IMB 771

SATTVA eTECH: CONTRACT SELECTION IN

COMPONENT PROCUREMENT

TARUN JAIN AND JISHNU HAZRA

Tarun Jain, Professor at the Indian Institute of Management Udaipur, and Jishnu Hazra, Professor of Production and Operations
Management, prepared this case for class discussion. This case is not intended to serve as an endorsement, source of primary
data, or to show effective or inefficient handling of decision or business processes.

Copyright © 2019 by the Indian Institute of Management Bangalore. No part of the publication may be reproduced or
transmitted in any form or by any means – electronic, mechanical, photocopying, recording, or otherwise (including internet) –
without the permission of Indian Institute of Management Bangalore.

This document is authorized for use only in Prof. TAS Vijayaraghavan's Logistics and Supply Chain Management, Term - IV, BM 2018-20 at Xavier Labour Relations Institute (XLRI) from Jun
2019 to Sep 2019.
 SATTVA eTECH: Contract Selection in Component Procurement

Nagesh Kumar1 took a deep breath as he decided to take a short break from his office and spend some
time in the corridor lounge. It was 3pm already and Nagesh was still trying to figure out how to tackle the
problem of massive inventories of a bulk semiconductor component at Sattva eTech. Nagesh was the
manager of the manufacturing division of Sattva eTech, an embedded new product development firm in
Bangalore, India. It was May 2018 and he had been asked to select an appropriate sourcing contract to be
awarded to Maxtronics Inc., a Taiwanese semiconductor component supplier firm.

Due to high volatility in the demand for final products, the sourcing managers at Sattva had stacked up
huge inventories of the component in question. Now, Nagesh was primarily concerned with the risk of
obsolescence of the inventories due to the highly dynamic nature of the embedded products market. On
the other hand, if the demand for the final products exceeded the estimated forecast, Sattva had the option
of sourcing components through short-term arrangements. However, Sattva faced high price volatility in
these short-term contracts as a consequence of the high variability in the market demand. Eventually, due
to high demand-supply mismatches, the manufacturing division faced excessive procurement costs.

Nagesh had realized that having a close relationship with upstream supplier was important for Sattva. As
he re-entered his office, Nagesh dialed the number of Shyam, the marketing manager (Asia Pacific
region) of the supplier, Maxtronics, to share the above concerns with him.

COMPANY BACKGROUND

Since the start of Sattva’s operations in 1980 (when it was still a part of VXL eTech), the company had
specialized in the design, development, and manufacturing of embedded new products. Sattva’s client list
included renowned firms in the fields of medical and industrial equipment, nuclear power plants,
industrial automation divisions, and military/defense industry. The company was formed under the
leadership of NV Maslekar, Chief Executive Officer and Kumar Shyam, Chief Technology Officer. The
company had received various quality certifications like ISO 9001:2008, AS 9100 C, etc. It had been
awarded by the Ministry of Micro, Small and Medium Enterprises, Government of India and Electronics
Industries Association of India for its superior R&D capabilities and lean manufacturing processes.

PRODUCT DESIGN AND MANUFACTURING PROCESS

The product design process would begin after the client firm and Sattva had agreed on the specifications
of the final product. The design engineers of Sattva decided the system and hardware architecture,
software requirements, and testing procedures of the final product. Next, based on the design
specifications, the Bill of Materials (BOM) was prepared and the components to be sourced were decided.

The design engineers further worked on the circuit designing, printed circuit board (PCB) routing, and
mechanical enclosure development. The components were loaded on the PCB boards and the mechanical
enclosures were assembled. The software and the firmware were developed by a dedicated software

1
Disguised name

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2019 to Sep 2019.
 SATTVA eTECH: Contract Selection in Component Procurement

development team in parallel. Finally, the product was assembled, software was loaded and integration
testing was performed. The final product was subjected to a series of quality tests before being dispatched
to the client.

COMPONENT SOURCING

The procurement team received the BOM requirements from the design team and sourced the required
components from internally approved suppliers. For the bulk components, that is, the components which
were common across various new products, the procurement team followed a Made to Stock strategy.
They kept inventory of such items required in most of the products. However, these components also
faced the risk of technological obsolescence if stocked for longer periods. Such components commonly
included PCB boards, capacitors, resistors, some commonly used connectors, power connectors, etc.

Further, some components which determined the core functionality of the product were not stocked and
ordered only when required for a specific product. These mainly included the microprocessor unit whose
computational speed (core functionality) was specific to customer requirements.

MAXTRONICS INC.

Sattva sourced AC/DC power module, a bulk component, from Maxtronics Inc.,2 a Taiwanese firm.
Exhibit 1 provides the details about this component. In 2019, the contract between Sattva and
Maxtronics specified the purchase quantity and unit procurement price of ₹700.3 Due to close relationship
with the supplier, developed through long-term relationship, Sattva shared the historical demand
information for the component with Maxtronics. Maxtronics also preferred this long-term contracting
relationship as it generated steady business. Sattva also benefited from the long-term contracts as
Maxtronics offered low unit procurement price as compared to the average price at which the component
was sold in the market. The unit manufacturing cost of component was around ₹200.

Since the expected lifetime of this component was around four years, Sattva typically placed an order
once in every four years. The reason for the combined four-year order was that the supplier only agreed to
supply large order quantities. Hence, on average, after every four years, Maxtronics would release a
newer generation component, and therefore, the old generation component would become obsolete. At
around that point of time, Sattva would place an order for the requirement of the next four years. The
component inventory leftovers at Sattva’s end or at Maxtronics’s end were salvaged at unit price of ₹25.
The average price charged by Sattva towards the final product was around ₹5000.4

High volatility in the number of new embedded product requirements led to high volatility in the
requirements for the underlying components. The historical product demand data on the number of
boards produced and the number of components used in each board, reveals that the AC/DC power

2
Disguised name
3
Disguised data on cost and price information; 1 USD = ₹70, on March 1, 2019
4
Disguised data

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2019 to Sep 2019.
 SATTVA eTECH: Contract Selection in Component Procurement

component demand over four years followed Normal Distribution with mean of 2000 units and standard
deviation of 500 units.

In the event the demand exceeded the available component capacity, Sattva also sourced components
from e-commerce website electrickey.com5. The historical prices of the component on eletrickey.com
were highly volatile due to the limited capacity of the e-commerce firm. In the scenario where the demand
faced by the website was high, electrickey.com would dynamically increase the prices. The monthly
prices of the component on electrickey.com for 2016-17 are provided in Exhibit 2. Assume that Sattva’s
production cost and the cost of all other input components are all normalized to zero. 6

THE WAY FORWARD

Nagesh shared his concerns regarding very high procurement cost over the last few years with Maxtronics
Inc. The supplier firm suggested a new contract structure. Sattva could reserve certain units of supplier’s
component capacity by paying unit reservation price of ₹25. Sattva would be free from any obligation to
purchase the reserved units. Next, after the demand information was revealed, Sattva could place the
order to Maxtronics Inc. at unit procurement price of ₹750. The maximum quantity that Maxtronics
would deliver was the amount reserved by Sattva.

Shyam suggested to Nagesh:

We believe that such a contracting structure will be beneficial for both of us. The moment
you reserve some capacity, we get a positive cashflow and at the same time, you can
place order only after you see the demand. That would tackle your issue of massive
inventories.

On the other hand, Nagesh had a different contracting structure in his mind. In this contract, Sattva would
commit certain amount of component capacity at unit procurement cost of ₹700. In the scenario when
purchased amount exceeded the actual demand, Sattva would have the option of returning the excess
number of components at a low buyback price. Nagesh was planning to negotiate this buyback price to be
around ₹580. Hence, this buyback contract would specify quantity, unit procurement price, and unit
buyback price. Nagesh was of the view that this new contract with buyback could solve the issue of
excess inventories. In the instance of demand spikes, Nagesh planned to source the excess components
from electrickey.com.

While reviewing the contract structures, Nagesh knew that he needed to consider qualitative as well as
quantitative factors while making a decision that would be win-win for both Sattva and Maxtronics.
Should he keep the old contract structure, or should he implement the contract design suggested by
Shyam? The third option available to him was to convince Maxtronics for the component buyback-based
contract. “This is going to be a long night!”, sighed Nagesh as he stepped out of his office.

5
Disguised name
6
Disguised data

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2019 to Sep 2019.
 SATTVA eTECH: Contract Selection in Component Procurement

Exhibit 1
Details of the Component: AC/DC Power Module

(a) Product designing and manufacturing stage

(b) AC/DC power module

Key functionally of AC/DC power module: AC/DC Power module is the convertor module that transforms power
in AC (Alternating Current) to DC (Direct Current) form.

Source: Company Records

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2019 to Sep 2019.
 SATTVA eTECH: Contract Selection in Component Procurement

Exhibit 2
Monthly prices of the component on electrickey.com for 2016-17 (disguised data)

Month Prices of Electrickey.com

Jan 1180
Feb 1320
Mar 1000
Apr 1150
May 1000
Jun 1500
Jul 1800
Aug 1000
Sep 1100
Oct 1160
Nov 1000
Dec 1200

Source: Company Records

Page 6 of 6

This document is authorized for use only in Prof. TAS Vijayaraghavan's Logistics and Supply Chain Management, Term - IV, BM 2018-20 at Xavier Labour Relations Institute (XLRI) from Jun
2019 to Sep 2019.