Cost Reduction On Spare Parts

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Offset the continuous margin erosion of Philips Semiconductors:

Cost Reduction On Spare Parts

Focus on spend or costs?

PUBLIC VERSION

Public report

Roeland van der Hoeven

Faculteit Bedrijfskunde

Rijksuniversiteit Groningen

December 2005

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Offset the continuous margin erosion of Philips Semiconductors:

Cost Reduction On Spare Parts

Focus on spend or costs?

PUBLIC VERSION

Student information

Name: Roeland van der Hoeven

Student number: s1412752

University: University of Groningen

Faculty: Management and Organizations Education: Technology Management

Mentor information

First Mentor: Prof. Dr. Dirk-Jan F. Kamann Second Mentor: Prof. Dr. J. van der Meer-Kooistra

Company information

Company: Philips

Product Division: Philips Semiconductors

Division: IC Manufacturing Operations (IMO) Department: Strategic Equipment Purchasing Supervisor: Mr. D. Boerrigter

(Strategic Equipment Purchasing Manager, IMO BE)

‘The author is responsible for the content of the graduation report;

the copyright of the graduation report is vested in the author’

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Philips Semiconductors BV did not allow publication of the final report. Therefore, confidential data (strategic actions, names and numbers) has been left out or changed, resulting in this adapted version.

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Roeland van der Hoeven page I

Preface

This report is the result of my graduation project at the department of Technology

Management at the University of Groningen. The research has been conducted within the purchasing department of Philips Semiconductors. This research comprehends an in- depth investigation into the total spending on spare parts and consumables for the IC Manufacturing Organization of Philips Semiconductors. Furthermore a study is made on where costs arise that are related to spare parts and how these costs can be reduced.

The research was really challenging, because although I was stationed in Nijmegen, the research data had to be collected at the three main IC Manufacturing Organization sites of Philips Semiconductors in Bangkok, (Thailand), Calamba (Philippines) and Kaohsiung (Taiwan). I have learned that working with patience and discretion are two very

important criteria’s when trying to work with other cultures successfully and to be able to obtain your goals. The other side of this, is that a lot of time was spend behind my desk, with only two people located in Nijmegen that were involved in this research. The last seven months have been very challenging, fascinating and instructive, resulting in an even larger enthusiasm for technology and the purchasing profession!

A lot of people, from various departments and countries, were very willing to help me in achieving my objectives. I would like to thank my company supervisor Dion Boerrigter who gave me the opportunity to perform this research, but also Jan Buitenhuis for his introduction and continuous support. In addition, I would like to express my gratitude towards my university mentors, Prof. Dr. Dirk-Jan F. Kamann and Prof. Dr. Jeltje van der Meer-Kooistra, who turned out to be critical, very knowledgeable, responsive and

supportive.

Finally, I want to express my special thanks towards my family and friends, in particular Simon, who helped me to work with the MS Access program and Wim, who made the text look as if English is my mother tongue. Also I would like to thank Wout and Emiel who took the time to read the thesis and to give comments where necessary. Last but not least: Jolien, thanks for everything!

Roeland van der Hoeven Nijmegen, Oktober 2005

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Roeland van der Hoeven page II

Summary

This report describes the research that has been conducted within the purchasing

department of the IC Manufacturing Organization (IMO) of Philips Semiconductors. Philips Semiconductors develops and manufactures semiconductors, which is a generic name for devices like transistors and integrated circuits.

Philips Semiconductors must continually reduce the total cost of all goods and services being purchased in order to offset the yearly margin erosion, which is extremely high. At the Back End part of the IC Manufacturing Organization, at which the assembly,

packaging and testing of semiconductors takes place, spare parts did not receive much management attention. Therefore the spending on spare parts was unknown and there was no coherent strategy on how to handle spare parts. The purchase department of IMO felt that costs could be saved on spare parts. These were the most important causes of this research. The following main research question has been formulated:

In order to answer the main research question, the following sub research questions are set up:

1. What are spare parts?

2. Where do costs arise?

3. How to reduce costs that are related to spare parts according to theory?

4. Describe the current situation and organization of supply management within Philips Semiconductors and the IC Manufacturing Organization

5. What are the current costs?

6. What is the current situation regarding spare parts?

The definition of a spare part turned out to be not univocal. A definition that matches Philips’s view well was: A spare part is considered ‘an individual part, subassembly, or assembly supplied for the maintenance or repair of equipment’ (www.its.bldrdoc.gov).

There are four primary channels for spare parts: the Original Equipment Manufacturer (OEM) channel, the Original Part Manufacturer (OPM) channel, the Distributor or Integrated Logistics Supplier (ILS) channel and the second source channel. A second source supplies OPM/OEM parts offering a better price. These suppliers are often local suppliers.

Cost reduction is an effort to trim the costs associated with acquiring a particular product or service (www.ism.ws). The term cost reduction on spare parts should be viewed in a broader spectrum than the costs of acquiring a particular product or service alone. The approach of looking at the cost of spare parts only is too narrow. The definition of a spare part shows that spare parts are needed for the maintenance or repair of equipment.

Therefore we had to look at how equipment and spare parts are related regarding costs as well. To find out what the cost relation is between spare parts and equipment the Cost Of Ownership model is used, which is developed by SEMATECH¹ (Dhudshia 2004). The model calculates the true Cost Of Ownership per good unit produced in a given time period. It turned out that the costs of non-availability (downtime) and maintenance costs

1 SEMATECH is a global, non-profit consortium for research in semiconductor manufacturing technology.

What is the current spending on spare parts at IMO BE and what can be

recommended to the equipment supply base management team to reduce the costs of spare parts in order to offset the margin erosion for Philips Semiconductors?

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Roeland van der Hoeven page III of equipment have a major correlation with spare parts. The following spare parts related main cost elements are identified and influence the Cost Of Ownership of equipment:

1. Quality of equipment and spare parts 2. Purchasing costs of spare parts 3. Price of spare parts

4. Inventory

The next step was to find out how to reduce costs on these four elements according to theory (sub research question 3). Collaboration with the supplier is the key to improve quality. Second, to reduce the purchasing costs, the amount of suppliers and the number of Purchase Orders need to be reduced. Third, the spare part costs itself. Main cost reduction possibilities are: increase purchasing power by purchasing larger volumes at fewer suppliers and negotiate about spare parts at the same moment as the purchase of equipment. Fourth, inventory is also a cost element, but is not elaborated further in this research. The relative spend is about 5% of the total spend (excluding wages)of the three production sites. The next step was to find out the current costs of the identified cost elements (sub research question 5). To elaborate the purchasing price of spare parts, the spares & consumables spend analysis report 2004 was delivered in July 2005. This was the first effort ever to make the spare parts spend transparent. The analysis showed that the total spend on spare parts in 2004 was US$ 80 Million for the three IC Manufacturing Organization sites Philips Taiwan (PSK) (Taiwan), Philips Philippines (PSC) (Philippines) and Philips Thailand (PST) (Thailand).

The total spend on spare parts for test equipment is US$ 40 Million. The spend on spare parts of assembly is estimated at US$ 40 Million. The report also showed that there are 531 suppliers being used from which more than 300 suppliers are utilized with a

spending of less than US$ 10.000 per supplier. The spares & consumables spend analysis 2004 was a real eye-opener, because the spending was much higher than expected.

The total cost (related to spare parts) for the purchasing function was estimated at US$ 1.2 Million. For the Automatic Test Equipment the proportion is extremely low (x%) in comparison with the other platforms. This is the result of the capped spare parts contracts that are in place for the Automatic Test Equipment.

Cost related to quality can be measured by measuring the unscheduled downtime.

Unfortunately, this information was not available for all platforms. The unscheduled downtime is very low for Automatic Test Equipment (0,6%) and Probers (0,4%). The unscheduled downtime of Wire Bonding (1.5%) and Die Bonding (about 2%) is very high.

The unscheduled downtime figures were unknown for the other platforms.

The current situation (sub research question 6), revealed that there was no coherent spare parts strategy for spare parts except for the Automatic Test Equipment platform.

The local sites have their own spare parts strategy: The strategy was to buy spare parts at the OEM preferably. If it is possible to find a local supplier that could provide a cost reduction, localization is preferred. This resulted in a huge complex supply base of 531 suppliers. Therefore limited collaboration with suppliers is possible and another result is the relative high purchasing costs due to the high level of interference of the local buyers.

For Automatic Test Equipment capped spare part contract are being applied. A capped spare part contract is a special contract that includes all spare parts for a specific equipment platform with a capped fee. These contracts seem to lower all four cost elements that are concerned with spare parts.

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Roeland van der Hoeven page IV The main recommendations (in short) are:

• Make one person responsible for the spare parts spend data collection and make this person quarterly report to the members of the supply base management team of equipment. Appendix 17 shows four steps on how to obtain such a report.

Appendix 19 shows the spares & consumables spend analysis report 2004.

• Get unscheduled downtime, MTTR, MTBF, MTBPF, spare stock hit rate, delivery times information of all platforms

• The CPM should perform Quarterly Review Meeting with the suppliers. These are reports that show the performance of a particular equipment type of a specific OEM. This report includes the development over time of the overall uptime, MTBPF, MTBF, MTTR spare parts spend and spare stock hit rate. Targets should be set per equipment type individually by the CPM. Furthermore the parts that fail the most are identified and together with the supplier, plans are made to reduce the usage of that specific part.

• The spend, savings and other results should be reported to the semi-annual meetings that take place with site managers and supply base managers to create commitment.

• The CPM should be responsible for the overall strategy, reporting and monitoring on spare parts for all IMO BE sites of their respective cluster.

• Install the OEM Capped spare parts contract for all clusters and platforms (if possible). It is highly recommended to communicate this thoroughly. For this purpose a document is made that discusses all aspects of the capped spare parts contract (appendix 18).

• If it is not possible or preferred to install a capped spare parts contract, it is advised to develop a global or regional second source to reduce the total number of suppliers

• In either case OEM’s or regional second sources, spare parts should be covered by global contracts. Users should be able to place orders directly at the supplier with no interference of the local buyers.

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Roeland van der Hoeven page V

List of Figures

Figure 0-1: Structure of the report ... 10

Figure 1-1: Markets Philips Semiconductors... 12

Figure 1-2: Income From Operations and Key financial data ... 13

Figure 1-3: Income from operations & sales Q1 2004 – Q2 2005 ... 13

Figure 1-4: Organizational Structure Philips Semiconductors ... 15

Figure 1-5: Revenue and growth of the semiconductor market ... 16

Figure 1-6: Value Chain Philips Semiconductors ... 16

Figure 1-7: Silicon Wafer ... 17

Figure 1-8: Process Flow of an Integrated Circuit ... 17

Figure 1-9: Organization Chart IMO... 18

Figure 1-10: Main locations IC Manufacturing Organization ... 18

Figure 1-11: Production Process IMO Backend ... 19

Figure 2-1: DuPont chart of Philips Semiconductors’ ROI 2004... 22

Figure 2-2: Structure of the report ... 26

Figure 3-1: Type of purchase... 29

Figure 3-2: Elements that influence the COO of equipment ... 32

Figure 3-3: Elements that influence the equipment availability... 32

Figure 3-4: Elements that influence maintenance costs... 33

Figure 3-5: Elements that influence unscheduled maintenance ... 34

Figure 3-6: Elements that influence the costs of spare part ... 34

Figure 3-7: The nine steps of the purchasing function (Kamann)... 35

Figure 3-8: All elements that are related to spare parts ... 37

Figure 3-9: quality influences availability ... 38

Figure 4-1: Purchasing Organization... 46

Figure 4-2: Three types of purchasing activities ... 46

Figure 4-3: Organization Chart SBMT - Equipment ... 47

Figure 4-4: Organization Chart MSG ... 48

Figure 4-5: Cluster Teams... 48

Figure 5-1: Overview Spend Test vs. Assembly (sheet 5, appendix 19)... 52

Figure 5-2: Platform Spend (sheet 12, appendix 19) ... 53

Figure 5-3: ABC Analysis Suppliers... 54

Figure 5-4: Cost drivers per purchasing activity ... 55

Figure 5-5: low quality Cost implication ... 56

Figure 5-6: Relation between Unscheduled downtime and MTBF... 58

Figure 5-7: Teradyne A565, Costs of unscheduled downtime ... 58

List of Tables

Table 2-1: demarcation of the research ... 24

Table 3-1: Spare Parts Supply Channels ... 30

Table 3-2: Description elements of the COO equation ... 31

Table 3-3: Cost drivers of the purchasing steps ... 36

Table 4-1: Organization Cluster Team Assy 1 and Assy 2 ... 49

Table 5-1: Percentage of spend with 12 NC ... 50

Table 5-2: Proportion purchasing costs of total spend (excl. supplier evaluation) ... 55

Table 5-3: Number of suppliers per platform ... 55

Table 5-4: Unscheduled downtime of specific equipment... 57

Table 5-5: Cost implication of certain production platforms ... 57

Table 5-6: Four costs elements related to spare parts... 59

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Roeland van der Hoeven page IX

Abbreviations

12NC 12 Numeric Code

ACS Auto data Collection System ATE Automatic Test Equipment

BE Back End

BBSC Business Balance ScoreCard

BU Business Unit

BW Business Warehouse CEO Chief Executive Officer

CLOGS Classification Of Goods and Services COO Cost Of Ownership

CPM Cluster Purchasing Manager CTC Cluster Team Chairman

ERP Enterprise Resource system

FE Front End

IC Integrated Circuit IFO Income From Operations ILS Integrated Logistic Supplier IMO IC Manufacturing Organization JIT Just In Time

MSG Manufacturing Strategy Group MTBF Mean Time Between Failure MTBPF Mean Time Between Part Failure MTTR Mean Time To Repair

OEM Original Equipment Manufacturer OPM Original Part Manufacturer

PO Purchase Order

PSC Philips Semiconductors Calamba (Philippines) PSK Philips Semiconductors Kaohsiung (Taiwan) PST Philips Semiconductors Thailand (city: Bangkok) SBMT Supply Base Management Team

SPEED Superior Production Execution through ERP Deployment TCO Total Cost of Ownership

TQM Total Quality Management VMI Vendor Managed Inventory

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Roeland van der Hoeven page 10

Introduction

Philips Semiconductors develops and manufactures semiconductors. A semiconductor is a generic name for devices like transistors and integrated circuits that can control the flow of electrical signals. Silicon is the basic material of most semiconductors. The focus of Philips Semiconductors is on semiconductor solutions for connected consumer

applications. The main markets are consumer, communication, automotive, computing and identification markets. The Semiconductor industry is strong cyclical and volatile.

According to Moore’s law², chip performance capabilities will double every two years. This creates downward pressure on semiconductor process and margins. In order to offset this margin erosion, Philips Semiconductors must continually reduce the total cost of all goods and services being purchased. It is gradually becoming more difficult to squeeze additional savings from areas like raw materials and other production items.

At the Back End part of the IC Manufacturing Organization, at which the assembly, packaging and testing of semiconductors takes place, spare parts did not receive much management attention, because the spending was relatively low and difficult to measure.

The focus of the supply base management team of equipment was on the spend of equipment itself. Therefore the spending on spare parts is unknown and there is no coherent strategy on how to handle spare parts. The purchase department of IMO BE feels that costs can be saved on spare parts.

The continuous focus on cost reduction, the unknown spends on spare parts and the feeling that costs can be reduced on spare parts are the main causes for this research.

Structure of the report

The report contains seven chapters, see

figure 0-1. The first chapter will introduce Philips Semiconductors, the IC Manufacturing Organization (IMO) and the main processes that take place. Chapter two will be devoted to the cause of this research, the research objective and final research question. In chapter three the main questions resulting from the research question will be addressed to in the theoretical part of this research. This chapter will be concluded with the sub research questions resulting from the theoretical research. Also the conceptual model will give an overview of what is considered important in this research. In chapter four, supply management and its organization at Philips Semiconductors will be discussed. In chapter five the costs that are related to spare parts will be given. This chapter includes the main conclusions of the spares & consumables spend analysis report 2004, which was

delivered in July 2005 will be presented. In chapter six, the current situation, the sub research questions coming out of the theoretical framework will be elaborated. Chapter seven will include the main conclusions and finally the recommendations of this research.

Figure 0-1: Structure of the report

2 ‘More life for Moore’s Law’, Business Week, June 20, 2005 1. Philips Semiconductors

2. Research Area

3. Theoretical Framework 4. Supply Management at Philips 5. Cost Analysis

6. Current Situation

ORIENTATION ANALYSIS DESIGN

7. Conclusions &

Recommendations

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ORIENTATION

1. Philips Semiconductors 2. Research Area

ORIENTATION ANALYSIS DESIGN

Recommendations

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Chapter 1. Philips Semiconductors

The purpose of this chapter is to provide insight to the context of this research. First, general information about Philips Semiconductors, the markets, the financial results, the semiconductor industry, the value chain, the process flow and strategic direction will be discussed. The IC Manufacturing Organization where the research took place is discussed next, including the organization, the main processes and the strategic direction.

1.1 Royal Philips Electronics NV

Royal Philips Electronics of the Netherlands is one of the world's biggest electronics companies. It is a global leader in colour television sets, lighting, electric shavers, medical diagnostic imaging and patient monitoring and one-chip TV products.

The activities of the Philips Group are organized in six operating product divisions, each of which is responsible for the management of its business worldwide, being Medical Systems, Domestic Appliances and Personal Care, Consumer Electronics, Lighting, Semiconductors and Other Activities. At the end of 2004, Philips had approximately 140 production sites in 32 countries and sales and service outlets in approximately 150 countries. Philips employs about 162,000 people and recorded a sales of EUR 30 billion.

1.2 Philips Semiconductors BV

Philips Semiconductors BV, headquartered in Eindhoven, The Netherlands, is part of Royal Philips Electronics NV and is one of the world's top ten semiconductor suppliers, with sales revenues of around 5.5 billion Euros in 2004 (see Appendix 1). The total production is about 18 Billion IC’s per year. Philips Semiconductors is a global organization with more than 35.000 employees in more than 60 countries, 20

manufacturing and assembly sites, 30 design centres, 4 system labs and more than 100 offices. Manufacturing facilities are in the USA, the Far East and Europe serving

customers worldwide. The main focus is on semiconductor solutions for Connected Consumer applications and the main markets are the consumer, communication, automotive, computing and identification markets (see figure 1-1).

Figure 1-1: Markets Philips Semiconductors Automotive

Car Infotainment Car Networking

Computing

Displays Handheld PC

PC Peripherals Consumer

TV & SeTopBoxes Home AV

Portable CE Games Home gateway

Identification

Chip cards Memory cards RFID

Other ID Communication

Mobile handsets LAN/PAN Traditional telecom

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Roeland van der Hoeven page 13 Financial results

Figure 1-2 provides the Income From Operations (IFO) and key financial data from 2000 up to 2004 (Philips³). For the first time since the year 2000, which was the best year for the semiconductor industry ever, Philips made a profit of 450 Million Euros. The main cause was the sales increase in comparison with 2003. The decrease of losses from 2002 and 2003 in comparison with 2001 is a result of cost savings due to reorganizations and cost reduction programs on raw materials and other production items.

Figure 1-2: Income From Operations and Key financial data

Currently, Philips Semiconductors is one of the poor performing business units of Royal Philips Electronics. Nominal sales of the second quarter of 2005 decreased by 6%

compared to the second quarter of 2004 (see figure 1-3). Furthermore, the lower income from operations compared to the second quarter of 2004 is attributed to lower sales activity, lower margins and a lower build-up of inventories, coupled with higher costs.

Compared to the first quarter of 2005, income from operations was positively impacted by the higher sales activity and the stronger dollar (Philips⁴).

Figure 1-3: Income from operations & sales Q1 2004 – Q2 2005

The major industry downturn in 2001, which also hurt Philips Semiconductors

dramatically, enforced Philips Semiconductors to have a great focus on cost reductions at that time. Currently, major emphasis on costs is still the case, because of the poor financial performance of Philips Semiconductors. In 2005 Philips Semiconductors is still facing decreases in its quarterly sales and Income From Operations.

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Roeland van der Hoeven page 14 Mission, Vision and Strategy

It is important to be aware of the corporate strategy, because it effects all decisions made in a company and it could also limit this research. Philips communicates strategies through so-called “One Page Strategies”. These one page documents embody the

essence of what is really critical to accomplish during a certain year. The One Page Strategy document, as a summary of the far more detailed strategy, links the long term Vision, Mission and Strategy, with concrete actions.

Each operational unit within the company develops its own strategy (fully aligned with the higher level strategies) and summarizes it in their own One Page Strategy. Every month, the success of the strategy deployment is measured and reported to the appropriate management team and if necessary, the Executive Management Team.

The vision, mission and strategy of Philips Semiconductors is adapted from the Philips Semiconductors One Page Strategy 2005, see appendix 2. The vision of Philips

Semiconductors is: “A world where everyone can always connect to information,

entertainment and services”. The mission is to be the leading provider of semiconductor- based solutions for connected consumer applications. The strategies to pursue this mission are:

• a balanced portfolio spanning Partner with leading customers, content and service providers

• Develop customer solutions based on Nexperia that combine semiconductors, software and services

• Manage emerging, mature and multi-market products

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Roeland van der Hoeven page 15 Organizational structure Philips Semiconductors

The organizational structure of Philips Semiconductors is represented in figure 1-4 (Philips²). Philips Semiconductors consists of several business units, representing the total range of semiconductor products. On a lower level, all business units consist of several business lines. Grouping of business lines is mainly based on affinities of applications and/or technologies. A typical structure of a business unit is shown in

appendix 3. Each business unit is supported by the supporting activities at the right hand side of the chart.

The core processes are Sales & Marketing, IC Manufacturing, Innovation & Technology and Strategy & Business Development. The production of the semi conductors itself takes place at the IC Manufacturing Organization (IMO). IMO is the production division of Philips Semiconductors, which is further explained in paragraph 1.4. The final product of IMO is a packaged IC (Integrated Circuit), although also some unpacked, or “naked die”

products are delivered. The business units work in close cooperation with IMO. This research took place at the IC manufacturing Organization (IMO). Purchasing at Philips Semiconductors is explained in chapter 4.

Figure 1-4: Organizational Structure Philips Semiconductors Sales & Marketing Operations

IC Manufacturing Organization Supply Chain Management

Chief Technology Office Innovation & Technology

Strategy &

Business Development

BU

Multimarket Semiconductors

BU Home

BU

Automotive & Identification

BU Mobile & Personal

BU

New Business Initiatives

Human Resource Management

Finance, IT, Purchasing (CPO)

Philips Business Excellence Quality

Legal Philips

Semiconductors

CORE PROCESSES BUSINESSES SUPPORT

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1.3 Semiconductor Industry and Value Chain

The semiconductor industry is a strong cyclical, volatile industry, however the general trend is positive; the demand for semiconductor devices increases each year as demand for electronic equipment increases.

Periods of tight supply are the result of under-investment in foundry capital and

equipment, which occurs during industry downturns. Firm (or high) pricing of electronic devices leads to strong revenue growth for semiconductor companies, increased

profitability and the return of capital spending on new capacity. This new capacity usually cannot be added incrementally to match demand. Instead, typically, too much new capacity is added too quickly, flipping the semiconductor market into oversupply, causing device pricing to resume its long-term downward trend. This cycle repeats typically every three to five years (Gordon 2003).

After 2001, the worst year in the semiconductor history, the global semiconductor market appeared to be on the road to recovery; however the industry is suffering from the weak global economy, according to Gartner Dataquest (Rinnen et al. 2005). Main causes are:

• Japanese and Euro zone weakness is hobbling global growth

• The downward decent of the US Dollar

• The lacking consumer spending

According to Gartner Dataquest, the semiconductor market almost equalled the overwhelming year of 2000 in 2004, with a total market size of US$ 220 billion, see figure 1-5. The market is forecasted to reach US$233 billion in 2005 and US$248 billion in 2006. For an industry that is used to double-digit growths, it’s just a mature growth.

0 50 100 150 200 250 300 350

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -35%

-25%

-15%

-5%

5%

15%

25%

Revenue (US$B) Growth Forecast 35%

Figure 1-5: Revenue and growth of the semiconductor market

The value chain of semiconductors is shown in figure 1-6. Since the 80’s companies started to focus on their core competences and specialized suppliers emerged. More and more processes are considered non-core and are being outsourced. This occurs in all links of the value chain.

Figure 1-6: Value Chain Philips Semiconductors

Development Production Packaging Sales OEM (Re)seller

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1.4 Process Flow

The process starts with a customer order for IC’s (see figure 1-8, step 1). The Business lines state the functionality that the IC’s must have and the design department then designs the IC in such a way that it meets these requirements (see figure 1-8, step 2).

In case of custom IC’s the customer sets the requirements, but normally Philips Semiconductors sell catalogue products.

The design is sent to a foundry (also called waferfab) from the IC Manufacturing Organization (IMO). Foundries are the

manufacturing facilities that create electronic circuits on silicon wafers, see figure 1-7. One set of electronic circuits of one chip that is created on a wafer is called a die. The die forms the heart of the packaged IC. Wafers contain multiple dies. At the preliminary stage of the IC manufacturing process the foundry produces only a limited number of these diffused wafers that are used for testing procedures.

Figure 1-7: Silicon Wafer The electronic dies are then verified. The first check is done by the semiconductor company, the second by the customer (see figure 1-8, step 3).

After approval, mass production at the foundry of the IMO Front End (IMO FE) starts (see figure 1-8, step 4). The primary process of IMO FE is manufacturing IC’s on a wafer in the “waferfabs”. A wafer is a big circle of silicon with hundreds of or even more than thousand individual IC’s on it. This is called front-end processing.

Next, the diffused wafers are shipped to IMO Back End (IMO BE). The primary process of IMO BE includes the assembly and testing of the manufactured IC’s. This process is called Back-End processing. During the back-end processing, the IC chips created during the front-end processing are first tested (see figure 1-8, step 5). Next the dies are cut out of the wafers, provided with golden wires and encapsulated into packages (see figure 1-8, step 6). Finally the IC’s are thoroughly inspected (see figure 1-8, step 7) before becoming completed products and shipped to the costumer (see figure 1-8, step 8).

Figure 1-8: Process Flow of an Integrated Circuit

Customer Wafer production Verification

Customer

Final Test Packaging

Wafer Test

Design

IMO Front End Business Lines

IC Manufacturing Organization Back End

1

2

7 8 5 6

3 4

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1.5 IC Manufacturing Organization

IMO is the production division of Philips Semiconductors. IMO is divided into two main parts: IMO Front End (IMO FE) and IMO Back End (IMO BE), see figure 1-9. The primary process of IMO FE is manufacturing IC’s on a wafer in

“waferfabs”. During the Back-End processing, the IC chips created during the front-end processing are encapsulated into packages and thoroughly inspected before becoming completed products.

This research focuses on IMO BE.

The main processes of IMO BE are wafer testing, packaging and final testing (see

figure 1-8). IMO BE has small test centres in Caen (France), Hamburg (Germany) and Nijmegen (The Netherlands). Only small scale packaging takes place at these sites. The other sites are the main assembly and test sites. The most important assembly and test sites are Philips Thailand (PST), Philips Taiwan (PSK) and Philips Philippines (PSC). This research focuses on these three sites.

Each site is specialized in certain packages (IC types), however the maximum production volume of one package type is limited to 80% of the total site volume. In order to spread the risk, 20% will be produced in another production site.

Figure 1-9: Organization Chart IMO Locations

The headquarters of Philips Semiconductors is situated in Eindhoven (The Netherlands).

The IMO headquarter is located in Singapore. The assembly facilities of IMO BE are located in Kaohsiung (Taiwan), Bangkok (Thailand), Calamba and Cabuyao (Philippines) and Suzhou (China), see figure 1-10. This research will focus on the sites Philips Thailand (PST), Philips Taiwan (PSK) and Philips Philippines (PSC) of IMO BE.

Figure 1-10: Main locations IC Manufacturing Organization

ICN Nijmegen

ICFH Hamburg

PSB Boblingen

PSF Fishkill

EPSI Caen

SSMC Singapore

CROL Crolles IMO Front End

PST Bangkok

PSK Kaohsiung

PSC Calamba

PSSL Suzhou

PSPI Cabuyao

TCC Caen

TCN Nijmegen

TCH Hamburg

IMO Back End

Human Resource Management

Financial Control Purchasing

IT

Communication Integration

Office

SCM &

Customer Service

Industrrial Strategy &

Innovation

Manufacturing &

Business Excellence IC Manufacturing Organization

SUPPORT

Headquarters IMO Singapore

Philips Thailand (PST) - Bangkok

Philips Taiwan (PSK) - Kaohsiung

(PSSL - Suzhou)

(PSPI – Cabuyao) Philips Philippines

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Roeland van der Hoeven page 19 Vision, mission and strategy of IMO

The strategic directions from IMO are derived from the One Page Strategy of IMO 2005, see appendix 4. As discussed in paragraph 1.2, individual Business Units and functional groups are encouraged to use the Philips Semiconductors One Page Strategy as a foundation for their own One Page Strategy document. The vision of IMO is the same as the vision of Philips Semiconductors: “A world where everyone can always connect to information, entertainment and services”. The mission of IMO is to provide the PD with a competitive advantage as value added supplier of Final Tested products. The strategies to pursue this mission are:

• Drive the integrated supply chain to meet end-customer expectations

• Demonstrate low cost leadership (Cost down roadmap)

• Drive Manufacturing Excellence

• Capital efficiency and flexibility by balancing internal and external capacity

• Maintain leadership in specialty process/assembly/test technologies

• Standardization of technologies & manufacturing processes

• Building lasting partnerships with Business Lines and Business Units

• Nurture-manufacturing pride for all employees Production Process IMO Backend

The back-end processing can be divided into assembly and test processes, which can be divided into several (main) sub processes (see figure 1-11). For a detailed description of all processes, see appendix 5.

When the wafers leave the fab’s of IMO FE, the IC’s on the wafer have to be tested first.

Next the wafer is sawn into separate dies. The dies that were positively tested before are then put on a lead frame. Subsequently, the IC’s are connected to the lead frame leads with gold fine wires. Next the IC’s, together with the lead frame are encapsulated with moulding resin for protection. From this step and further the IC will be protected. Now the lead frames are cut apart into individual packages and the leads protruding from the packages are shaped (bowed) and cut into the final product form. The final step of IC chip manufacturing is the marking onto the package surface. Before the IC chips are packaged, the individual IC’s undergo their final test and finally they are shipped to the customer.

Figure 1-11: Production Process IMO Backend Wafer

Testing Sawing

Grinding Die

Bonding Wire

Bonding Molding Plating

TrimForm Marking Final

Testing Packing

Back End 1 /Assy 1 Test

Test Back End 2 / Assy 2

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1.6 Conclusion

This chapter provided a general view of Philips Semiconductors. First Philips

Semiconductors itself has been discussed, including the markets, products, financial results, strategy, organizational structure, the semiconductor industry and value chain.

This research will be conducted in the business unit where the IC’s are produced. This business unit is called the IC Manufacturing Organization (IMO). The process flow, from customer order to final products, shows the link between the business units and the IC Manufacturing Organization. The following items are discussed: the organization itself, the organizational structure, locations and strategy of IMO.

Within IMO, the research will be conducted in the Back End part of the organization. This is the organization where the IC’s are being assembled into packages and are being tested. This research is about cost reduction on spare parts related to the equipment of IMO BE. Therefore an overview has been given from the main production processes that take place at IMO BE. Most of the facilities of IMO BE are located in the Far East, but the research is being executed in Nijmegen.

In the next chapter the research area will be addressed to, including the cause of this research and the problem definition. Chapter three is devoted to the theoretical aspects.

Chapter four will describe the purchasing function and its organization at Philips Semiconductors.

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Chapter 2. Research Area

In this chapter, the problem area will be further analyzed. This will result in the problem definition, containing: the research objectives, the main research question and the boundary conditions of the process and results. The main research question is worked out into several sub research questions. Finally the structure and methodological justification of this report will be given.

2.1 Problem Analysis

The adapted research objective as formulated at the beginning of the research was:

“The objective of this student internship is to develop and set up the implementation of a Spares and Consumables cost reduction program for all test & assembly sites of IMO BE.

The first phase of the project is to get a detailed insight in the actual spend for Spares and Consumables. Next phase is to develop a coherent saving strategy.”

2.1.1 What is the cause of this research?

According to Moore’s Law³, chip performance capabilities will double every two years. In combination with a strong rivalry within the semiconductor industry, the pressure on semiconductor process and margins are extremely high. In order to offset this margin erosion, Philips Semiconductors must continually reduce the total cost of all goods and services that are being purchased. Because of the already executed cost reduction programs of areas like raw materials and other production items, it is becoming more and more difficult to squeeze additional savings. The cost reduction programs resulted in an approximately 10 % cost reduction for the selected areas. At the Back End part of the IC Manufacturing Organization, where the assembly, packaging and testing of

semiconductors takes place, spare parts did not receive much management attention, because the spend was relatively low and difficult to measure. Therefore the spend on spare parts is unknown and there is no common strategy on how to handle spare parts;

the local sites have either none or their own spare parts policies. The Equipment Supply Base Management Team of IMO BE feels that costs can be saved on spare parts.

The Equipment Supply Base Management Team of IMO BE is responsible for the

worldwide coordination of equipment purchasing policies and works closely with factory engineering in Cluster Teams to set productivity improvement goals and platform selection criteria. When equipment is being purchased, the production sites generally utilize the OEM (=Original Equipment Manufacturer) channel for the spare parts, because the parts are included in the warranty. However, because OEM adds a substantial mark- up to the spare parts, the local sites started to look for alternative sources after the warranty. It led to the development of the direct channel from OPMs (Original Part Manufacturers) and second source markets. (McGovern and Costello 2002). This made that the supply base very complex, which is one of the reasons that the total spend on spare parts are unclear.

The extreme margin erosion on and therefore continuous focus on cost reduction, the unknown spends on spare parts and the expectation that costs can be reduced on spare parts, are the main causes of this research.

2.1.2 What are Spare Parts?

The definition of a spare part is not univocal. Dictionaries provide the following meaning of a spare part: ‘an extra component of a machine or other apparatus’

(www.themotoringdirectory.com), or ‘A component that is designed to replace an existing

3 ‘More life for Moore’s Law’, Business Week, June 20, 2005

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Roeland van der Hoeven page 22 identical part that is lost or that has become worn or faulty’ (www.allwords.com). A spare part is not a consumable or another part that wears down after a certain period. A

consumable is a part that gets used up during the process (www.its.bldrdoc.gov).

For the purpose of this research, a spare part is considered ‘an individual part, subassembly, or assembly supplied for the maintenance or repair of equipment’

(www.its.bldrdoc.gov).

2.1.3 What is the relevancy?

In this paragraph the relevancy of purchasing in general and spare parts will be

discussed. An analysis of the cost structure of Philips shows the importance of purchasing.

The average purchasing value in relation to costs of goods sold is approximately 50%. If the other business costs, which have an important purchasing component, are added to the purchasing value, the total amounts to approximately 68% (Van Weele 2002). While more and more activities are being outsourced, this percentage will grow even further.

The effect of purchasing savings on Philips Semiconductors’ Return On Investment for 2004 can be shown by the DuPont chart⁴, see

figure 2-1. In the given example, a 1% savings on purchasing results in an increase of the Return of Investment of more than 6%. If we would perform the same calculation to the second quarter of 2005, a 1% savings on purchasing results in an increase of the

Return of Investment of over 17% (see appendix 6).

Figure 2-1: DuPont chart of Philips Semiconductors’ ROI 2004

However, the purchasing value of spare parts is only a small percentage of the total purchasing amount. As mentioned before, the exact percentage is unknown. Together with the fact that spare parts consist of many small orders, it is explained why spare parts did not receive much management attention. It is clear that purchasing can

significantly improve sales margins through realized cost savings. On top of that, through better quality and logistics, purchasing can contribute to a higher capital turnover (Van Weele 2002). This part has been underexposed until so far.

4 Adapted from college sheets form D.J.F. Kamann (2004) session 9; lecture 6; sheet 44 Purchasing 2507 Million 2482 Million*

Other Costs 2507 Million Total Assets

2669 Million

Turnover 5464 Million

Costs 5014 Million 4989 Million*

Profit 450 Million 475 Million*

Profit Margin 8.2 % 8.7 %*

Return On Investment 16.4 % 17.4 %*

Turnaround 2.0 x

Turnover 5464 Million

6.1% increase of ROI

*=1% Cost reduction

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Roeland van der Hoeven page 23 2.1.4 Problem Owners

In this paragraph the problem owners, together with their relation to the problem will be introduced. According to De Leeuw (2000) it is important to make a distinction between functional and instrumental problems. There can be more instrumental problems that have the same functional problem. The problem owners will be discussed together with the instrumental problems they experience.

The Equipment Supply Base Management Team is responsible for the worldwide coordination of equipment purchasing policies (explained in chapter 4). The members are:

• Head of the Equipment Supply Base Management Team – Initiator of the project (Dion Boerrigter), is missing information to be able to measure the performance of the CPMs regarding spare parts. He is aware that information is missing for the CPMs to be able to make the right choices when purchasing the equipment.

Higher management wants to know the current spending on spare parts and a plan how to reduce this spend. He feels that costs can be saved on spare parts.

However, having no insight in costs makes it very difficult to set up a plan to reduce costs (instrumental problem).

• Cluster purchasing managers (CPMs) – CPMs are members of the equipment supply base management team and of the cluster teams (see chapter 4). The CPMs purchase the equipment for certain production clusters for which the spare parts are being used. They have no insight in the costs of spare parts. Therefore they cannot make a well-considered choice for equipment.

The functional problem is that, when the performance is not optimal. In this research the functional problems are: the unknown spend on spare parts and the missing coherent spare parts strategy.

2.1.5 Demarcations

In order to ensure the feasibility of this research it is necessary to make some demarcations. The initial research objective found on the Philips Internet site was as follows:

“The objective of this student internship is to develop and set up the implementation of a Spares and Consumables cost reduction program. The first phase of the project is to get a detailed insight in the actual spend for Spares and Consumables and to categorize them into the various Equipment Clusters. Next phase is to develop a coherent saving strategy which addresses the spend in the different clusters together with a detailed implementation plan.” The initial scope of the project included all test & assembly sites of IMO BE.

The initial objective can be split up into the following elements:

1. Gain detailed insight in the actual spend for spares and consumables and to categorize them into various equipment clusters

2. Develop a coherent savings strategy which addresses the spend in the different cluster with a detailed implementation plan

3. All test & assembly sites of IMO BE

During the first phase of the research: the spend analysis of spare parts, it became clear that some demarcations had to be made in order to ensure the feasibility. An explanation per element is given below:

1. The spend analysis (see appendix 19) will include both spare parts as well as consumables. This report will focus on spare parts only. Most consumables were assigned to purchasers in the organization after this spend analysis. There was no need to set up cost reduction methods for the consumables. Therefore is has been

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Roeland van der Hoeven page 24 decided to leave the consumables out of this research, to reduce the amount of work and complexity and therefore being able to finish the research on time.

It was not possible to gain insight in the spending per equipment cluster. An equipment cluster is a family of machines of the same brand and the same type.

This level of detail was not possible to achieve in the given time period.

2. A detailed implementation plan per equipment cluster was not possible in the given time period.

3. Although the initial scope of the research included all test and assembly sites of IMO BE, it had been decided that the focus will be on the three assembly sites Philips Taiwan (PSK), Philips Thailand (PST) and Philips Philippines (PSC), all located in the Far East, only. It was very hard to collect data from the other sites and this would take much too long to finalize the report in the given time period.

However, all recommendations coming out of the report should be applicable for the other locations also.

See the above made demarcations summarized in table 2-1 below.

Spend Analysis (appendix 19) In this report

Items Spare Parts Consumables Spare Parts Consumables Production sites

(see paragraph 1.5) Philips Thailand (PST) Philips Taiwan (PSK) Philips Philippines (PSC) PSSL PSPI TCC TCN TCH

Philips Thailand (PST) Philips Taiwan (PSK) Philips Philippines (PSC) PSSL PSPI TCC TCN TCH Level of detail

machinery Production platform

Equipment Brand and type Production platform

Equipment Brand and type Platforms Automatic Test Equipment,

Handlers, Probers, Packers, Sawing/Grinding/Taping, Molding, Trim Form, Ball Mounting, Isolation Sawing Punching, Plating, Marking, Die Bonding, Wire Bonding, Other

Automatic Test Equipment, Handlers, Probers, Packers, Sawing/Grinding/Taping, Molding, Trim Form, Ball Mounting, Isolation Sawing Punching, Plating, Marking, Die Bonding, Wire Bonding, Other Table 2-1: demarcation of the research

It is now clear what the cause is of the problems, who the problem owners are and what problems they encounter. The next step is to formulate the definition of the problem.

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2.2 Definition of the problem

From the above sketch of the problem, including the cause of the problem, the relevancy, the problem owners and the demarcations, the final definition of the problem can be composed. The definition of the problem will answer the question: Who wants to know what and for what reason (De Leeuw 1996)? The definition of the problem contains the research objectives, main research question and the boundary conditions.

2.2.1 Research Objectives

The main objective of this research is to gain insight in the total spending on spare parts per production platform and to give recommendations on how to reduce the costs of spare parts.

2.2.2 Main Research Question

The research objective leads to the following main research question:

2.2.3 Boundary conditions

This research is subject to several boundary conditions that are in place in order to make the research feasible (De Leeuw 2000). The boundaries conditions of this research are split up in the boundary conditions of the process and boundary conditions of the results.

Boundary conditions of the process

• The time in which the actual research will take place will be 8 months at maximum.

• The final thesis should meet the methodological and scientific demands as required by the University to achieve an academic level

• The quality of the research depends greatly on the data received from and the cooperation of the different stakeholders.

• The research will be restricted to three main assembly sites of IMO BE: Philips Thailand (PST) (Thailand), Philips Taiwan (PSK) (Taiwan) and Philips Philippines (PSC) (Philippines), see figure 1-10.

Boundary conditions of the results

• The recommendations must fit in with the overall supply management strategy

• The final thesis will be confidential and may not be made public without changes

• Although the research itself will be about the three main assembly sites Philips Taiwan (PSK), Philips Philippines (PSC) and Philips Thailand (PST) only,

recommendations should be applicable for all IMO BE sites.

2.3 Sub Research Questions

In order to answer the main research question, the following sub research questions need to be answered:

1. What are spare parts? (3.1)

2. Where do costs arise? (3.2)

3. How to reduce costs that are related to spare parts according to

theory? (3.3)

4. Describe the current situation and organization of supply management within Philips Semiconductors and the IC Manufacturing Organization

(Chapter 4)

5. What are the current costs? (Chapter 5)

6. What is the current situation regarding spare parts? (Chapter 6) What is the current spending on spare parts at IMO BE and what can be

recommended to the equipment supply base management team to reduce the costs of spare parts in order to offset the margin erosion for Philips Semiconductors?

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2.4 Structure of the report

The main research question contains the following elements: Spare Parts, Costs of spare parts and cost reduction. The theoretical part of this research in chapter three will try to find an answer to the following questions:

• Spare Parts: What are spare parts, where can they be sourced, what type of purchase is it, who are the users, when are they used?

• Costs of spare parts: What costs are related to spare parts? Where do they arise?

• Cost reduction: How can these costs according to literature be reduced?

Answers to these questions are given in the theoretical part of this research. In chapter 4 general information concerning supply management at Philips Semiconductors will be discussed. The theoretical part will reveal four main elements in which the costs of spare parts arise. These elements are: Quality, Price, Purchasing Costs and Inventory. For these four elements the costs will be given in chapter five. In chapter six the current situation will be explored. This chapter compares the current practices with the cost reduction approaches according to literature. In chapter seven the overall conclusions will be given and the chapter will end with the recommendations on how to reduce costs on spare parts at IMO BE. See

figure 2-2 for an overview.

Figure 2-2: Structure of the report Chapter

Theore-3:

tical Concepts

3.2 Where do costs arise?

3.1 What are Spare Parts?

3.3 How to reduce the costs?

Chapter 5:

Cost Analysis

Chapter 4: Supply Management at Philips Semiconductors Chapter

Research 2:

Area

2.2 Definition of the Problem 2.1 Problem Analysis

2.3 Sub-research questions Introduction

Chapter 1: Philips Semiconductors

5.2 Purchasing costs 5.1 Spend Analysis

5.3 Quality related costs 5.4 Inventory related costs

Chapter 7: Conclusions & Recommendations 3.5 Sub-research Questions

Chapter 6:

Current Situation

6.1 Test

6.3 Assembly 2 6.2 Assembly 1

2.4 Methodological Justification

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2.5 Methodological justification

2.5.1 Type of research

In order to guarantee the quality of the research, it is important to clarify the type of it, with the purpose to give shape to the frame of reference for the direction and content.

The first step is to make a distinction between practically oriented and scientific-oriented research (De Leeuw 1996). The objective of this research is to provide the client with specific knowledge and therefore can be characterized as practically oriented. Within practically oriented research, it can be classified as policy supportive research, as it attempts to provide useful knowledge in the customer’s specific situation. The final results of this research are recommendations as provided in literature that gives directions for IMO BE in order to reduce costs on spare parts. These recommendations will be described as a knowledge product in chapter seven.

2.5.2 Data Collection

Various techniques and methods are used for data collection. For desk research internal documents, external reports and literature are used. For the spend analysis the ERP system of Philips Semiconductors is used: SPEED (adapter version of SAP R/3) and Business Warehouse. See paragraph 5.1 for further explanation. Interviews are being used to gain more indebt knowledge. Most stakeholders are located in the Far East so interviews have to be executed by e-mail and telephone. All interviews are open

interviews (De Leeuw 1996). This means that there is room for the interviewee to share his or her view on the matters.

2.6 Conclusion

In this chapter the problem area has been further analyzed, resulting in the definition of the problem of this research. In the next part, the sub research questions will be

addressed to.

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ANALYSIS

Introduction

1. Philips Semiconductors 2. Research Area

ORIENTATION ANALYSIS DESIGN

Recommendations

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Chapter 3. Theoretical Framework

This part will discuss the relevant theoretical aspects of this research, answering the first three sub research questions: “What are Spare Parts”, “Where do costs arise?” and finally,

“How to achieve cost reduction on spare parts?”

3.1 What are Spare Parts?

The definition for a spare part is not univocal. Dictionaries provide the following meaning of a spare part: ‘an extra component of a machine or other apparatus’

(www.themotoringdirectory.com), or ‘A component that is designed to replace an existing identical part that is lost or that has become worn or faulty’ (www.allwords.com). A spare part is not a consumable or another part that wears down after a certain period. A

consumable is a part that gets used up during the process (www.its.bldrdoc.gov). For the purpose of this research, a spare part is considered ‘an individual part, subassembly, or assembly supplied for the maintenance or repair of equipment’ (www.its.bldrdoc.gov).

Maintenance engineers are responsible for the maintenance of equipment. Roughly, there are two types of maintenance: scheduled (preventive) maintenance and unscheduled (corrective) maintenance. With scheduled maintenance, equipment is checked and determined parts are replaced. In general the older the equipment, the more spare parts used and the more equipment installed, the more spare parts used.

3.1.1 Type of Purchase

In most literature, spare parts are considered Maintenance, Repair and Operating Materials, also called MRO articles. Much literature is available concerning MRO articles, however not about spare parts only. Bearings, pipes, valves, fittings, electrical repair and replacement items, office supplies and spare parts are typically considered MRO items (Bechtel and Patterson 1997). For a complete overview of the types of purchases generally made by companies, see figure 3-1.

Figure 3-1: Type of purchase

According to Van Weele (2002), the major purchasing related characteristics of Maintenance, Repair and Operating supplies are:

• Very extensive article assortment

• High degree of specification

• Low, irregular consumption (very low inventory turnover rate)

• User has substantial influence on the choice of the product

In practice MRO items take up to 80% of the product codes. At the same time, they rarely make up more than 20% of the purchasing turnover and, as a result of the characteristics mentioned earlier, quite often 80% of the buyer’s work concerns these articles. Measures aimed at increasing purchasing efficiency should primarily focus on reducing the administrative work involved.

Materials Product Related

Consumables Spare Parts

Office Supplies

Mechanical Parts

Electrical Parts

Industrial Supplies

Tools

MRO* Equipment Travel IT

Non Product Related Spend

Cost Reduction On Spare Parts

Offset the continuous margin erosion of Philips Semiconductors:

Cost Reduction On Spare Parts

Focus on spend or costs?

PUBLIC VERSION

Public report

Roeland van der Hoeven

Faculteit Bedrijfskunde

Rijksuniversiteit Groningen

December 2005

Offset the continuous margin erosion of Philips Semiconductors:

Cost Reduction On Spare Parts

Focus on spend or costs?

PUBLIC VERSION

Preface

Summary

Table of Contents

List of Figures

List of Tables

Abbreviations

Introduction

ORIENTATION

Chapter 1. Philips Semiconductors

1.1 Royal Philips Electronics NV

1.2 Philips Semiconductors BV

1.3 Semiconductor Industry and Value Chain

1.4 Process Flow

1

2

7

8 5 6

3 4

1.5 IC Manufacturing Organization

1.6 Conclusion

Chapter 2. Research Area

2.1 Problem Analysis

2.2 Definition of the problem

2.3 Sub Research Questions

2.4 Structure of the report

2.5 Methodological justification

2.6 Conclusion

ANALYSIS

Chapter 3. Theoretical Framework

3.1 What are Spare Parts?