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Creating A Factory Within A Factory


Dr. Habil Ulli Arnold
Dr. Habil Ulli Arnold, Professor of Industrial Marketing and Supply Management, University of Stuttgart, Stuttgart 711/121-3161.
Eberhard E. Scheuing, Ph.D., C.P.M., A.P.P.
Eberhard E. Scheuing, Ph.D., C.P.M., A.P.P., NAPM Professor of Purchasing and Supply Leadership, St. John's University, New York 718/990-6770.

82nd Annual International Conference Proceedings - 1997 

Abstract. The concept of a factory within a factory describes a virtual organization. This approach results in a highly flexible enterprise with limited physical assets of its own. Instead, it holds a small number of suppliers responsible for most engineering and manufacturing activities. The lead company focuses on planning and coordinating supplier activities and on marketing the outputs of the virtual organization. Purchasing has become a strategic element in the value chain and a core competency of the firm.

Process Organization As Main Design Factor. The lean management and business reengineering approaches focus mainly on the re-design of processes. They are based on Porter's concept of a value chain with an identification of primary and secondary chain activities. Reengineering means relating each of these activities to competitive advantage.

In companies producing goods, manufacturing has always been the focal point of the other primary activities marketing and procurement. In this paper, we analyze the need to insource manufacturing and engineering activities from a finished goods producer's point of view. Consequently, the processes are organized in a market-oriented manner. The finished goods market provides information about customers' needs. And the supply market provides information about qualified sources for products and services needed to satisfy customer needs.

Managing Supplier Relationships - An Evolutionary Approach. Traditionally, many suppliers have been responsible for many parts. A first step toward rationalizing the supplier base and benefit from economies of scale is to standardize the parts bought from external suppliers, e.g., use the same door handle on several car models. The second step is to upgrade selected suppliers to the level of subassemblers by asking them to integrate the work of a group of parts suppliers, e.g., delivering complete doors. In this modular sourcing approach, first-tier supplier partners provide added value by coordinating inputs from a variety of upstream parts suppliers. While the modules are very specific, the responsible supplier partners are able to realize economies of scope and typically deliver just-in-time.

As these networking relationships progress, first-tier suppliers assume responsibility for designing their modules in a system sourcing context. Eventually, the question arises whether the hub company leading this set of interactive relationships should retain any engineering and/or manufacturing activities in-house or rely completely on external resources for these elements of the value chain.

Redefining Core Competencies - A Two-Step Model. The answer to this question leads to the factory within a factory concept, as illustrated in fig. 1:

Fig. 1: Two-Step Model for Redefining Core Competencies (figure not available in text-only version)

Step 1 depicts classical outsourcing decisions that transfer non-essential activities to external providers, based primarily on cost considerations.

In step 2, the company examines the sources of its competitive advantage to redirect its resources towards its true core competencies. As it refocuses on a leaner set of competencies, such as coordinating and managing a diverse supplier base, the factory within a factory concept becomes a powerful paradigm. We will illustrate this revolutionary approach by using two examples from the automotive industry.

Transforming Relationships. By sharpening the definition of its core competencies, a company highlights the potential for having suppliers produce components on its premises. As shown in Figure 2, in traditional buying arrangements suppliers produce parts on their premises and then ship them to customer organizations who assemble them into finished products.

As leading organizations streamline their processes and focus on value added, they increasingly transfer production tasks to their suppliers. After all, car buyers select models that reflect their lifestyles rather than considering technical details like the type of door handle used. Lean companies thus emphasize the creation and marketing of innovative products while shifting the responsibility for making these products to their suppliers.

Fig. 2: From Traditional Buying to Virtual Organizations (figure not available in text-only version)

As they advance along the continuum shown in Figure 2, companies identify selected first tier suppliers who can assume the role of subassemblers, coordinating and integrating the work of upstream suppliers into modules, such as fully assembled doors or instrument panels. These modules represent distinct elements of the final product and are characterized by clearly defined interfaces. The company and its select group of supplier partners make long-term commitments to each other, engage in joint product development efforts, and share in the resulting benefits.

From In-Plants To The Factory Within A Factory. While they are quite powerful and most beneficial, there are distinct limitations to such cooperative relationships. Though closely linked, the two types of organizations (suppliers and customers) remain separate and act accordingly. They exchange and share information but there are time lags and even communication gaps. Although substantial benefits are derived, a sense of shared destiny may be lacking. And many customer organizations do not look beyond their first tier suppliers to build mutually supportive relationships with second, third, and fourth tier suppliers.

It takes a leap of faith to move from arms-length relationships to customer/supplier intimacy. At Semco, a progressive manufacturing firm in Sao Paulo, visitors encounter three kinds of people, all working side-by-side every day: company employees, former employees who have become entrepreneurs in their own right, and supplier employees. At Bose Corporation, an American manufacturer of high-quality audio systems, and its JIT II® licensees, supplier representatives work on customer premises day-by-day as so-called "in-plants." They interface and cooperate with their customer counterparts in a seamless fashion and participate in real time in decision making, problem solving, and product development processes. They are members of teams, not visitors, contributors, not outsiders looking in. They - and their employers - share the pain and the gain.

Although in-plants are deeply committed to the success of the customer organizations where they work, their ability to manage the flow of inputs from their employers is necessarily limited. Because they have reversed roles from being absent from customer premises to being absent from their employer premises, they now lack the daily face-to-face interaction and involvement with their colleagues in their own organizations. While they are hardly considered "outsiders" in their own organizations, priorities shift, and they may no longer be part of the grapevine and the decision making network "at home." And they may not be able to make their employers respond as quickly and as well as they and their customers may want and need. After all, production and shipment of the materials, parts, components, and/or modules that their employers supply takes place at one or more distant plants according to schedules and priorities that they did not help set. And shipments may be delayed by weather conditions or other factors.

This is where the factory within a factory comes in. Setting up shop on customer premises is not only an impressive time and money saver but also a highly visible sign of an extensive commitment to a customer. Inasmuch as it moves supplier production on-site, it is a logical progression from the in-plant model of supplier-customer cooperation. On the other hand, it represents a substantial risk for both parties, reflecting advanced levels of mutual involvement and trust. As part of the factory within a factory concept, a supplier installs its own manufacturing equipment and personnel on customer premises and might even be responsible for assembling a module into a final product.

Moving from Asset Ownership To Orchestration: The Virtual Organization. The responsibility for final product assembly provides the stepping stone toward the culminating point of the sourcing journey: the virtual organization. In a factory within a factory environment, suppliers set up shop on customer premises but the modules produced by these integrators are assembled into the final product by customer employees.

An example of this approach is the Micro Compact Car (MCC) company, a joint venture of Mercedes Benz and SMH, the manufacturer of the popular Swatch watches, which produces the so-called Smart car. MCC built a plant in Hambach (France) where it only owns the real estate and the final assembly line. The press shop, engine production, seats, body parts, front module, doors and cockpit are defined modules produced on this site in small "pre-plants" owned by particular suppliers. These suppliers are responsible for engineering and manufacturing the parts and are thus tied into the production planning system of MCC. They produce just-in-time and deliver directly to the final assembly line where MCC workers assemble the modules into the finished car.

A virtual company goes one step further by transferring even the responsibility for the final assembly line to outside suppliers. Volkswagen's revolutionary truck plant in Resende, Brazil is an example fo such a virtual company since its employees are not involved in any physical production. All manufacturing work is done by its suppliers. The seven suppliers listed in Figure 3 own all physical assets, including the final assembly line. Only 200 of the 1,500 employees at the plant work for VW. They are responsible for quality assurance, marketing, and sales only.

Fig. 3: VW's virtual plant in Brazil
(Adapted from Woodruff/Katz/Naughton 1996, p. 56)

Virtual organizations have redefined their core competencies as managing customer and supplier relationships as opposed to their traditional roles as manufacturers of things. They focus on identifying and even anticipating customer needs, and assemble networks of suppliers whose combined efforts can satisfy these needs. Their competitive advantage and success derive from their ability to interlink their purchasing and marketing functions and orchestrate diverse contributions into powerful symphonies.

Purchasing As A Value Creator. Virtual organizations transfer all manufacturing activities to their supplier partners. They view their value added as the ability to assemble and manage complex coalitions of resources to meet the need of today's and tomorrow's customers. With production outsourced, puchasing becomes the governing hub of the organization's supplier/resource network. It creates value by choreographing the linkage of customer needs to the capabilities of multiple suppliers.

Purchasing's management of supplier partners has to be proactive in the factory within a factory context. Instead of being an agent for the needs of the organization's manufacturing function, its new role is the strategic identification and management of efficient, competent and responsive suppliers. World class suppliers are essential to the success of the factory within a factory concept. They are 'vital organs' in the virtual organization's body.

The Risk of Supplier Emancipation. As suppliers grasp their roles as vital organs, they become more and more self-confident. After all, they control most of the engineering and manufacturing know-how. A key risk for the factory within a factory concept - especially its advanced variant of the virtual organization - is thus supplier emancipation. They could use their know-how to bypass or eliminate the hub organization and instead form a coalition of their own.

Purchasing executives can avail themselves of two powerful tools for managing the risk of supplier emancipation. They can diffuse this threat by using the Roman principle of 'divide and conquer' by building competitive sourcing into their network relationships. Better yet, they can build a sustainable competitive advantage on a well-known brand name.

Conclusions. As purchasing progresses on its path toward advanced sourcing models, it migrates from traditional buying patterns to becoming the agent of change to virtual organizations. A vital step along this path is the factory within a factory where suppliers set up shop on customer organizations' premises. In the process, purchasing becomes an organization's center for relationship management by aligning customer needs with supplier capabilities and choreographing performance for mutual benefit.


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