INDUSTRIAL BUYING BEHAVIOR IN ELECTRONICS: CASE OF MEMORY CIRCUITS

K.E. Kristian Moller, Helsinki School of Economics and University of Vaasa, Finland

ABSTRACT -

This study focuses on the buying behavior of a semiconductor component in a Finnish company. A detailed decision process model is developed by identifying the stages of the buying process and the departments and persons involved. Emphasis is put on the criteria and decision heuristics employed. The practical implications of the findings are pointed out and their relationship with theoretical buying behavior concepts is analyzed.

INTRODUCTION

This report is a part of an international Industrial Buying Behavior Project conducted in the United States and 7 European countries. The present paper gives an analytical in-depth description of the buying process of a strategic semiconductor component. Based on the data collected in four two-phased semistructured interviews with both the buying and technical personnel of Nokia Electronics (NE), Finland, an inductive model for buying memory circuits is developed and discussed.

The behavior and management implications reported are limited to NE's purchases of one type of production material; the attempt is not to generalize across other firms, components, or time periods. The study is a building block for constructing a generalized model. The approach follows the tradition of decision systems analysis (Wind, 1967; Farley, Howard and Hulbert, 1971; Pettigrew, 1975> and Farley, Hulbert and Weinstein, 1980). For a detailed methodological discussion see: (Baker and Woodside, 1982) and (Woodside and Vyas, 1982).

GENERAL CONTEXT AND ORGANIZATION OF BUYING IN NOKIA ELECTRONICS

Nokia Electronics is an independent division of the Nokia Group, a leading industrial company in Finland. NE consists of four subdivision: Telecommunications, Industrial Automation, Data Processing, and Forest Industry Systems, organized as profit centers. These are supported by Finance and Economics, Marketing, Components & Technology, and Materials Administration Departments. In 1980 net sales were 120 million USD, 15% of parent company sales; 26% of the sales were export invoicing. In Scandinavia NE is a major producer in certain products, eg. minicomputers, terminals, specific data modems but very small compared to multinationals like IBM, Siemens, and LM Ericsson. Telecommunications and Data Processing profit centers use the bulk of the components purchased through the Materials Department. Typical endproducts requiring a great number of components are NE's own minicomputer series Mikko, as well as terminals, radio links, and data transmission modems.

The central semiconductor buying market, especially the LSI (large scale integrated circuits) components are characterized by: (1) Business fluctuations due to economic conditions and active R & D creating new component generations, which is reflected in fluctuating prices and delivery times, (2) Rapid learning effects causing as big as 30% yearly reductions in the prices of new component generations; on the other hand, the yields at launching stages can be only 5-10%. (3) An oligopoly of few large American and Japanese producers are dominating the market. Further, the quality of LSI-components is crucial for electronics end-products. In brief the buying situation is featured by both technological (quality) and commercial risks

In Nokia Electronics buying is organized under the Materials Department led by a Vice-President reporting directly to the Division President. The Materials Department is divided into two Buying Offices, in Helsinki and Espoo, 10 miles apart, led by Purchasing Managers. The Espoo Office is responsible for the Telecommunications purchases and has three buying groups - for active and passive electronic components, and electromechanical components. The buying volume is about 15 million USD. The Buying Office shares premises with the Production unit of the Espoo plant and the R & D engineers for Telecommunications. The Helsinki Office is responsible for the buying of the other three subdivisions. There are two buying groups for components and one for other materials and capital equipment. Concerning components the most important customer is the Data Processing subdivision producing Mikko minicomputers and terminals in Helsinki. The buying volume of components is about 7.5 million USD. The buyers' work is supported by a Quality Control unit within the Materials Department consisting of a manager and three component engineers. Quality Control is responsible for testing all LSIcomponents, and for developing new testing methods.

To have immediate access to principal producers and the latest information about the semiconductor market Nokia Electronics has established a Buying Office at the US subsidiary Nokia Inc., Atlanta, Georgia. This has recently (1979) expanded operations by establishing a buying unit in Silicon Valley, California. These buying offices are not used for independent purchasing of components, but they are important for buying market research, personal contacts, and fast purchasing operations in times of crises. To sum up, in Nokia Electronics buying is administratively centralized but geographically or plant-wise decentralized. This organization facilitates the buyers' and Quality Control component engineers' interaction with the R & D and production people.

Accepting a New Component into Buying Program

The initiative for incorporating a new semiconductor component into Nokia Electronics' buying program usually comes from the R & D department of the subdivision in question. The suggestion has to pass a standard acceptance procedure described in Figure 1. First, the R & D engineer (RDE) contacts the component engineer of the subdivision production unit (CEP) and tells him about the characteristics of a new component required for a new prototype under design. The CEP provides the designer with information about the existing components and their producers. The principle is to use standardized components whenever possible. If the production component engineer lacks adequate knowledge he turns to the respective Materials Department's Quality Control component engineer (CEQC), who is responsible for monitoring international component development and availability. When the designer (RDE) has provided specific enough information on his component requirements the Buying Office orders sample components from all relevant producers.

FIGURE 1

NEW COMPONENT ACCEPTANCE PROCESS

Parallel with accomplishing a prototype of the new product (by the R & D) both component engineers develop a preliminary Material Code (MC) for the new component and test the sample components A Material Code comprises basic component specifications, information about alternative producers (their number, market shares etc.), an estimate of the volume required in the first normal year of

production, and a target price. Quality Control is responsible for sample testing and Material Code development. A technically acceptable and commercially advisable component is suggested to the R & D engineer, and a list of acceptable producers is defined. At least two and at most five producers are selected (more than five producers are considered to increase evaluation and buying costs unnecessarily). The choice criteria comprise factors like price, quality specifications, delivery history, general dependability. The interaction of the R & D and Quality Control terminates at Product Inspection where the prototype is evaluated component by component. In case of an important prototype the Inspection is carried out by the R & D engineer, Production and Quality Control component engineers, and Purchasing Manager. The guideline in Inspection is to minimize component costs by trying to use only standardized components from commercially attractive producers, while still maintaining high quality. After possible alterations the Material Code, with its volume requirement and target price, is approved. The actual buying process is then handled by the Buying Office.

BUYING OF SEMICONDUCTORS: THE CASE OF 16 K EPROM-MEMORY CIRCUITS

The 16 K EPROM -component is an active memory circuit, having a 16-kilo memory capacity. It has been used for 2-3 years as a micromemory unit in Nokia Electronics' Mikko minicomputers produced by the Data Processing subdivision. To provide the minicomputer with the necessary user flexibility it has to be reprogrammable which requires durability and dependability. The memory's price accounts for about 3% of the material costs of a Mikko computer line. Owing to its importance for the computer's performance the memory is, however, a strategic component for the computer.

Buying Market Situation and Annual Contracts

According to the appraisal of the Manager of Materials Department the Japanese have, at the moment, the leading role in memory development and production. US companies rank second, European producers have not been able to make a significant entry into the market. Few fairly large producers dominate the market (e.g. Intel, Hitachi, Fujitsu, Mostek, Nippon Electric Company and Texas Instruments). Nokia Electronics is internationally a small buyer, with annual (1981) demand of about 40,000 16 K EPROM memories. This is about 0.5 % of European demand and 15-20% of Finnish purchases. Nokia Electronics has, however, some importance as

one of the leading buyers in the Scandinavian market. The memory buying market is influenced by business fluctuations, R & D and learning curve effects.

As strategic, frequently required components, the memories are purchased through annual contracts. Potential suppliers have been previously evaluated according to price, quality characteristics, delivery dependability, and supplier characteristics. At the moment Nokia Electronics has four accepted producers: two American and two Japanese companies. On the request of Nokia Electronics the supplier names are not disclosed. The dominating features of the memory circuits contracts are delivery terms, quality and price - with a clause providing for "a considerably downward trend in the market". For instance, the price of 16 K EPROM memories for 1981 was renegotiated even before any deliveries were made.

The present contracts are with one American and one Japanese producer, the other two producers are in reserve. The choice reflects Nokia's policy to try to create keen competition between the producers of these dominating countries. The Japanese companies have only relatively recently been included in Nokia Electronics' list of accepted producers, and only after a conflict resulting in a major change in the buying sources of memories and other key semiconductors. As such the development merits a brief digression.

Until the late 1970's Nokia Electronics used almost entirely US made semiconductors. The buyers, however, were not satisfied with the negotiations. The chief buyer believed that the American producers were aware of each other's prices and acted accordingly. Also single source situations, delivery difficulties, and even cancellations turned up during periods of capacity shortages. The Materials Department evaluated leading Japanese producers by acquiring information and component samples. These satisfied the Quality Control and Buying Office, and the Department introduced the new component alternatives to the R & D people. The majority of R & D engineers had been working only with American semiconductors as electronical innovations has traditionally been made by US companies. Consequently the R & D department refused to use Japanese components whatever the test results. The deadlock was not settled until the Materials Department had arranged a minute inspection visit, attended by the R & D manager, to the Japanese producers' plants. The results were found satisfactory and the Japanese producers became Nokia's standing semiconductor contractors. Because of Nokia Electronics' profit-oriented dynamic buying policy, all contracts are evaluated periodically and the market is monitored for potential suppliers. This procedure is described in the next section

Memory Circuits Buying Process

As an old component the 16 R EPROM memory has passed the new component acceptance procedure and has a Material Code. The Helsinki Buying Office is responsible for the buying process comprising the check-up of contracts, search for new suppliers and their evaluation, sending requests for quotations (RFQ's), and finally negotiating and choosing the vendors for annual contracts. The buyers are supported by the component engineer belonging to the Materials Department's Quality Control unit. A decision analysis flowchart is given in Figure 2.

Initiative and Information Search. In routine situations the Production unit of the Data Processing subdivision gives the expected quantity of micromemories and the approximate production (delivery) schedule to the Buying Office. As mentioned Nokia has four accepted suppliers for memories and annual contracts with two of them. The Buying Office continuously receives new suggestions and information on the memory circuits. The producers are fairly active; Nokia Electronics receives about three significant company visits per main producer annually. Usually both technical and sales representatives are present. The R & D designers are the principal targets of technical marketing. Further, Nokia Electronics' American buying Offices provide information on market developments. Other relevant sources are trade fairs, especially Munchen Electronika and Composant Electronic in Paris, trade journals, technical advertising and other buying companies. A severe problem in information acceptance is reliability. Nokia's buyers claim that some American producers provide information on interesting new components which actually do not exist yet. Producers try to evaluate the marketing potential. If the results are unsatisfactory the project is silently dropped but some R & D designers may actually have started new product designs based on the promises made. In addition to external search the buyers receive suggestions from the Data Processing subdivision's R & D unit. Generally these require more sophisticated memories. These initiatives have to come through the production and Quality Control component engineers. Finally the Quality Control unit provides the Buying Office with the results of the delivery inspection of the present contractors' memories.

Initiation and information search are routine matters as long as there are at least the four accepted producers. The situation changes if only one producer is available or some of the main suppliers are not satisfactory. In the past the latter condition lead the Buying Office to active search for Japanese producers.

FIGURE 2

BYUING PROCESS OF 16 K EPROM MEMORY CIRCUIT

Selecting Suppliers for Quotations. The annual contractors are evaluated on their memory quality, delivery performance and price level. These factors are used as criteria in determining acceptable suppliers for RFQ's. The original definition of the criteria is a two-stage process where the R & D engineer and the component engineers agree on the minimum technical requirements specified in the Material Code - and the Buying Office sets the price, delivery and guarantee targets, see Figure 1. If a contractor is not considered satisfactory it can either be dropped or the matter is taken up in the coming negotiations. Radical steps can be taken only if there are acceptable alternative producers. A few years ago Nokia Electronics dropped an American memory producer. The decision was made only after the Japanese alternatives had been accepted. The rejection reasons were poor delivery performance and the aim to get better price agreements by using also non-US producers.

The RFQ's are planned according to the annual agreements to facilitate the evaluation process and negotiations. Usually, however, more than one order size is used. A typical request might ask for firm bids for 30-70-100 % of the total volume of memory circuits. Other important specifications are the downward trend price clause, and delivery guarantees and schedules.

Negotiations and Supplier Selection. The quotations are evaluated by the Buying Office by comparing them on the specified items. The goal is to establish annual contracts with 2-3 producers. As the technical specifications have been tested and should be almost identical among the producers, the buyers concentrate on delivery terms and price. Before opening the negotiations the buying situation is assessed and a target price set. The aim is to reach a mean price level somewhat below the world market price for a specific purchasing volume. The quoted prices and other market information are used as guidelines. When a change to a new memory generation is expected, a leading producer is given priority despite a possibly higher price. In case of equal prices producers who can guarantee flexible changes in volumes within the contract period are preferred. Finally the information collected on each producer is rechecked and individual negotiation arguments are formed.

Since the number of bidders is only four negotiations are carried out with each of them. The initial contacts are arranged by the Purchasing Manager of the Helsinki Buying Office and his chief electronic component buyer. Decisive talks are attended by the Purchasing Manager of the other Buying Office, the component engineer from either the Production unit (Data Procession) or Quality Control, and on special occasions the Manager of Materials department. The producer's interests are generally in the hands of his marketing manager for Finland or Scandinavia and the respective agent's marketing manager or managing director.

In negotiations the arguments selected are used in order to get concessions concerning price and delivery terms. The policy is to create competition between the producers. Further the volumes are often changed on the basis of previous supplier performance. The reasons are given to the supplier in question. In general delivery difficulties have been the principal reason for quantity reductions. Nokia's Purchasing Manager (Helsinki Buying Office) regards the atmosphere in negotiations as very important. Certain openness and trust should be expected when long-term contracts are discussed. Considering the American and Japanese parties he thinks that the latter are more trustworthy because they very seldom promise anything they cannot keep. The US producers seem to be guided by more short-term and strict profit policy. Some have, eg, dropped a component abruptly if it has fallen below their profit margin. According to Nokia's sales personnel also these cultural or negotiation style dimensions are taken into account.

The negotiations usually take about two months, concentrating at the final stages on the price issue. If a producer offers the lowest price it is usually given the largest order. In case of two contractors the ordinary split would be 70/30 %, and in case of three 50/25125 :. Price, established relationship, and dependability influence both contractor selection and order quantity decisions. When there are no considerable differences between the two selected contractors the order is split; in 1981 between a Japanese and a US producer. The manager of the Materials Department has the final decision maker.

PRACTICAL IMPLICATIONS

Nokia Electronics has clearly recognized the significance of buying and centralized this function under the Materials Department reporting directly to the Division President. The organization of the Department takes into account both the commercial and technical requirements in semiconductor components through the

joint operations of the Buying Offices and the Quality Control unit. Further, the Quality Control engineers have an important mediating role in the crucial relations with the R & D engineers and with the component engineers of the Production units. The concern about components integrate the R & D, Production, and Buying functions. The potential conflicts of R & D and buying interests are channelled through the Production unit and Quality Control component engineers who have more in common as for education and jargon. Their roles secure strong quality orientation for the Materials management.

The buying process of strategic components is characterized by a series of preselective stages of securing the final supplier choice and order quantity decision. The first stage covers the introduction of a new component into the buying program. Here the emphasis is on finding two to five technically acceptable producer candidates. The principal issue is to establish quality acceptability through sample analysis, the responsibility is mainly on the Quality Control component engineer. The R & D designer, Production unit component engineer, and Buying Office staff interact in the final decision stage where the component is issued a Material Code and the list of accepted suppliers is confirmed

As the search and testing procedures are terminated after establishing five acceptable producers the Quality Control component engineer (and the chief buyer who may provide him additional information) acts as a gatekeeper in regard to with the companies first approached. The five rule is seen as necessary to avoid high vendor testing and evaluation costs. A producer may, however, be included in the testing procedure if his prices are significantly below the listed producers'. This practice diminishes the risk of biased action on the part of the Quality Control component engineer.

The second selective stage concerns the submitting of RFQ's According to a policy principle all producers on the list receive an RFQ. Before that, however, the contractors' delivery and quality performance is carefully evaluated. In case of discontent an active search for new producers is mobilized in order to maintain a position where the company can drop or shelve unsatisfactory contractors. An example of this kind of action was the introduction of Japanese producers into the negotiations to balance the US contractors' unsatisfactory delivery dependability and price level.

The evaluation of quotations forms the third appraisal stage. The emphasis is on delivery terms, quality guarantees, and quoted prices. These and the supplier history provide the basis for negotiation strategy and target prices. In negotiations Nokia's tactic is to try to create competition among producers in order to get concessions. The buyers are striving for an established target price and delivery flexibility in terms of quantity and schedule. Moreover, a price caluse hedging against a possible downward trend in market prices is a standard clause in the contracts.

In the final stage two or three producers are selected for annual contracts. The decision is based on the negotiation results, known supplier history, and the willingness to maintain long-term supplier relationship. These same criteria are further used, emphasizing prices, in the order quantity division between the selected suppliers.

As can be noted the early part of the buying process concentrates on component quality. The latter part carries through the buying and delivery related criteria and procedures. In the light of the summarized buying case Nokia Electronics' buying system seems to be able to integrate technical and buying interests, and further to carry out targeted contractor negotiations effectively.

Concerning electronic component marketing Nokia's buying system suggests a few implications. As to a producer marketing new generation semiconductors it would be important to be included in the tests for the list of accepted producers. The first phase efforts should be concentrated on the R & D designers and both component engineers. If the marketer is not accepted at this stage the principal method to get a chance later is aggressive pricing. One should also have information on the established suppliers' possible capacity and/or quality difficulties and try to use this period for focusing marketing efforts on the buying staff. Considering an accepted contractor the policy depends on how important a customer Nokia Electronics is. Nokia tries to maintain long-term relations but does not tolerate poor delivery or quality performance long without retaliating.

THEORETICAL COMMENTS

The objective has been to describe the central events, decisions, actions, and persons (or organizational positions) involved in buying memory circuits, an LSI-component in

one company. Here the aim is to conceptualize the findings and relate them to certain research paradigms active in industrial buying behavior research.

Concerning the fairly complex structural solutions for integrating the R & D, Production and Materials Administration it seems that these are reactions both to contextual and internal complexity - comprising the often discussed buying market turbulence and vested interests of R & D staff versus the buyers. This phenomenon is in accordance with the organization theory postulate that complex context brings about complex organization solutions.

The relationship between Production, R & D, and Materials Administration is organized around the component concept. The actions and decisions are focused on components and the different points of view toward these are reflected in the central organizational solution - in the Production unit and Quality Control component engineers. The intersection of R & D designers' component requests - often unique and Buying Office's strive for "cheap" - but still reliable standard components forms the focal point of conflict in the buying process. The component engineers referred to actually represent a method for both reducing the probability of conflicts and solving them. Concerning social conflict and exchange in buying see (O'Shaughnessy, 1977), (Bagozzi, 1978). and (Wilson. 1978)

In addition to the social conflict and power concepts the perceived risk theory has an important role in buying behavior research (Hakansson and Wootz, 1975; Newall, 1977). In the case of Nokia the employed selective processes, comprising the principal part of the total buying process, hedge effectively both the quality and buying type risks. First, through the formalized procedure of Material Code establishment and the confirmation of Accepted Producer List. Second, through the evaluation of the listed producers on their price, quality and delivery performance for the RFQ's and finally again in the negotiation stage. Risk reduction was in each case performed by staff specialized in the risk type in question. Moreover, the buying policy principles employed have also a risk securing influence. The requirement of at least two or five procedures covers against delivery shortages and supplier dependence and the price clause hedges against the rapid learning curve effects reflected in downward price trends.

The decision heuristics used in the buying process exhibit interesting patterns. In the Material Code or producer acceptance a noncompensatory judgmental rule is employed (for a discussion on judgmental rules see: (Green and Wind, 1973), (Crow,

Olshavsky, and Summers, 1980), and (Moller, 1981)). The established minimum levels for component quality specifications act as criteria in an essentially conjunctive dichotomizing of the producers into accepted/ unaccepted sets. The R & D managers early rejection to use Japanese components is an illustration of the disjunctive heuristics. The country of origin or actually company image formed the top criterion which the manager used in his discrimination of the two supplier groups (Japanese vs. US).

When the buying process proceeds to the supplier evaluation for RFQ's the more complex compensatory rule is applied. Here price, delivery and quality performance can, in some degree, compensate each other. No formalized or explicit importance weights were used, although it became apparent that the criteria had different weights depending on the unique situation in question. A similar compensatory heuristics was also employed in both the final supplier choice decision and in the division of the orders between selected suppliers.

The choice or judgmental rules described are both empirically and theoretically sensible. In the early stage when the emphasis is on the quality qualification of the alternative producers the used conjunctive rule represents the most simple and certain way of ensuring the objective. The compensatory heuristics employed in the RFQ's stage, final supplier selection, and order quantity decision, are more complex and cumbersome to carry out but allow for taking into account the various factors influencing the decision. In balance, the results justify the usefulness of collecting detailed buy-flow descriptions. Such research is helpful both in creating new hypotheses about industrial buying and in validating existing theoretical conceptualizations.