AFC took its supply chain from disorganized to turbocharged in three years. Lessons learned by this telecom equipment company apply to all midtier OEMs.

Jennifer Baljko EETimes Supply Network (07/01/2004 10:00 AM EST)

Perhaps in a different market cycle, AFC Inc. would merely have tinkered with its broken supply chain, repeatedly patching it up to focus on satisfying surging demand.

Instead, as a depression struck the telecommunications equipment sector, the company opted three years ago for a complete overhaul of its procurement and production systems.

Ted Pennington, senior director of supply chain management at AFC (Petaluma, Calif.), admits the company did not set out to reinvent the modern electronics supply chain, but his team has certainly turbocharged its rickety system. Today, AFC sports a completely redesigned supply chain marked by solid improvements in lead time, inventory turns, on-time-delivery rates and gross margins.

"There has been a tremendous amount of activity in the last three years. We invested in the processes, tools and people," Pennington said. "When the [telecom] market starts to recover, we will be in a better position than people who are just starting to retool now."

The changes implemented at AFC were dramatic and uncommon for a midtier OEM. The company started by dumping the turnkey contract-manufacturing model that had powered its growth in the 1990s. Under that system, electronics manufacturing services providers had managed the entire supply chain, including procurement.

The company pulled those activities in-house and established a six-member Materials Leadership Team (MLT) to oversee components and individual product line management. The team owns all supply chain processes, including technology decisions and services; handles project development and budgeting; and oversees supply chain deployments.

Beyond increasing its investment in supply chain management applications, AFC tore down the wall separating its engineering and production systems. Now, the teams work together from design through production. AFC recruited supply chain degree holders and hired workers with EMS and OEM experience to deepen its supply chain expertise. Job and responsibility swapping among members of MLT is common; indeed, it's part of a bid to foster understanding of the different operational structures.

We do a lot of cross-team collaboration and positions rotation, even though we are not a big company, where these practices are more common," said supply chain manager Felipe Martinez. "It helps to get ideas flowing and see how other operations work."

Back from the brink

Four years ago, AFC, formerly Advanced Fibre Communications until a recent rebranding, was one of the fastest-growing companies in the telecom market. In 2000, its revenue shot up 41 percent, to $416.9 million, from $296.6 million in the preceding year.

Managing a supply chain in the midst of such explosive growth required more than blind reliance on EMS providers, but at the time AFC executives struggling to meet high customer demand had limited time for such nuts-and-bolts activities.

Since the company's founding in 1992, AFC's resources had been concentrated on technology development. The task of building close relationships with suppliers was relegated to a distant third in terms of priority. AFC got away with that approach in its first years, but the model eventually proved to be flawed.

"When the contract manufacturers came in with turnkey solutions, there was this preconceived idea that they would manage the supply chain," said Benjamin Favin, FTTP (fiber-to-the-premises) supply operations manager. "OEMs sometimes divorced themselves from the process."

AFC's experience mirrored that of many other midtier companies during the 1990s. In the haste to satisfy sizzling demand from dot-com businesses late in the decade, many OEMs simply ignored crucial supply chain operations.

At AFC, that meant no advanced planning strategy, no formal processes for tracking orders, no understanding of what metrics to apply in an allocated market and no strong ties with suppliers. The survival strategy centered on sourcing components wherever they could be located and plugging leaks as they sprouted.

"Supply chain in this company wasn't a core competency in the 1990s. It was all about how we could spin products out of here faster," said Jeff Rosen, vice president of operations and customer service.

The telecom market's collapse late in 2000 knocked AFC and many of its competitors into a tailspin. AFC's revenue fell 41 percent in 2001, to $327.6 million; recovered a bit in 2002, to $344.1 million; and fell again last year, to $333.5 million. Analysts this year forecast a 55 percent spike in revenue, to $515 million.

AFC executives say this time the company's supply chain can handle the challenges posed by the rapid sales growth seen on the horizon. The company has spent about $2 million for software applications designed to smooth its operations, they said.

Starting point

AFC's supply chain transformation began with an assessment of what the company had in place, what it was missing and what had to be done to get to the next level.

"Honestly, what we did wasn't anything new or groundbreaking," Pennington said. "We looked at best practices and put them to good use."

After bringing all its purchasing and materials management activities back in-house, AFC renegotiated contracts with manufacturing partners and component suppliers. It also set cost targets for partners and categorized components into those that would be sourced by EMS providers and those that would be managed in-house. EMS providers now handle about 50 percent of the commodities, such as crystals and passives, while more expensive products with higher technology content, such as ASICs and some memory components, stay under AFC's wing, Martinez said.

MLT members, coordinating with EMS counterparts, set trading partner expectations that spelled out accountability parameters and defined which data would be collected and reported back to AFC. The company has also opened regular communication channels with partners and has taken steps to ensure the accuracy of data generated internally and externally.

At the heart of some of these processes were upgrades to existing software platforms and the addition of new ones. The suite of tools includes programs from Baan, Cognos, Documentum eRoom.net, Healex Systems, Steelwedge and Valdero, with an Agile and RosettaNet rollout on the calendar.

"We want to be able to put objective information in front of the supplier," Favin said. "We want to be able to say: 'There's X amount of inventory in your system. We needed Y amount of inventory. How do you justify going above or below that?' "

It's a numbers game

The acronym LOGIC sets the stage for all AFC practices, projects and processes, according to Pennington. It stands for five key metrics: lead times, on-time delivery, gross margins, inventory turns and customer rate of return.

Thus far, the numbers are encouraging. Lead times, which had been as high as six weeks in 2000, fell to two weeks in the second quarter of 2002 and have remained at that level since, Pennington said. On-time delivery went from less than 70 percent in the 2002 second quarter to 96 percent in the first quarter of this year, just shy of the 98 percent goal.

Inventory turns, which at one point were down to 2.5 a year, now average about eight. Twelve is the goal, Pennington said. The customer rate-of-return metric, which looks at how many products come back within 180 days after shipment, is holding steady at 1 percent. And gross margins, which had tumbled to 34 percent in 2001, climbed to 49 percent in 2003 and hit 51 percent--despite declining average selling prices--in the March-ended quarter.

"The gross margins resulted in earnings' exceeding expectations, but revenue wasn't that high," said Ted Moreau, an analyst at Robert W. Baird & Co. (Milwaukee, Wis.).

Beyond supply chain

Now that it has plugged its supply chain leaks, AFC is applying similar strategies within engineering and new-product introduction, according to Joelle Prather, senior manager of supply chain technology and solutions.

"Three or four years ago, cost targets for new projects were not shared with the engineering teams," she said. "MLT had the data for those things, but we had to educate the engineers on how to apply it."

The supply chain team has since inserted itself into the engineering process. By getting purchasers and supply chain managers involved in analyzing the bill-of-materials (BOM) selection, AFC reduced prototype costs by 40 percent, Prather said.

Engineering and supply chain teams regularly work together to develop prototype orders and to draft budgets for new projects. Once the engineers have a preliminary BOM, the MLT runs component pricing scenarios and sets estimates that can be routed up to AFC's finance office.

There is also a more open dialogue now about component life cycles and new technologies on the horizon--information that resides on the purchasing and supply chain manager's desktop, Prather said.

"By building up a rapport with engineering, we were able to show them how to save money and still meet their objectives," she said.

EMS partners have responded positively to the changes implemented at AFC, and at least one of them said it plans to introduce similar measures in its operations.

"They track costs; they know what is going on with their suppliers and component pricing," said Roger Malmrose, a business development manager at Flextronics International Ltd. (Singapore). "They are up-front about what is going on, and that goes a long way in building trust."

Although forecast accuracy is still the bane of the high-tech sector, the increased communication between AFC and its EMS providers makes for a more predictable, more manageable supply chain process, said Latchman Venkatesh, vice president of supply chain management at Flash Electronics Inc. (Fremont Calif.).

"They are now running their organization with a different skill set," Venkatesh said. "They added tools like eRoom, where everyone can see what is going on and issues can be resolved before they escalate. Communication with them has tremendously improved--and in this business, communication is the key."

That's great, but . . .

Despite the strides, AFC still plays in the volatile, never-a-dull-moment telecom space. And that means Wall Street has its share of concerns.

One uncertainty is how fiber-to-the-premises, a next-generation platform for high-speed Internet access, will play out. While it has the potential to be a huge market, with the number of connections estimated at between 3 million and 15 million over the next few years, no one knows for sure how quickly telecommunication service providers will embrace the new technology, analysts said.

Fiber-to-the-premises "requires lots of equipment, and it's expensive to do," noted Alex Henderson, an analyst at Smith Barney Equity Research (New York).

But AFC is positioned to become an early beneficiary of growth in the fledgling market thanks to a contract it recently signed with Verizon for active elements of fiber-to-the-premises technology, said Baird's Moreau. And the soft telecom market has not eroded AFC's financials as much as some of its competitors'.

"[AFC] is doing well in a market that has been relatively flat," Moreau said. "They have done a great job managing their business."

AFC has other supply chain projects on deck. It is replacing manual data collection with automated processes, and it is improving the way it manages component life cycles as part of a list of 27 "to do" items the company must accomplish to meet LOGIC objectives.

"We're not done yet, but I would say we're 70 percent there," Pennington said. "We've done all the critical things, and now we're focusing on the value-add areas."

Jennifer Baljko can be reached at jbaljko@yahoo.com.