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NEW YORK, July 25, 2001 — In their quest to develop virtual manufacturing and supply chain operations, many high-tech companies have found that outsourcing has provided more headaches than solutions, according to a new report released today by management consultancy Booz·Allen∙and Hamilton.

For high-tech companies like Cisco, Sony, Palm, Compaq, Apple, and Philips, outsourcing the manufacturing of key products and components has not lived up to expectations, and has contributed to their financial and performance difficulties. A detailed analysis of the supply chain problems these companies have experienced appears in the article, "Why Cisco Fell: Outsourcing and Its Perils," to be published in the August 2001 issue of strategy+business, Booz·Allen’s quarterly business journal.

According to the report, the failure has been not with the theory of outsourcing, but the practice. Outsourcing was designed to make manufacturing and distribution more efficient, reduce inventory, and sharpen the focus on product design and innovation. Yet the results have been mixed at best, as shown in report cards on outsourcing effectiveness for Cisco and Compaq’s Pocket PC. Each company received an overall grade of "C," with high marks for focus on innovation and customer responsiveness, and poor grades for reducing inventory.

According to Ed Frey, Vice President at Booz·Allen & Hamilton, the current outsourcing models cannot effectively adjust the supply of products from contract manufacturers to dramatic changes in demand, leading to product shortfalls in times of high demand and more recently, bloated inventories as demand tapered off. The effects of significant revenue shortfalls have been compounded as high-tech companies such as Cisco were locked into commitments to buy large quantities of new products from their suppliers. "Like Lucy and Ethel in the chocolate factory, these companies are left with a glut of product and nowhere to put it. Unfortunately, it’s just about impossible to hold a fire sale in high-tech," Frey said.

The report highlights a major flaw in outsourcing today – the basic conflict of objectives between original equipment manufacturers (OEMs) such as Cisco and Compaq, and the contract equipment manufacturers (CEMs) such as Solectron and Jabil Circuit who actually produce the products. OEMs need flexibility so they can quickly ramp-up supply as new products become "hits." However the CEMs need predictability — not flexibility — for their production schedule, because they often operate on razor-thin profit margins, and must maintain a relentless focus on cost.

The OEMs have also missed out on the informal communications and problem-solving channels that existed when the entire supply chain was still under one roof, according to Bill Lakenan, a Booz·Allen Principal. "Water cooler comments from the marketing department about how rapidly the new product was taking off were invaluable. They kept production people closer to the market so they were able to quickly respond to changing conditions. Now this grease that used to smooth the product flow is gone — so the supply chain has been rougher," says Lakenan.

The report offers an approach to make outsourcing more successful for high-tech companies by redefining how supply chains work. Keys for effective outsourcing include: actively managing capacity to handle a sudden surge in demand; utilizing a rolling process to reserve aggregate capacity in the long term, while specifying exact production schedules closer to production dates; improving coordination of production planning; building flexibility into product designs; and learning from mistakes and adapting the supply chain over time.

Founded in 1914, Booz·Allen & Hamilton pioneered the business of management consulting. Today, it is one of the world’s leading international management and technology consulting firms, with more than 10,000 employees in over 100 offices worldwide and sales in excess of $2 billion. Booz·Allen & Hamilton corporate headquarters are located in McLean, Virginia.

Booz·Allen’s client base includes many of the world’s largest industrial and service corporations, as well as major institutions and government bodies around the world, including most U.S. departments and agencies. Booz·Allen provides services in strategy, systems, operations, and technology to clients on six continents. The firm delivers a powerful combination of strategy, e-business expertise, industry knowledge, functional capabilities, implementation expertise, and technical know-how to organizations facing the challenges of the new economy.

Consistent with its position as a business thought leader, Booz·Allen sponsors strategy+business, a quarterly journal containing the best ideas in business. Visit the Booz·Allen Web site at www.boozallen.com or the strategy+business Web site at www.strategy-business.com.

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