Procurement Risk Management (PRM) at Hewlett-Packard Company

1. Procurement Risk Management (PRM) at Hewlett-Packard Company Venu Nagali, Ph.D. Distinguished Technologist Procurement Risk Management Group Stanford Risk Management Roundtable November 13, 2006

2. HP has the largest IT supply chain HP Supply Chain actively manages $51B of company spend (80% of total) • #1 in Material Spend -$43B • Memory - #1 • Microprocessors (Intel & AMD) - #1 • Windows Software (Microsoft) - #1 • Hard Disk Drives - #1 • Laser Engines- #1 • Optical Disk Drives - #1 • Chipsets (Intel) - #1 • LCD Panels & many more - #1 • #1 in CM/ODM Spend • #1 in Electronics Industry Logistics Procurement - $1.7B • Provide spare parts for 1M Service interactions per month $64B Total Spend Material Cost (67%) Non-SC cost (20%) SC Cost (13%) Venu Nagali – ESCA Sep 06

3. HP’s Supply Chain Strategy:Adaptive Supply Chain Customers demand more. Supply chains must be agile enough to adapt to constant changes in their markets. improve agility • Speed-up introduction of new products and services to market • Design and provide anything anywhere • Manage change and global operations more easily • Enable profitable growth mitigate risk managecosts increase quality Venu Nagali – ESCA Sep 06

4. Lack of risk mgmt processes has resulted in billions of dollars in losses for OEMs … Demand risk Price risk Dell Computer May 14, 2004: Stock drops 3% as earnings are held back by memory prices Oct 18, 1999: Stock drops 13% as higher memory prices result in a $470M earnings shortfall Cisco Systems April 2001: $2.5B inventory write-off due to rapidly weakening demand coupled with locked-in supply agreements Price risk Availability risk Ford Motor Company December 2001: Ford posted $1B loss on palladium & other precious metals contracts. Shareholder files suit alleging mistake in company’s hedging Agilent Technologies July 1999: Stock price drops 26% after an inability to obtain key components cause revenue shortfall Venu Nagali – ESCA Sep 06

5. … and cause pain throughout the supply chain March 19, 2001 Solectron Announced 8,200 layoffs and a $400 million restructuring charge to realign capacity to meet decreased demand. March 20, 2001 JDS Uniphase Announced global realignment due to reduced demand - includes a 20% staff reduction and a $425 million restructuring charge. Venu Nagali – ESCA Sep 06

6. Objectives of PRM @ HP:Measure & Manage Procurement Uncertainties Customer Procurement Planning& Mfg Sales Supplier Uncertain Component Prices Uncertain Product Prices Margin Risk Price-Cost MatchingProblem Shortage & Inventory Obs. Costs Supply- Demand MatchingProblem Hidden Material Costs Uncertain Component Supply Uncertain Product Demand Uncertainty Symptoms PRM Solutions Venu Nagali – ESCA Sep 06

7. PRM at HP addresses risks due to high probability events high demand risk PRM @ HP supplier bankruptcy Other processes quality availability risk earthquake price risk fire hurricane Impact transit delays shipping accident customs delays theft of parts or products low Probability of Adverse Event low high Venu Nagali – ESCA Sep 06

8. Organizational challenges in implementing PRM Strategy Metrics & Processes Skills & Toolsets • Currently, risk management is not a core part of the supply chain strategy • Current supply chain metrics do not address risks • Current processes do not support risk management • Poor understanding of techniques to measure and manage of risks • Current ERP and supply chain mgmt systems do not address uncertainties Venu Nagali – ESCA Sep 06

9. Components for PRM framework • Measure Risk: • Forecast scenarios for product demand, component cost and availability • Manage Risk: • Use a portfolio of structured contracts for different segments of demand • PRM Process: • Cross-functional process • Periodically reassess risks & manage them Venu Nagali – ESCA Sep 06

10. Demand forecast (units) Hi scenario 400 Uncommitted 300 Flexible quantity contract Base scenario 200 Fixed quantity contract 100 Lo Scenario 0 Time PRM Approach: Manage risks using structured contracts with suppliers Venu Nagali – ESCA Sep 06 HP Confidential

11. Strategy & Governance Contract Origination Contract Monitoring Contract Evaluation Contract Execution Re-engineering business processes to implement PRM • New metrics put in place to track supply chain risks • Risk mgmt is now a core part of commodity strategy • Cross-functional process involving procurement, planning, finance & marketing Venu Nagali – ESCA Sep 06

12. Consulting Training Software HP PRM implementation methodology • Consulting • Commodity-specific • Business process • Deal structuring and valuation • Change management • Training • Core concepts • Forecast scenario generation HPRisk Suite of PRM software • HPRisk contract valuation • HPHorizon demand forecast scenario software • Price forecast software • Inventory buffer calibration software Venu Nagali – ESCA Sep 06

13. PRM enables a combination of objectives • Earnings & Cost Predictability • Protect product margin against volatile component prices Cost uncertainty Demand uncertainty Availability uncertainty • Portfolio cost savings • Lower material & inventory costs • Assurance of supply • Protect against shortage risk Venu Nagali – ESCA Sep 06

14. Relative size of annual impact Year1 Year2 ASICs & custom assembly ASICs Spare parts Year3+ MPUs Chipsets Lenses Optical drives Network Asics Scanner & Camera Sensors HDD Packaging TFT Panels Plastics Memory Ad Media Energy PRM implemented for a range of commodities & across all HP businesses Custom Components Direct Memory Standard Components Indirect Procurement Venu Nagali – ESCA Sep 06

15. Commitments across the supply chain have reduced the “bull-whip” effect Buyer Tier-1Supplier Tier-2 Supplier Demand forecasts Conventional Approach Cost forecasts Quantity Commits PRM Approach Cost Commits • Conventional approach • Non-binding nature of the forecasts significantly increases demand, cost & availability uncertainty • PRM approach • In certain cases at HP, demand and order volatility across 2 tiers in the supply chain decreased by 50% • Essentially, the PRM approach can substantially reduce the bull-whip effect Venu Nagali – ESCA Sep 06

16. PRM Accomplishments: HP has obtained significant financial benefits from implementing PRM HP Spend Impacted by PRM Process Incremental Savings Enabled Estd. Incremental savings from material, inventory & AoS costs • About $7 billion in HP spend using the PRM process in FY’06 • Significant AoS benefits to enable revenue & customer satisfaction • Over $300M in incremental savings enabled over the past 6 years • PRM considered a competitive advantage by HP senior management Venu Nagali – ESCA Sep 06

17. Venu Nagali – ESCA Sep 06