Development Stage

Situation Analysis and Conceptual Design

Strategy Validation

Detailed Design Validation of Supply Chain and Quick Response Systems

~

Identifies local vendors in China who can supply the raw materials and components needed for manufacture of high-precision valves

Putting Infrastructures in Place – Strategy Integration

Testing and Enabling the China Supply Chain and Quick Response systems

~

Initiate contact with suppliers. Starts three steps supplier evaluation and accreditation program.

Realizing the benefits

Delivering the Localized Supply Chain

~

Finalizes firm orders and sign supply contracts.

Phase 1 is the analysis of the current supply chain system and where the gaps and weaknesses exist. The result of this will be consolidated into a conceptual design ideal for the new supply chain system in China. Considerations should be made on all aspects of the new supply chain in this phase like warehouses, factories, suppliers, distributors and even retail outlets. This is done in three months starting on January until March 2008.

Phase 2 is to validate the assumptions underpinning the conceptual design, which will then form a detailed blueprint of the future strategic supply chain model and concepts. The quick response system design shall also be embedded early in this phase. Simultaneously with this is the process of identifying potential vendors in China who can supply LSD with raw materials needed to manufacture its products. This also done in three months starting in April and ending in June of 2008.

Phase 3 involves deploying an appropriate infrastructure which includes aspects such as process design, organizational design, performance measurement       and information systems. At the same time, the team should initiate contact with potential suppliers and commencing the three-step supplier evaluation and accreditation process. This is finished between July and September of 2008.

Phase 4, the final stage of the implementation strategy is about embedding the new supply chain system infrastructure and delivering the benefits to MGT. There should already be firm orders and supply contracts signed. This is done starting October and ending in December 2008.

Long-Term Strategy Implementation

The long-term strategy is the formation of strategic partnership with Chinese suppliers. LSD enters partnership agreements with strategic suppliers who can complement LSD’s long-term manufacturing requirements.

The long-term strategy implementation will have three phases to be carried out in 2010.

Year 2010

Phase 1

Phase 2

Phase 3

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Diagnostic

  • Review of Supply Chain Strategy and Market Priorities
  • Supply Chain Analysis
  • Market Identification

Stakeholder Discovery

  • Discovery of Customers/Suppliers
  • Stakeholder Dialogue
  • Business Plan Development

Pilot Development and Launch

  • Pilot test selected development program
  • Use pilot result to validate approach
  • Launch the partnership

The first phase of developing strategic supplier partnership is the diagnostic phase. This involves the review of LSD’s current market priorities and existing supply chain strategies to identify major flaws, leverage points and impacts of its existing strategies, key market trends, and financial benefits. High leverage supply chain opportunities are identified in this phase. This is done in four months starting in January and ending in April 2010.

After concluding phase 1, the team then moves to phase 2, the stakeholder discovery. Under this phase, the team engages with existing suppliers and customers through structured interviews and meetings to explore major opportunities for joint development. Business plans for at least 10 potential pilot initiatives are created to capture identified partnership opportunities. This will be finished in 5 months starting in May and ending in September of 2010.

Phase 3 will be concerned with the pilot development and launching of significant new strategic partnership based on the business development plans created in Phase 2. The pilot development details the value propositions and key marketing messages for the new strategic partnerships, the goals, roles and commitments of each partners, and setting up operational requirements. The new partnership is then launched by LSD and partner suppliers. This phase will take 3 months starting on October and ending with the launching in December of 2010.

VIII.            CONCLUSION

The French supply chain system was mired with complexity and instability resulting in long supply cycle, high controlling difficulty and high system costs. LSD’s pre-transfer inventory turnover ratio is only 1.1, on time delivery is only at 72% and more alarmingly, LSD’s order delivery time is 12 weeks, all resulting to a dismal 89% quality yield. There are also bottleneck constraints that are negatively influencing the upstream supply chain resulting in longer procurement cycles and high inventory risks. The supply chain was also prone to “bullwhip effect”, a trend of larger and larger swings in inventory tied to customers’ unstable demand patterns.

In China, MGT Fuzhou Company’s supply chain system was far from perfect and based on their processes, it is not suitable for LSD’s production requirements. Fuzhou’s raw materials are all provided by internal suppliers and the company was responsible for purchasing only low-value, non-important materials from local suppliers, accounting for approximately 30% in its total procurements.

It is therefore very crucial that MGT decentralize LSD’s supply chain in China, integrate important systems like QR and QC, in order to create a flexible, adaptable and consistent supply chain system that will cut procurement lead time and achieve customer responsiveness. This will also enhance LSD’s profit margin by reducing overall manufacturing costs while accelerating high-precision valves’ time to market therefore maintaining LSD’s global brand competitiveness.

In the long run, forming strategic partnership with Chinese suppliers will further minimize supply shortage and distribution risks resulting in fast and flexible response to customer’ changing, diverse and unpredictable demands. LSD will greatly benefit from these partnerships as it will promote efficiency in production, help reduce transaction costs therefore improving LSD’s profitability and liquidity. Additionally, LSD will be able to gain vital information and important industry forecasts, determine order status in real time and have access to suppliers’ inventory data.

 

IX.            POTENTIAL PROBLEM ANALYSIS

There are two potential problems that may surface with the cross-border relocation of LSD’s factory from France to China. First is the human resource issue and second is the possibility of supply disruptions caused by LSD’s anxious French suppliers.

The closure of LSD’s factory in Rouen, France is sure to deprive people of jobs. They might harbour a strong grudge towards the company and it is difficult to predict how much trouble they might cause for the factory transfer. Kevin Lurton already made it clear that some of the employees are valuable to LSD’s transition and offered them a job at LSD’s China factory. Employees who can’t afford moving to China should be given the option to retire with very generous packages, over and above the minimum legal requirement. It will help laid off employees to start their own businesses or help them survive the period of unemployment while they look for another job opportunity. Those employees who are valuable to MGT and can’t afford moving to China should be offered a job at MGT headquarter located just 300 kilometers northeast of Rouen.

Similarly, LSD’s relocation to China could set off fears among French suppliers which could disrupt the supply chain even before a new one is created. French suppliers may put forward harsh demands or resort to abnormal practices such as covert price increases, supply disruption, quality tricks, and contract clause changes, all of which might harm the operational continuity of the factory. But the impact of the disruption, if any, is minimal at the very least. LSD already accumulated an inventory of raw materials worth US$2.6 million at its French warehouse. Given that the forecasted 2008 sales revenue is only US$4.83 million, LSD has more than enough inventory to manufacture high precision valves for 2008, at the time also, a new supply chain system in China has already been implemented.

In addition to human resource and supply chain issues, a more basic question needs to be addressed: why not stay in France and just fix the French supply chain? While this can be done, LSD’s concerns don’t just stop there. European market is already saturated after seven decades of development. There’s nothing more in this market now but fierce competition and low profit margin. LSD’s vague market segmentation is resulting to product overlap with another MGT owned company. Asia on the other hand is an emerging market where LSD can successfully penetrate if it can strike a balance between quality and price. An industrial product made in Europe to be sold in Asia is just not viable. LSD’s manufacturing costs are already a concern. Shipping high precision valve products to Asia is sure to drive costs up (owing to high costs of shipping and import tariffs). The result is a high priced, low margin product that Asian customers will hesitate to buy. Moving LSD’s manufacturing to China will substantially reduce direct and overhead costs (cheap labor, raw materials, eliminate importation costs, reduce shipping and other overhead expenses) while creating an adaptable and flexible manufacturing and distribution systems. The result is quality, lower-priced, and high margin products that Asian customers will buy.

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