The video game system business may seem miniscule for a giant like Microsoft. The entire video game console market is approximately $5.7 billion while Microsoft alone generated $25 billion of revenue in the latest fiscal year. However, some analysts believe that the Xbox is intended for bigger things—which explains why, unlike other consoles, it features a hard disk drive and an Ethernet adapter card. In fact, the Xbox's list of current and potential capabilities can make one do a double take—it can play DVDs, download digital music and movies, access the Internet and function as a personal video recorder. So how did Microsoft assemble such a feature-laden video game system? The answer is clever design and outsourcing.

Design know-how enabled Microsoft to develop a competitive video game system while outsourcing allowed the company to manufacture the product economically and in rapidly accelerating volumes. To take on such established video game system makers as SONY and Nintendo, the software giant had to offer technological superiority and affordability. Technological prowess? Check. With the Xbox's 733 MHz Intel Pentium III microprocessor, 64-megabyte memory, 2-gigabyte hard drive and broadband modem, that was covered. Affordability? That's where Flextronics, an electronics manufacturing services (EMS) provider came in.

Even though Flextronics had never built a video game system before, the company clinched the deal with Microsoft because of its manufacturing expertise and global presence. The contract manufacturer makes computer mice for Microsoft. "We had a history with Flextronics," says Todd Holmdahl, general manager, Xbox hardware. "They had a cost effective solution, they were a global partner and could deliver a global solution to us. They manufacture in Hungary and Mexico." This was a strategic plus since the U.S. and Europe are big markets for the Xbox. Flextronics also supports Microsoft's future plans—a change of production venue from Mexico to China where labor rates are lower. "Flextronics has facilities in China that allow us to transfer the knowledge effectively and efficiently," he says.

Flextronics' role extended beyond manufacturing to design and development of the Xbox. While main suppliers provided the components—Nvidia designed the custom graphics processor and Intel developed the processor and motherboard—Flextronics developed the enclosure and tooling to make the mechanical parts, says Jim Sacherman, vice president of business development for Flextronics. "We also did test development, developed machines to test the game's systems as they came off the line," he says. "We co-located our test engineers at Microsoft and, alternatively, on the mechanical side they co-located with us because enclosure development was at our facilities in San Jose."

A year before the Xbox was even in production, Flextronics' materials group was already busy working with suppliers. They finalized the details involving the box's components—pricing, supply and vendor managed inventory (VMI). This was important preparation for an abrupt manufacturing ramp. "Guaranteeing the quantity of parts to meet the seasonal demand was definitely an issue with parts just because the quantities were great and the ramp was quick," says Sacherman. "We ramped from zero to 100,000 units a week in four to five weeks. We hadn't done this before in a product of this magnitude in these quantities. We ramped mice in those quantities before, but with the Xbox there were a lot more materials that had to ramp up quickly."

To track inventory, Flextronics and Microsoft utilized online tools with forecasting and other capabilities. In addition, the two companies exchanged data through Web portals and sharepoint applications. "These tools give us the ability to view all inventory positions, including work in progress (WIP), warehouse inventories, VMI levels, and inventory levels on hand at suppliers. We also have the ability to see real-time production outputs, by factory, by SKU (stock keeping unit), by line," says Holmdahl from Microsoft.

These online tools ensure product quality. "We have 50 data acquisition stations on each Xbox line and there are 15 lines. They gather massive amounts of information such as quality data," says Mike Webb, senior vice president of information technology for Flextronics. "If there is an issue in manufacturing or with a component, we catch it before it gets into a customer's hands. The information is sent to Microsoft every hour and is stored in a data warehouse." If a faulty console does make its way into a consumer's home, Microsoft can look up its serial number and view its manufacturing history, says Webb. In this manner, similar glitches can be avoided in the future.

While Microsoft manages the sourcing of big budget components, Flextronics is in charge of the sourcing of small budget items—a common outsourcing arrangement among OEMs (original equipment manufacturers) and EMS providers. "Often when a company outsources, it divides up the responsibilities for sourcing," says Sacherman. "The OEM often will handle sourcing for strategic high dollar items and leave the sourcing of low dollar items to its EMS partner." Microsoft oversees the roughly 40 strategic suppliers that provide the Xbox's microprocessors, DRAM, flash memory, power supplies, disk drives, DVD drives and graphics chips, while Flextronics sources components such as resistors, capacitors and some semiconductors.

While sourcing low-dollar items may seem like a small role, it represents increased responsibility for the EMS provider. "If you go back 10 years our sourcing responsibility with OEMs was zero. We were given a bill of materials and an approved vendor list," says Sacherman. "Currently our sourcing responsibility is much greater than that. We expect that to increase." In fact, even when it comes to high-cost components, Flextronics is part of the process. The company is in charge of placing purchase orders and sending forecasts of the console's manufacturing schedules to suppliers.

Whether the Xbox is a success or not is still subject to debate, but one thing is certain: Microsoft must bring the console's price down to entice more video game enthusiasts. When it entered the market last November, the Xbox sold for $299—a price that is $150 below the cost of manufacture, says an In-Stat MDR report. In June, the video game system's price was cut to $199—comparable to SONY Playstation II but $50 more than Nintendo GameCube. Fortunately, there is good news for Microsoft. Although its initial entry into the market may not be slaying the competition, the territory being fought over is getting bigger—with video game console sales expected to reach $12 billion by 2005. And with an able manufacturing partner like Flextronics, it has already morphed from latecomer to contender.

Source: Outsourcing the Xbox
Jim Carbone
Purchasing, August 15, 2002
http://www.purchasing.com