Balancing Price With Quality

by Noriko Takezaki

For Japanese PC manufacturers, going overseas to procure parts was quite a challenge. The requirements of the unique double-byte character code setting used for Japanese-language processing had helped to keep Japan's PC market closed, and Japanese PC manufacturers had got used to relying on domestic parts supplied by their affiliated component manufacturers.

However, the diffusion of DOS/V (i.e., IBM/AT-compatible) computers for Japanese-language processing, starting in about 1993, broke the stranglehold that proprietary PC architectures held on the Japanese market and opened the door for foreign PCs and components. Facing tough price competition from foreign manufacturers, such as Dell, Compaq, and Gateway 2000, and then among domestic vendors as well, Japanese PC manufacturers began seeking ways to market lower-priced machines. Procuring low-cost PC components - such as hard disk drives, motherboards, and power units - from suppliers outside of Japan, particularly in Asia, seemed to be the answer.

Asian suppliers
Overseas procurement has been used mainly for "volume-range" (low-cost, low-profit margin) desktop PCs. Fujitsu, for example, which has gained a significant market share by aggressively pricing its new PCs, procures about 90% of the components for its FMV series computers from Asian countries. Fujitsu gets CRTs and motherboards from Taiwan, hard disk drives from Singapore and Malaysia, power units from China, and floppy disk drives from Malaysia and Thailand.

Although NEC maintains the proprietary NEC98 product architecture, it too has increased overseas procurement efforts. The proportion of overseas components in NEC's desktop PCs is now about 60%.

To assist them in obtaining more information on component suppliers around the globe, several Japanese manufacturers have set up so-called International Procurement Organizations (IPOs) abroad. Fujitsu currently has IPOs in such countries and areas as Taiwan, Singapore, Hong Kong, Thailand, The Philippines, and Oregon and San Jose in the US. NEC, meanwhile, has IPOs in Hong Kong, Taiwan, Singapore, China, Malaysia, the UK, and Boston and Mountain View in the US.

"We cannot just sit and wait for opportunities," says Haruki Okada, general manager of Fujitsu's purchasing division. "International procurement is now essential to the business of sales, even more so than the conventional style of purchasing domestically."

Price versus quality
In terms of price, foreign-made components surely have satisfied their requirements. (The cost of motherboards, for instance, is 15% to 30% less when their production is entrusted to a Taiwanese company on an OEM basis.) When it comes to quality, however, foreign-made components have not always lived up to stringent Japanese standards.

This has proven a big headache for Japanese computer makers. Even following new model releases, some PC manufacturers have had to issue product recall notices because of problems associated with defective foreign components.

"Under the pressure of being competitive in the global price wars, Japanese PC manufacturers have had to depend on overseas procurement - often without sufficient preparation," observes Katsuya Yoshioka, associate senior analyst at NCB Research Institute (a research body of the Nippon Credit Bank group). "They weren't fully aware of some basic [non-Japanese] market facts: that high quality equates with high price, and that the relationship between manufacturer and supplier is more-or-less equal."

In Japan, most component suppliers belong to a keiretsu: a group of companies working closely with a particular, major Japanese manufacturer (although the system is beginning to weaken). In a keiretsu relationship, suppliers are expected to do their utmost to satisfy demands (no matter how unreasonable) from the manufacturer, such as for quicker delivery and lower cost. In return, the suppliers receive support from the manufacturer, such as long-term guarantees of stable order placement and technological assistance.

For international procurement, Japanese manufacturers were initially dismayed to find that they could not apply the keiretsu formula to foreign suppliers. "In countries outside Japan, if a supplier feels that a manufacturer's conditions for product quality and price are not acceptable, the deal between them is simply not realized," notes NCB Research's Yoshioka. "In Japan, on the other hand, since suppliers depend heavily on manufacturers, they often must submit high-quality components to manufacturers even at low prices [to maintain the relationship]. This difference was bewildering for Japanese manufacturers at the beginning."

Desperate times,
desperate measures
In general, Japanese manufacturers place greatest emphasis on maintaining high product quality. Yoshioka observes that this strictness toward product quality by Japanese PC manufacturers derives in part from their experience in manufacturing mainframes.

However, increasing market competition has forced Japanese PC manufacturers to change their conventional view toward product quality and put more emphasis on lower retail prices. In other words, they have started thinking about how much they can compromise, how much they can ease their quality standards in return for the lower cost.

According to NCB Research, some manufacturers have simplified their evaluation process to shorten overall product lead time. Instead of performing their conventional 100% component testing, PC makers have started doing sampling tests of components more often. Sometimes, they even omit the time-consuming endurance tests.

In spite of the Japanese reputation for quality "packaging," many manufacturers have also loosened their degree of strictness for factors that do not affect product performance - things such as thickness of connector coating, color finishing, or flaws on the chassis. They have also shortened the guarantee period they require of PC component suppliers. Manufacturers who might once have asked suppliers to guarantee a five-year supply of a particular component, for example, might now (especially since product models change every few months) ask for a guarantee of a year or even less.

Problems and solutions
Japanese PC makers have faced a series of unexpected problems, due in large part to the lower quality standards of Asian manufacturers. This has caused them to rethink their procurement strategies. Some PC makers have become more vigilant regarding component quality control, while others have decided to reduce the scope of their foreign procurement, such as entrusting foreign suppliers with production only and not with product design.

"We have discovered some ways to make full use of the benefits of foreign procurement, while avoiding problems as much as possible," says Fujitsu's Okada. "We have set up our own product certification system for foreign procurement, for example. We now carefully check component quality and reliability, such as by visiting local manufacturing sites in person."

To maintain adequate product quality, most Japanese manufacturers now send their own quality control experts to a supplier's local site to train them in Japanese-style quality control. Such training, however, is not always welcomed by the foreign suppliers; they are not accustomed to receiving such training from manufacturers, and often perceive it as officious intervention.

Some Japanese PC manufacturers, fed up with the insufficient quality assurance of foreign suppliers, have decided not to deal directly with foreign manufacturers. Instead, they now entrust product quality control to other Japanese companies that have experience in dealing with such suppliers. Others are even considering ending their offshore procurement efforts and going back to domestic suppliers (and will almost certainly do so if the yen exchange rate is favorable).

"If we have to spend more time and money for quality inspection of foreign-procured components, then foreign procurement just doesn't make sense," says Fujitsu's Okada. "We started overseas procurement because we thought it was an effective strategy to reduce total product cost. But if it means low product quality, we can no longer regard it as the right solution. Overseas procurement is not a must."

The product quality issue represents a big hurdle that Japanese manufacturers must overcome if they are to make their overseas procurement efforts successful. "It will take much more time and effort before Japanese PC manufacturers can fully enjoy the benefits of overseas procurement," says NCB Research's Yoshioka. "Since the yen is leaning toward depreciation now, Japanese manufacturers need to study their situations objectively, and in a broader context."

Estimated costs of high-end notebook PC (average)
Actual market price	JPY430,000
Distributor's margin	JPY35,000
Wholesale price	(JPY395,000)
Manufacturer's profit:	JPY70,000
Manufacturing cost:	(JPY325,000)	100%
Assembly, miscellaneous costs	JPY117,500	36.2%
Component costs:	JPY207,500	63.8%
LCD panel (12.1 inch, color TFT)	JPY70,000	21.5%
Chassis, keyboard	JPY 6,000	(1.8%)
Pointing device (track pad)	JPY 2,000	(0.6%)
Motherboard	JPY10,000	(3.1%)
CPU (Pentium 133 MHz)	JPY21,000	(6.5%)
Chipset(e.g., Intel Triton)	JPY4,000	(1.2%)
Cache memory (SRAM, 256 KB)	JPY2,000	(0.6%)
Main memory (DRAM, 16 MB)	JPY14,000	(4.3%)
Graphic controller	JPY3,000	(0.9%)
Video RAM (2MB)	JPY4,000	(1.2%)
Bus controller	JPY3,000	(0.9%)
Sound chip	JPY7,000	(2.2%)
PCMCIA Card slot	JPY1,500	(0.5%)
Power unit	JPY5,000	(1.5%)
Input/output adapter	JPY1,500	(0.5%)
HDD (1.0 GB, 2.5 inch)	JPY20,000	(6.2%)
FDD (3.5 inch)	JPY3,000	(0.9%)
CD-ROM drive (6X)	JPY7,000	(2.2%)
Battery Pack (lithium ion)	JPY9,000	(2.8%)
Other components	JPY8,000	(2.5%)
Windows 95	JPY4,000	(1.2%)
Bundled software	JPY2,500	(0.8%)