Case Study For Operation Management

STRATEGIC SOURCING AT WHIRLPOOL CHINA: FINDING THE IDEAL SUPPLIER Dr. Martin Lockstrom, Thomas E. Callarman and Shengrong Zhang wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca. Copyright © 2012, CEIBS Version: 2012-06-19

It was April 10, 2011, when Gianluca Castelletti, head of Whirlpool’s Asia International Procurement Office in Shanghai, was informed by his colleagues that the company was about to launch a new refrigerator model in just six months. With the current worldwide focus on energy saving, and as one of the biggest home appliances producers, Whirlpool China planned to introduce a new energy-efficient refrigerator. Castelletti immediately spotted a challenge in Whirlpool China’s plan to launch a new energy-efficient model within such a short period of time. Under the current global trend of energy-saving, consumers were demanding new energy-efficient products, which obviously would involve new kinds of technology. For the new refrigerator model, the basic difference was in the motor, since the current style of AC motor, which offered a low cost, would need to be replaced with DC motors, which offered much higher energy efficiency. Castelletti would have to find a suitable supplier of DC motors, and he had less than six months to do so. Delayed components would cause delays in the production of a new refrigerator, and thus, a later launch of new products. Within the home-appliance industry, the fierce level of competition meant that any delays in launching new products would result in a severe loss of sales for the stragglers. Castelletti now faced a tough challenge: How should he go about the process of finding a suitable supplier for the required DC motor parts? Should he explore the possibility of developing the company’s current supplier, or should he quickly engage an existing supplier of DC motors? Sourcing the right components was the first step in launching the new product. The pressure increased even further when Castelletti received call from his supervisor, inquiring about his planned strategy for sourcing the new motor for the energy-efficient refrigerator. Castelletti had to quickly decide where he could find the suitable suppliers in order to avoid delays in launching the new product. The question was “how”? Castelletti called together his team to develop a plan.

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Page 2 9B12D012 COMPANY BACKGROUND Whirlpool’s History Whirlpool Corporation was the world’s leading manufacturer of major home appliances. In 2010, the company had more than $18 billion revenues and net earnings of $619 million (see Exhibit 1). On a worldwide basis, Whirlpool had 68,000 employees working in 67 manufacturing and technology research centres. It produced all major categories of home appliances, including stoves, washers and dryers, dishwashers, refrigerators, garage organizers, and countertop appliances. Whirlpool produced and marketed Whirlpool, Maytag, KitchenAid, Jenn-Air, Amana, Gladiator Garage Works, Inglis, Estate, Brastemp, Bauknecht, Consul, and other major brand names to consumers in almost every country around the world . Whirlpool’s global headquarters were located in Benton Harbor, Michigan, with manufacturing facilities and sales outlets across North America, Latin America, Europe and Asia. In total, the company’s products were sold in more than 130 countries. Ironically, Whirlpool was founded on a business failure. In 1908, Lou Upton’s invested his savings in a venture that manufactured household equipment, but the business did not succeed. Upton retained one asset from the business that he hoped would be valuable: the patents on a hand-operated wringer washing machine that he thought could be converted to an electric model. In 1911, Upton joined forces with his uncle and his brother to launch the Upton Machine Company in St. Joseph, Michigan, which produced motor-driven wringer washers. After a quick business expansion, 1929 saw the company merge with the Nineteen Hundred Washer Company of New York. Twenty years later, the company’s name was changed to Whirlpool Corporation, and it soon earned the title of industry leader. After a series of other acquisitions, Whirlpool participated in an acquisition with the Maytag Corporation on March 31, 2006. This was a significant step for Whirlpool to become “the largest home appliance maker in the world,” a title that had previously been reserved for Electrolux. Whirlpool’s philosophy focused on customer loyalty. Its products were built to be reliable with long lifecycles, which meant substantial emphasis had to be paid to product quality. The company’s focus on quality was rooted at the conceptual stages and continued throughout the manufacturing process. The results of these quality efforts, combined with Whirlpool’s commitment to innovation and cost productivity, brought about a strong competitive advantage. Stiff competition from competitors such as Electrolux, General Electric, LG, etc. also created a competitive pricing environment, and hence, it was essential that Whirlpool concentrated on cost reduction, productivity initiatives, and innovation in order to offset high material costs and maintain its position in the market. Furthermore, lean manufacturing and operational excellence were the principles on which Whirlpool relied to ensure a continuous improvement of process and to meet its high standards of quality. China’s Household Electrical Appliance Market Aided by the rapid development of the Chinese economy and a rising GDP per capita, China’s household electrical appliances industry grew quickly in response to the government’s policy of stimulus in domestic

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Page 3 9B12D012 demand. According to China’s Household Electrical Appliances Industry Report, China had become the largest household electrical market in Asia Pacific area in recent years. According to the data from China Household Electrical Appliances Association, more than one-third of the household electrical appliances in the world were produced in China in 2007. Approximately 50 per cent of the world’s televisions were manufactured in China, along with 70 per cent of air conditioners and almost 100 per cent of the world’s microwave ovens. China stood out as one of the largest household appliance makers in the world, also boasting a large market share. Establishing a foothold in China had been a long and tedious process for Whirlpool since its entry into the market in 1995. At that time, Chinese regulations required foreign companies to work with local partners. The company’s chief executive officer (CEO) at that time announced a joint venture agreement after its investments of more than $100 million with local house appliances producers. The joint venture agreements gave Whirlpool a chance to produce the top four household appliance categories: washing machines, microwave ovens, refrigerators and air conditioners. Three short years, later Whirlpool was forced to pull out of two of the five joint ventures due to its unfamiliarity with and unclear positioning in the Chinese market. In 2001, China joined the World Trade Organization, and the resulting freer access to China’s market greatly improved conditions for Whirlpool. Furthermore, relocation of the company’s Asian headquarters to _Shanghai changes in the Chinese consumer mindset (i.e., Whirlpool’s offerings began to be accepted as a high-quality products) and incorporating learning from other multinationals all helped Whirlpool to compete more successfully in the Chinese market. By 2011, China accounted for approximately 3 per cent of the company’s global sales, including sales to other manufacturers. Whirlpool employed more than 2,500 people in China, and its microwave factory in Shunde produced more than two million units per year, most of which were shipped to North America and Europe. Washers and refrigerators were produced in factories that had been newly established in a joint venture with Hisense, one of the largest appliance producers in China. THE INTERNATIONAL PROCUREMENT OFFICE IN SHANGHAI Various factors could turn global sourcing into a tricky process: transportation delays, lack of technology and capacity of foreign resources, cultural and language differences, quality assurance, political and economic stability, and proper inventory management systems, to name just a few. For these reasons, Whirlpool set up an international procurement office in Shanghai to support its own manufacturing operations in Asia and to provide support for any other operation in the world that sourced components from Asia. In 2010, the Asian international procurement office sourced more than US$1 billion in China out of $8 billion global direct spend. Companies chose to source in China for many reasons, including reducing capital investment, gaining more market share, focusing on core competencies, and increasing the company’s flexibility in production. Although China may have shown a cost advantage when it came to raw materials, inconsistencies existed in the areas of quality and reliability. Other hindrances that companies often faced when operating in China stemmed from the fact that the country lacked capable service providers and suffered from shortcomings in the areas of transportation and IT infrastructure. At times, high rates of damage/loss in transit also caused a problem. For a supplier to be considered as a Whirlpool supplier, it had to match the following criteria:

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 Whirlpool code of conduct and other requirements;  Minimum quality audit score;  Best total cost of ownership and manufacturing efficiency;  Continuous innovation in design and manufacturing for best-in-class quality and technology;  Structured project tracking, design reviews with management tollgates, utilizing design and process

FMEA, fault tree analysis, reverse engineering and other tools where applicable; and  Access to UL, CSA, VDE and other agency approval. The following requirements were dependent on the commodity analyzed:  Laboratory capability for engineering conformance and reliability testing.  Prototype capabilities. Whirlpool required a very restricted supply quality system, namely the Whirlpool Supplier Quality System. The Whirlpool Supplier Quality System was developed based on the ISO 9001. The household appliance industry was broader than the ISO 9001 requirements, including process capabilities assessments (see Exhibit 2). Based on Castelletti’s experience, most suppliers in China, even those who supplied Whirlpool’s competitors, could not reach the minimum required score when audited as potential suppliers during the first round of Whirlpool’s selection of potential suppliers. With the minimum score required being 60/100, the first-round score among good, local suppliers was approximately 50. Elements were weighted separately to bring about the total score of 100. Since 1996, Whirlpool had followed a restricted Six Sigma program, and within the company, more than 1,500 Whirlpool employees possessed Six Sigma training. The training program included teaching the employees to use Lean and Six Sigma techniques. This system was intended to improve the quality and efficiency of Whirlpool’s manufacturing, technology, and business processes and products. When a supplier showed a distinct advantage on cost structure and could provide clear value, the SQE (Supplier Quality Engineer) and SDE (Supplier Development Engineer) team at Whirlpool’s international procurement office would provide resources to facilitate closing the gap within a certain time frame. The commodity team was also in charge of facilitating the supplier qualification process. The international procurement office had a special budget for the SQE team for supplier development, covering the travel costs of supplier visits and continuous training. The SQE members often travelled, moving from one supplier to another to conduct gap-closure development by providing training or by coaching the execution of given projects. The suppliers were not charged for the training they received from Whirlpool; however, they were expected to take some initiatives to acquire outside resources for self-improvement if their current situations were judged to be insufficient. For example, those local suppliers that did not have capable people in place would be pushed to hire the right people to enhance their quality process. FINDING THE RIGHT SUPPLIER To find a suitable supplier of DC motors for the new energy-efficient refrigerator model, Whirlpool used the Sourcing Strategy Development (SSD) process, which included four steps for sourcing the right suppliers: Step 1 – internal analysis; Step – 2 external analysis; Step 3 – Strategy development; and Step 4 – implementation. Even before Step 1, it was necessary to define the commodity and allocate

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Page 5 9B12D012 responsibilities and resources through co-ordination of global and regional activities. An internal analysis identified and prioritized the process-partner requirements, then evaluated the performance of the existing supply base, and reviewed the existing supply base. The SSD process should also identify the switching costs in Step 1. When the internal need was clear, then the process moved forward to Step 2, the external analysis, which included analyzing the supplier industry and competitors and evaluating competitor performance and strategies. The evaluation process made use of SWOT (Strength, Weakness, Opportunities, Threat) analysis and Best-in-Class performance analysis. From the results of the internal and external analysis, Step 3 was then used to develop the sourcing strategy. In this stage, Porter’s Five Forces Model was also adopted to analyze the competitiveness. After understanding the existing strategies, strategic options were formulated and their financial impact was analyzed. In developing a sourcing strategy, preliminary negotiations could be carried out, a suitable strategy and suppliers should be selected, and the critical path for implementation should be defined. Step 4 addressed the implementation stage, wherein the planned strategy was put into play, feedback was given to the chosen process partners and suppliers, and final negotiations were nailed down. In the implementation phase, if the goals had not been met, the strategy needed to be revised. With the complete SSD analysis, the sourcing strategy had put Whirlpool in a position to find suitable suppliers. THE CHALLENGES Acting as a supplier for one of the largest home-appliance makers in the world was not an easy job for suppliers. First, the suppliers had to agree to some aggressive payment terms. Whirlpool’s U.S. procurement team privileged the consignment stock process, which meant that any agreed-upon payment terms started when parts were withdrawn from Whirlpool’s components warehouse, located in every Whirlpool factory. The warehousing time and the transportation lead time, including sea and land transportation times, were consequently added to the agreed-upon payment terms but were not predetermined — or even pre-determinable. Many suppliers found it difficult to accept these challenging payment terms. Second, the suppliers had to endure a long sample-testing process When suppliers were deemed qualified (i.e., after passing the quality system audit) to move ahead for a particular project, Whirlpool still required them to provide samples that passed the sample tests and application tests (see Exhibit 3). Third, suppliers faced a continuous challenge in terms of cost and quality improvement, year on year, especially since Whirlpool placed a great deal of emphasis on both quality and cost. For the sourcing team, continuous improvement was expected in terms of each year’s sourcing performance. Whirlpool used a technology road map for its own corporate technology evolution; therefore, its suppliers were expected to meet that same requirement each year to ensure continuous progress. Whirlpool’s strict selection criteria made it difficult to find suppliers in China. To launch new products, Castelletti had to make full use of Whirlpool’s Asia International Procurement Office in Shanghai. Finding the right supplier for DC motors in less than six months was the key challenge in front of Castelletti. With the help of its Global Sourcing Strategy and its selection criteria, Castelletti had to decide how to find the optimal supplier.

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Page 6 9B12D012

Exhibit 1

KEY FINANCIAL FIGURES

Consolidated Statements of income ( Millions of dollars, except per share data)

Year Ended December 31 2010 2009 2008 Net Sales $18,366 $17,099 $18,907 Expenses Cost of products sold 15,652 14,713 16,383

Gross margin 2,714 2,386 2,524

Selling, general and administrative 1604 1544 1798

Intangible amortization 28 28 28

Restructuring costs 74 126 149

Operating Profit 1,008 688 549

Other income (expense) Interest and sundry income ( expense) 197 175 100

Interest expense 225 219 203

Earnings before income and taxes and other items 586 294 246

Income tax benefit 64 61 201

Earnings before equity earnings 650 355 447

Equity loss of affiliated companies N/A 1 N/A

Net Earnings 650 354 447

Less : Net earnings available to non-controlling interests 31 26 29

Net earnings available to Whirlpool $619 $328 $418

Per share of common stock Basic net earnings available to Whirlpool $8.12 $4.39 $5.57

Diluted net earnings available to Whirlpool $7.97 $4.34 $5.50

Dividends $1.72 $1.72 $1.72

Weighted-average shares outstanding ( in millions) Basic net earnings available to Whirlpool 76.2 74.6 75.1

Diluted 77.6 75.6 76.0

Source: Internal resource provided by the company.

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Exhibit 2

SUPPLIER EVALUATION MATRIX

Source: Internal resource provided by the company.

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Page 8 9B12D012

Exhibit 3

SUPPLY CHAIN FLOW DIAGRAM

 

 

 

Source: Internal resource provided by company.

 

Shortlist suppliers based on stringent criteria

On site quality assessment: Minimum criteria of 60 required

Comparative benchmarking

Sampling process in China or in any other Engineering center in the world

Agreement of commercial conditions, including Payment terms

International Procurement Office works with suppliers to ensure min quality is met

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