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High Tech Needs AnalysisExecutive SummaryThe major identifiable opportunity for selling products and services to a high technology company is associated with the company's Cost of Goods Sold (COGS) which is the sum of the labour, materials, and overhead that go into the supply of the company's own products and services. It is typically the largest single item of expense on a company's income statement and the outside purchases are of a more regular nature than purchases made for such activities as selling, marketing and administration. Ottawa-Carleton's high technology cluster has approximately 1,000 companies and approximately 57,000 employees. Its companies have combined annual sales of approximately $12 billion and COGS of approximately $6.5 billion (all figures refer to calendar year 1999). The COGS includes $2.4 billion for products purchased from outside, and $1.5 billion for services purchased from outside. The remaining $2.5 billion of COGS goes toward internally-supplied services. After allowing for corporate overhead (typically 20%) that must be applied to products and services from outside, the "market opportunity" to outside firms is $1.9 billion for products and $1.2 billion for services. The major sales opportunities for companies wishing to supply products to Ottawa-Carleton high technology companies lie in a sector identified as "Telecommunications, Satellite & Mobile Communications" which is one of seventeen sectors used to define the industry by Ottawa Economic Development Corporation and the Ottawa Business Journal. It has annual sales of $4.7 billion and a COGS of $2.6 billion. It purchases $1.2 billion worth of products from the outside world. On the services side, the Telecommunications, Satellite & Mobile Communications sector is also a heavy consumer at $471 million, but another sector identified as "Information Technology Systems" is even larger at $518 million. In order to define the sales opportunities more precisely, the outside purchases are broken into twelve categories (or bins) for the products and twelve for the services. The largest product bin for all of the sectors combined is semiconductors and the largest service bin is assembly. The latter refers to situations where the company purchases raw materials and sends them to outside contractors for assembly. The opportunities available to an outside supplier depend primarily on the supplier's capability. For example, a supplier of machined parts would be interested in the product bin labeled "Machined Parts and Assemblies". The industry in total purchases approximately $200 million per year of such products. Companies wishing to use the information presented in this report will have to pursue individual opportunities on their own because the data gathering did not go down to the level of individual companies. It goes to the sector level only, but a listing of companies by sector is provided. IntroductionCanada's high technology industry presents unusual sales opportunities to suppliers of goods and services of all types. Depending on how one defines high technology, that industry employs between 500,000 and 1 million people and has annual sales of between $70 billion and $120 billion. Its exports account for about 50% of sales and are therefore between $35 billion and $60 billion annually. It is the export-oriented sector of the industry that presents the best opportunities for Canadian suppliers because the weak Canadian dollar makes imports very expensive. If high-technology companies are unable to find enough Canadian sources for the products and services that go into their finished products, they lose much of their competitive advantage in foreign markets. The high technology industry that has been built up in the Ottawa-Carleton region is more export-oriented than its counterparts in other regions because most of the companies have been "home-grown" and were established to address foreign market niches right from the beginning. By contrast, Toronto's high technology industry is a mixture of home-grown companies which are also export-oriented and foreign-owned branch plants, most of which are sales subsidiaries that import finished products from other countries. This report will present the findings of an analysis that was done on the Ottawa-Carleton high technology industry to identify sales opportunities for Canadian suppliers of goods and services that could have applicability to that industry. MethodologyThere are many challenges to quantifying what any industrial sector purchases from its suppliers. By far the major one is the need for company confidentiality. Very few companies in any industry are willing to have their names appear on a list which reveals what they purchase in any kind of detail. The problem is further enhanced in the high-technology industry where a company's technical advantage is often directly related to the products and services that are consumed in the delivery of its own products and services. For example, the adoption of a new type of microprocessor or software operating system can tip off competitors to a new strategic direction that is being pursued by the company. The needs analysis whose results are presented in this report was limited to the products and services consumed in the actual supply of the products being delivered by the 1,000 or so high technology firms now operating in Ottawa-Carleton. In other words, it is limited to the "cost of goods sold" (COGS) line on the income statements of those companies. While it is true that a typical company purchases products and services that fall under other categories on both its income statement and its balance sheet, its COGS line will capture the majority of its outside purchases. To illustrate this point, every company purchases products and services that fall under the categories of capital equipment, selling, marketing, research and development (R&D), or general and administration (G&A) expenses. However, such purchases tend to be more sporadic in nature and seldom represent the same kinds of sales opportunities to outside firms that the COGS purchases do. For example, when a company expands its workforce or its physical facilities, it will buy additional assets such as furniture and computers. Their costs are then amortized over different periods of time and allocated to several departments in the company. Some of these costs are included in the COGS as manufacturing overhead. In addition to their sporadic nature, such purchases usually go to suppliers that are well entrenched. Another reason for not including them in this analysis is that most suppliers of "non-COGS" products and services wishing to dislodge existing suppliers can pursue sales tactics that are well understood in the retail industry. For example, an astute supplier of office furniture will be on the lookout for new buildings going up or news of company expansions. It is not nearly as easy to identify a COGS opportunity because so little is known about what goes into the COGS line of most high technology companies. The unlocking of that mystery, even in a partial way, is the main objective of this report. Typically, the purchases made by a company for supporting its sales, marketing, R&D and administration activities are much less than its COGS purchases. However, some Ottawa-Carleton companies are more R&D intensive than COGS intensive. A future Doyletech report will address at least R&D purchases, but this analysis is limited to COGS purchases. As will be explained, the COGS activity can vary from extensive manufacturing activity to distribution and support with very little value added in terms of modification to the product or service being delivered. The Seventeen SectorsThe Ottawa-Carleton high technology industry, like any other, is made up of different sectors. Examples are aerospace, computer hardware, computer software, and information technology systems. The types of products and services that are purchased outside and that are expensed on the COGS line will vary widely from one sector to another. For example, a computer hardware company will purchase items such as semiconductors, cabinetry, and printed circuit boards, while a computer software company will purchase floppy disks, manuals, software products, and special-purpose packaging materials. The Ottawa Technology Industry Guide published by the Ottawa Business Journal in partnership with Ottawa Economic Development Corporation breaks the industry into seventeen relevant sectors as follows:
The COGS analysis for each of these sectors was carried out as follows: Twelve "bins" of products and twelve "bins" of services were selected to capture the purchases that are likely to be made in each sector. Those bins will be described more fully in the next section, but an example of a product bin is semiconductors and an example of a service bin is assembly. The latter is used to capture those situations in which a company sends component kits to an outside assembly house and its only purchase from that house is for services. A COGS figure was assigned to each of the sectors based on interviews with selected companies in that sector and on Doyletech's knowledge of high technology income models. For example, the COGS figure for computer hardware was assumed to be 50% and the figure for software products was assumed to be 20%. Approximately 75% of the companies in the region were contacted on such parameters as employment, COGS, and the makeup of the bins. The COGS figure was further broken down into labour and materials (the treatment of overhead will be discussed later). A figure of 50% for each was assumed for most of the sectors. Exceptions were in the more hardware-oriented sectors where the product percentage was assumed to be 60%. Each bin was assigned a value based on the total estimated sales of the companies in a given sector, the percentage that was assigned to COGS and its breakdown by products and services. The following analysis illustrates the above methodology, using the computer hardware sector as an example:
The Product and Service BinsThe following are the twelve product bins used in this analysis:
The following are the twelve service bins:
These classifications are also based on the company interviews and on Doyletech's experience in the industry. Obviously, any individual company will have product and service bins that are not listed here, but to keep the analysis manageable, a limit of twelve was placed on each. Just as the COGS varies significantly from one sector to another, so will the contents of the product and service bins. A company using the data in this report should be prepared to segment each of the bins into as many as twelve segments in order to obtain the right fit between its supply capability and the listed requirements. Section 11 will deal with the interpretation of the data. Applying the ModelWhile a typical company purchases all of its COGS products from outside suppliers, (unless it is a vertically integrated company that supplies some of its own components like semiconductors), it is not likely to purchase all of its services. There will be significant in-house services in the form of testing, quality assurance, management and the like. The ratio of inside to outside services will vary significantly from sector to sector. To illustrate how the model is applied in its entirety, the following numbers apply to the computer hardware sector:
The $41 million worth of product purchases for this particular sector can be broken down as follows:
The $14 million worth of services that are purchased from outside sources can be broken down as follows:
The Impact of Manufacturing OverheadThe COGS line for any company's income statement includes material, labour and overhead. In this analysis, the impact of overhead will be as follows: The costs of products and services purchased from outside arloaded costs. For example, in the case of the $41 million worth of product purchases for the computer hardware sector, 20% goes toward overhead because that is the overhead rate that applies to this sector. In other words, the cost of the products is $33 million (80% of the $41 million) when they arrive at the receiving dock, but $41 million when they arrive at the assembly line. Included in the manufacturing overhead are amortization costs for manufacturing equipment, allocations for occupancy and certain services such as manufacturing management. In fact, some of the in-house services refer to overhead items. The majority of them refer to the cost of converting the product purchases (materials) into finished products. The listed cost of the service purchases (i.e. the services that can be purchased from outside sources) are also loaded costs. In other words, in the case of the $14 M of service purchases made by the computer hardware sector, their actual cost when delivered to the receiving dock (or the front desk) are 20% lower than those listed, or $11 M. While manufacturing overhead will vary from sector to sector, a figure of 20% will be applied to all of them because any deviation from that figure would be within the margin of error that can be expected from this analysis. The amounts quoted for purchased products and services will reflect loaded costs. When interpreting the results of this analysis a factor of 80% will be applied to convert the data on product and service purchases to data on market opportunities The Impact of Non-Manufacturing CompaniesThe methodology used in this analysis is based on the assumption that all of the companies perform some kind of manufacturing or value-added activity other than distribution and support and that they perform all of the normal corporate activities such as R&D, selling and marketing. The fact of the matter is that a large proportion of them do not, even though most of them would show a COGS line on their income statements. For example, a sales subsidiary that buys all of its products and most of its supporting services from a parent company does not present much of a market opportunity for non-controlling suppliers, particularly for suppliers of products. Yet it will have a COGS line on its income statement because it does receive inter-company billings from its parent company that allow it to leave some profit on its books. Canadian tax authorities will insist on reasonable inter-company pricing. Research and development subsidiaries present a similar problem, even though the mechanics are different. Their missions are to perform R&D for their parent companies. They sell the results of that R&D to their parent companies at a profit (this is also required by Canadian tax authorities) and they do have a COGS line on their income statements that is comprised mostly of labour costs (i.e. in-house services). However, they do not purchase much in the way of either products or services from the outside world and it would be misleading to suggest that their outside purchases are related to COGS in the same way that they are related in a fully integrated company that performs R&D, manufacturing, distribution and post sales support. Variations of this measurement problem were encountered in nearly every one of the sectors. For example, there are Canadian-owned companies that purchase products from other companies (both foreign and domestic) and re-sell them without adding very much value. Nevertheless, they have a COGS which is significant; they get a distributor's discount that is intended to cover the cost of selling and servicing the product. The point of the above discussion is that it is not just manufacturing companies that have a COGS line on their income statements. This analysis includes many that do no manufacturing in the traditional sense. One way of dealing with such companies would have been to create new sectors in addition to the seventeen that are being used. As this approach was investigated, it became obvious that it would have jeopardized company confidentiality, a principle that is essential to an analysis of this type. All of the companies surveyed were assured that a user of this information would not be able to identify the product bins and the service bins applicable to them individually. They were told that their names would be associated with a given sector and that the contents of the bins would apply to the sector in total and not to individual companies. A supplier company wishing to use this information would start by determining what bins it is capable of filling and then doing its own sales and marketing work to determine which companies it is capable of working with. It is their own responsibility to identify the "truncated" companies for which the bin data does not apply. The way in which Doyletech handled companies that clearly fell outside the traditional manufacturing model was to adjust the three main variables it had at its disposal in this analysis, namely sales per employee, COGS breakdown, and the contents of the bins. Sales subsidiaries and sales distributors have higher sales per employee and higher COGS, but their product bins would be virtually empty because there is little or no opportunity for a non-related supplier to supply them with product. Their service bins would be less empty because they do use local service providers for packaging, shipping, etc. R&D subsidiaries and subcontractors typically have lower sales per employee but their COGS is very high because they do not require a high gross profit since they have little or no marketing and selling costs. In summary, all of the companies which were originally included in the seventeen sectors were left there but the sales per employee, the COGS, and the bin contents were modified to accommodate those that are not true manufacturing companies*. It should be remembered that this analysis is focused only on the demand for products and services associated with the COGS line. A follow-up study focusing on the R&D line and the Sales/Marketing line would be an obvious complement to this study. However, since the COGS line is the largest in any high technology company, it was felt that a COGS analysis was the place to start in assessing the business opportunity presented by Ottawa's high technology industry. Sectoral AnalysisThe first step in assessing the demand per sector was to assign a COGS figure to each of them and then break it down into products and services. The services were further broken down into those that are supplied internally (e.g. testing, quality assurance and management) and those that are supplied externally (e.g. assembly, product engineering consulting, and warehousing). This data was extracted from a number of sources, but mainly from company interviews and Doyletech's experience in the high technology industry. The Doyletech experience was also relied upon to make the appropriate adjustments for the truncated companies referred to in the last section. The following is a listing of COGS and its components as applied to each of the sectors:
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