Consolidated Products: The Industrial Systems Business Unit

Consolidated Products is a $21 billion company headquartered in Atlanta, Georgia. The

companys five business units, which offer a wide array of products and services, are the
result of an aggressive strategy of mergers and acquisitions starting in the late 1980s.
Exhibit 1 provides an overview of Consolidated Products and its five primary business
units. The corporate staff is surprisingly small, comprised of general management, legal
staff, and human resources. Part of the reason for this small staff is due to the eclectic
array of businesses housed within one corporate entity. A Business Week editor recently
commented that Consolidated Products could easily be broken up into five separate
companies, since at one time it was five separate companies. The editor also said that if
the company ever learned how to leverage its size in the marketplace, Consolidated
Products could be a Wall Street powerhouse!
While Consolidated Products is a global corporation with facilities around the world, it
operates each business unit as a highly independent and decentralized company. The
corporate culture is best described as entrepreneurial, with each business unit being
headed by an executive vice president who has complete profit and loss accountability.

Exhibit 1
Consolidated Products (2001)
Consolidated Products
Headquarters

Sales: $20.6 billion

Location: Atlanta

Sales: $2.2 billion

Location: Nashville

Engineered
Materials

Santek Images

Sales: $4.4 billion

Location: New York

ConMed Products

Industrial Systems

Sales: $6.5 billion

Location: Tampa

Pharmacon

Sales: $2.5 billion

Location: Chicago

Sales: $5 billion
Location: Dallas

INDUSTRIAL SYSTEMS
Industrial Systems, a $5 billion business unit headquartered in Dallas, Texas, is
developing a new line of industrial pumps. This unit will assemble pumps in its own
facilities, but intends to outsource many of the key components and subassemblies,
including the electronic control sensors that are becoming the accepted standard on new
pumps and compressors. The decision to outsource the electronic sensors resulted from
an executive-level study that concluded the cost to manufacture electronic sensors inhouse was highly prohibitive.
Marketing, which is responsible for forecasting and demand planning, estimates that first
year demand for the new line of pumps, and therefore the control sensors that manage the
operation and performance of the pump, would be approximately 500,000 units, with a
20% growth expected for year two. Sensor demand depends totally on final product
demand, which can be somewhat volatile.
Exhibit 2 details the monthly sales forecast for the new product line. The marketing
director is responsible for forecasts, and he maintains that a 95% confidence interval
around the actual demand will likely be between 500,000 and 750,000 units. Supplier
responsiveness and ability to satisfy volume fluctuations will be critical.
Exhibit 2
Two-Year Pump Product Line Forecast
August 2002
September 2002
October 2002
November 2002
December 2002
January 2003
February 2003
March 2003
April 2003
May 2003
une 2003
July 2003

60,000 units
75,000 units
50,000 units
50,000 units
35,000 units
55,000 units
50,000 units
40,000 units
40,000 units
45,000 units
45,000 units
50,000 units

August 2003
September 2003
October 2003
November 2003
December 2003
January 2004
February 2004
March 2004
April 2004
May 2004
June 2004
July 2004

70,000 units
60,000 units
45,000 units
45,000 units
45,000 units
42,000 units
45,000 units
50,000 units
50,000 units
50,000 units
58,000 units
48,000 units

Industrial Systems is targeting the price of its pumps from $1300-$1800, depending on the
model and configuration. The electronic sensor must be in the $135-$150 range. The
company plans to introduce the new line of industrial pumps to the marketplace in August
2002. It must have inventory by June 2002 to begin process proving and pilot production.
Industrial Systems relies on cross-functional commodity teams to develop sourcing
strategies for key purchased items. Executive management views this supplier selection
decision as critical to the success of the new product line. Control sensor technology
helps differentiate the final product in the eyes of the customer. This is important to
counteract the perception that industrial pumps are a commodity item.

The commodity team has spent the last several weeks visiting three suppliers, and is
currently evaluating various supply options. The team expects to begin negotiation with
one or more suppliers within the next several weeks.
Five suppliers responded to the commodity team's Request for Proposal, which was
forwarded twelve weeks previously. Although other electronic control suppliers exist, only
five showed an interest in the proposal. An initial review of these proposals revealed that
three of the five suppliers were cost competitive given the initial target cost.
The team visited three suppliers directly to collect detailed information. The visits ranged
from one to two days each, with all three visits completed within a three-week period.
These visits were time-consuming and exhausting, particularly since one of the suppliers
was located in Asia. Unfortunately, Industrial Systems does not have an International
Purchasing Office (IPO) to support its international procurement activities. Furthermore,
no one on the team spoke Japanese. Fortunately, the other two suppliers, located in the
U.S., were much easier to visit. In fact, one supplier was located only fifty miles from the
buyers assembly facility.
The following sections summarize data collected during the commodity team's three
supplier visits.

Supplier 1: Control Technologies

Control Technologies Technologies, located in Nagasaki, Japan, was the largest supplier
the team visited (sales of $6.25 billion). The plant covered ten acres, with a wide variety of
electronic components produced in the facility. Control sensors represent a large segment
of the suppliers production (Control Technologies commits 50% of total capacity to sensor
production and derives 60% of its revenues from sensors). Because of its size, however,
the company seemed most interested in large contracts ($100 million or more annually).
Geographic distance from Texas, along with the need to accommodate the needs of some
large customers, made this suppliers quoted lead time the longest of the four suppliers
being evaluated.
The highest-ranking manager that met with the commodity 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 customer, who the buying team found out had
formed a strategic supply alliance with Control Technologies. The commodity team felt a
bit "snubbed" at the facility, particularly the group's female member. The facility, however,
was efficient, spotless, and modern.
When the team visited engineering, they spoke with a manager in sensor design. The
engineer estimated, based on previous experience, that the ramp-up time to begin
production that would satisfy product specifications would be about four months.
Furthermore, tooling costs would likely be $3.25 million.
The sales manager was particularly proud of his companys new Internet-based electronic
data interchange (EDI) system.
This system allowed direct communication with
customers. He was also proud that Control Technologies was "the price leader" for the
industry, and was producing sensors for several major companies. He also talked about
the company's extensive investment in research and development. When the sales
manager heard that the sensor order, based on 550,000 units in year one, would likely not
exceed $67,5 million per year, he hesitated, saying that he would need to discuss the
order with management. The economics associated with large orders is what made
Control Technologies a low-cost producer.
Relevant Control Technologies data include:

Quoted price = $130 per unit (quoted at 120 yen to $1 U.S.)

Delivery lead time = 9 weeks
On-time delivery record = 94% on-time (for large customers)
Quality = 10,200 PPM defects
Transportation costs from Asia to Industrial Systems = $22 per unit
Current installed capacity for sensor production1 = 97%
Duties and customs = $11.50 per unit
Insurance = $2.50 per unit
Frequency of shipment = Monthly
Tooling costs = $2.75 million
Ordering, inbound receiving, and quality inspection costs = $5.50 per unit
Ramp-up time = 4 months
Denomination of contract = Yen

Supplier 2: Techline
A second candidate for the contract is Techline, a smaller manufacturer located in
Colorado Springs, Colorado. The company focuses exclusively on the design and
production of electronic sensors for industrial pumps and compressors. The team
discovered this company almost by accident. A team member was browsing a trade
journal and saw Techlines 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.
Techlines 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 another supplier for 18 years. The company entered the sensor market four years ago
and, during this time, has established a reputation for delivery reliability and innovation.
The president explained that Techlines success was based largely on its commitment to
develop new technology, especially technology that enhanced product reliability. He also
claimed that he knew every customer personally
Everyone in the plant seemed highly motivated. The president was particularly excited
about the possibility of working with Industrial Systems, and promised to work closely with
the company on this contract and for any new product lines. 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 in Techlines
relatively short history. He also indicated that several other buying teams were also going
to be sending teams to evaluate Techline within the next several weeks. However, he
assured the team that he would do whatever it took to maintain reliable delivery schedules
if Techline 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 Techline data include:

Quoted price = $142

Delivery lead time = 4 weeks
On-time delivery record = 96% on-time
Quality = 12,500 PPM defects
Transportation costs from Techline to Industrial Systems = $6.50 per unit
Current installed capacity for sensor production = 92%
Duties and customs = $0.00 per unit
Insurance = $1.75 per unit
Frequency of shipment = weekly
Tooling costs = $4.3 million
Ordering, inbound receiving, and quality inspection costs = $3.50 per unit
Ramp-up time = 5 months
Denomination of contract = Dollars

Supplier 3: Sensor Link

The third supplier, a reputable manufacturer of electronic sensors, was located less than
fifty miles from Industrial Systems. About half the companys sales came from electronic
sensors. In fact, the firm was one of the larger producers of these units worldwide. In
addition, the plant manager pointed out that the company has committed significant
resources to setting up a JIT production system for the electronic sensor line. The buying
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
Industrial Systems, they would have no problem delivering the product in two-day lot sizes
"just-in-time." The manager was able to show reports that backed this claim. Sensor Link
also had a solid reputation within the industry for working with its customers on future
product development.
Upon 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 sensors 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 shut down of the sensor when the pump was started.
However, he assured the team that the design engineers were working full-time on the
problem and that it would be solved well before Industrial Systems placed an order. When
the plant manager returned, the quality manager made no further mention of the problem.
Relevant Sensor Link data include:

Quoted price = $139

Delivery lead time = 2 weeks
On-time delivery record = 97.5%
Quality = 11,500 PPM defects
Transportation costs from Sensor Link to Industrial Systems = $16 per unit (due to
frequent deliveries of small quantities)
Current installed capacity for sensor production = 95%
Duties and customs = $0.00 per unit
Insurance = $2.00 per unit
Frequency of shipment = Every other day
Tooling costs = $3.95 million
Ordering, inbound receiving, and quality inspection costs = $3.25 per unit
Ramp-up time = 4 months
Denomination of contract = Dollars

Supplier Financial Data

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 supplier. The team also had to convert Japanese yen into dollars.
Exhibits 3 and 4 summarize selected supplier financial data.

Exhibit 3
Selected Supplier Balance Sheet Data (U.S. $ in millions)
For Period Ending December 31, 2000
Control
Technologies

Techline

Sensor Link

ASSETS
Cash

$105.9

$35

$75

Marketable securities

$152.5

$9

$115

Accounts receivable

$889

$54

$395

Inventories

$1177.7

$105

$183

$2,325.1

$203

$768

Investments at equity

$838.4

$26

$50

Goodwill

$400

$38

$130

Total investments and other

assets

$1,238.4

$64

$180

Property, plant, and

equipment

$1,958.5

$155

$372

TOTAL ASSETS

$5,522

$422

$1,320

Notes payable

$625.5

$21

$59

Accounts payable

$725.9

$95

$205

Taxes due on income

$270

$25

$63

Accrued payroll and

employee benefits

$453.2

$50.5

$210

Total current liabilities

$2,074.6

$191.5

$537

Long-term debt

$1,643.5

$65

$266

Shareholders' equity

$1,803.9

$165.5

$517

TOTAL LIABILITIES AND

SHAREHOLDERS' EQUITY

$5,522

$422

$1,320

Total current assets

LIABILITIES AND
SHAREHOLDERS' EQUITY

Exhibit 4
Statement of Income Data (U.S. $ in millions)
Year Ended December 31, 2000
Control
Technologies
Net sales

Techline

Sensor Link

$6,250

$600

$2,400

Cost of goods sold

$5,575

$401

$1,555

Selling, general, and

administrative expenses

$450

$81

$630

Interest expense

$175

$35

$72

Costs and expenses

$6,200

$517

$2,257

Income before income taxes

$50

$83

$143

Estimated taxes on income

$20

$40

$69.5

NET INCOME

$30

$48

$73.5

Additional Information and Assumptions

Although Industrial Systems is buying an electronic sensor that has features defined
by industry standards, extra design features and performance capabilities that will
differentiate the end product will result in additional tooling requirements at each
supplier.

The company expects the line of pumps 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 pumps at the end of two years.

Industrial Systems plans to maintain some level of safety stock inventory for the
sensors, at least for the first year. Due to long material pipelines, Industrial Systems
expects to maintain a one-month safety stock inventory if it utilizes an Asian supplier.
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 16% of the inventory's unit cost. The company assumes carrying
costs for safety stock material.

For this analysis, assume the unit price quoted by each supplier is what Industrial
Systems would pay for the sensor 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 Industrial Systems takes an active role in coordinating inbound transportation

shipments, company policy prohibits assuming title to material until the material
arrives at the receiving dock.

On average, a quality defect costs Industrial Systems $400 in various charges to

correct the non-conformance.

Assume the date is currently January 2002 with first production by the supplier
required in June 2002.

Case Assignment Questions

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.

2. The issue of single versus multiple sourcing is an important consideration during

supplier selection. Using the following table, identify the potential advantages and
disadvantages of single and multiple sourcing (not only as they relate to this case).

3. Instead of conducting supplier evaluations through formal assessment, some firms

rely on product samples as a means to validate supplier capability. What are the
risks associated with relying only on supplier samples when making a supplier
selection decision? How can a company minimize this risk?

4. No supplier selection decision is without risk. Create a table for each supplier that
identifies the various risks associated with the decision and identify ways to
mitigate or manage the impact of each risk if it were to occur.