Supplier's Specialization towards Prototype Production: An Empirical Analysis and Profitability Modelling Tool for Networks

The optimal location of R&D in established global manufacturing companies depends on many factors and direct costs may not be the most important ones. R&D competencies may be difficult to relocate to low cost (LC) countries. At the same time, volume production may be competitive only in LC countries. Hence, there is a rising need for global OEMs to find capable suppliers to design and build prototypes physically and culturally near, even though volume production is off-shored. The earnings logic of a prototype building supplier is often based on the profit margins in the volume production phase. To achieve the benefits of utilizing local prototype producers, there should be a method to analyze the separation of volume and prototype production processes. We conducted an empirical case study at a global construction equipment manufacturer and one of its system suppliers. We created a generic profitability simulation tool that demonstrates the profitability effects of the separation of prototype and volume production processes to both parties. The tool takes into account the annual volumes, costs and profits of both parties. The base of the calculations was the current cost structure of the supplier company. As an assumption, we expect cost savings in volume production after transferring it to a LC country. On the other hand, some costs, for example transaction cost and production transfer cost, will increase. As a managerial result, there were three critical variables to be taken into account: volume effect on unit costs at the supplier, absolute and relative profitability of prototype production, and OEM's new cost elements.