For many North American manufacturers, the decision to source or manufacture products or components offshore is no longer a choice. It’s a matter of survival.
Whether it’s done to lower costs in an effort to stave off an onslaught of low-priced imports at home, or whether the goal is a source of production in a growing overseas market in order to compete more effectively there, manufacturing outsourcing and offshoring are increasingly becoming ways of life for more U.S. companies.
But that doesn’t mean it’s easy. And it doesn’t mean that the decision to move production offshore is always a no-brainer, or that there aren’t plenty of pitfalls along the way.
Three “gotchas”
If your company is considering a move into offshore production or sourcing, or expanding its current global activities, there is a world of things to consider.
For starters, listen to consultant James W. Teegarden, who tells a tale of three North American manufacturers that got into the offshore sourcing game. Though the names have been changed to protect the innocent, says Teegarden, a senior partner for Houston-based Valpers Performance Partners Inc., the stories are true. And they illustrate some common perils of offshore outsourcing that U.S. companies must learn to avoid.
The first company Teegarden calls “Ajax.” When Teegarden was called in by Ajax management to root out the source of a “quality crisis” at the company, he discovered that the problem was even worse than management thought. Customers were losing faith in Ajax, and employees were concerned about the company’s long-term future.
As Teegarden probed the issue, he discovered that Ajax had been instructed by its parent company to move aggressively to source component parts offshore. Because Ajax management didn’t have the skills or resources to effectively evaluate these suppliers, or to effectively communicate their requirements to them, the results were predictable: Ajax received components from its offshore supplier that were not to specification.
Because of the long supply lines for these components, however, Ajax management was reluctant to send back the out-of-spec parts. Instead, as a way to avoid unacceptable delivery times for Ajax finished products, management encouraged employees to find ways to use the out-of-spec parts. Not surprisingly, this practice proved to be the source of the “quality crisis,” and the cause of a major uptick in costly product returns from the field.
“What had started out to be a cost savings initiative turned out to be a disaster for Ajax,” Teegarden observes.
The second company described by Teegarden is a valve manufacturer that he calls “Consolidated.” Several years ago, Consolidated entered into a manufacturing joint venture in China. A few years into the joint venture, Consolidated discovered, much to its dismay, that its joint venture partner had introduced a valve exactly like the Consolidated valve, and was selling it in direct competition to Consolidated.
Consolidated’s solution was to buy out the joint venture, including the production facility. Unfortunately, however, within just a few months, Consolidated discovered that some ex-employees of the joint venture had taken their drawings, process expertise and knowledge, and were back to selling a competitive product again. So in the end, Consolidated lost control of its product expertise and its intellectual property, Teegarden says.
Teegarden calls the third company “Vanguard.” This company set out not to source or manufacture offshore, but to save on labor costs by establishing an offshore technical support function for its products.
Vanguard did just about everything right, says Teegarden. The company was able to find educated, highly qualified individuals to staff the foreign tech support center, and it brought the new hires to the United States to give them a thorough product training indoctrination. Vanguard also sent some of its own U.S. employees to the offshore location to work with the group during initial launch of the tech support function.
The only glitch was that some of Vanguard’s U.S. customers had trouble with the accent of the foreign-based tech support team. And it wasn’t long before Vanguard’s U.S. sales staff started hearing complaints.
Vanguard’s problem wasn’t as serious as those experienced by Ajax and Consolidated, Teegarden observes. But it did turn into a nuisance for the sales team, and was a continuing source of irritation for some customers until Vanguard spent additional training monies on teaching “conversational English” to its new tech support staff.
Come again?
Communication problems can not only be an issue for customers dealing with a foreign-based tech support staff, but also for manufacturers themselves in dealing with their offshore suppliers. In fact, language barriers, cultural differences and time zone disparities are among factors that are sometimes overlooked by U.S. manufacturers when setting up outsourcing arrangements, say industry sources. The resultant miscommunication can lead to delays, extra costs and sometimes even complete breakdowns in outsourcing relationships.
Indeed, when companies first embark on a global sourcing plan, they frequently underestimate the costs they will encounter across a number of fronts, experts agree. “What we’ve found is that in some places, companies think they can cut their labor costs to 10 percent (of their domestic labor costs), but then they discover the additional cost of dealing with the supply chain issues, the language problems, intellectual property protection and other things, and suddenly that cost savings that looked like 90 percent can drop to the 30 percent to 40 percent range,” notes Dan Miklovic, vice president and research director at GartnerG2, the business research arm of Stamford, Conn.-based Gartner Inc. “That’s still significant, but it’s not the huge number that companies thought they were looking at before.”
Supply chain and logistics costs can eat into the anticipated savings from China sourcing strategies. “One thing to remember is that when you start moving your supply chain half way around the world, it starts getting a lot more complex to manage,” says Miklovic. “Unless you’re making some really high value stuff that you can afford to fly on airplanes, then the challenge is that you’re going to be shipping it by sea.”
Ocean transit times from China to U.S. West Coast ports is about 20 days. But due to time required to get goods from China factories onto ships and from the ships to their own facilities, lead times for many U.S. companies is typically 30 to 40 days, say industry sources. And unexpected slowdowns related to security delays and unloading backups in overtaxed ports are becoming more common.
World of hurt
This may mean a need for U.S. companies to develop costly buffer stocks or alternate domestic suppliers. And the long transit times put the pressure on for accurate forecasting of market demand, particularly in high tech and consumer electronics industries in which product life cycles are short. “All it takes is for a new version of a cell phone handset to come out, and you’ve got a whole boat load of the older ones on the way that is 40 days out, and you’re in a world of hurt,” as Miklovic puts it.
Some North American manufacturers are sourcing components and products abroad, but maintain capacity at home to add final variation to a product to meet changing market needs and customer requirements.
One example is Rockwell Automation Inc.’s drives business, which sources high volume circuit boards from Malaysia and mechanical components from China for products sold in the North American market. “If you can shrink the variability of what you’re buying long distance, that helps, because you can drive up the volume of common commodities you’re getting, and you’re lowering your risk from market swings,” says Bob Eisenbrown, vice president for the unit, based in Mequon, Wisc.
It is not uncommon for the Rockwell’s drives business to tailor final product configuration in the U.S. to meet domestic customer requirements. “Even if we need to make a custom version of a product for a specific customer, we can reprogram firmware on a standard product in one of our facilities here, for instance, to make that unique product available very quickly.”
One oft-heard piece of advice provided by various industry sources is that offshore sourcing or production must be a strategic decision that is well thought out, and not just a short-term, cost-saving tactic. The starting point for developing a strategy for global sourcing should always be your customers, Teegarden advises. While customers today are clearly demanding lower prices, they are also demanding greater value from their suppliers, and price is only one part of the value equation, he points out. If offshore sourcing enables a lower price, but also results in lower quality, longer lead times or diminished customer support, for example, that could work against you.
Support for that view comes in a study done last year by Boston-based Aberdeen Group Inc., which surveyed 117 enterprises regarding their trade activities in China. Nearly a third said that supplier product quality and fulfillment reliability was extremely challenging, or was the most challenging issue they faced. These kinds of performance problems at China-based manufacturing partners provide “a clear warning sign that price-based supplier selection is the wrong strategy in China,” says the report, “The China Trade Management Strategies Benchmark Report,” published in September 2004.
“For many Chinese manufacturers, you may be among their first exposure to Western procurement and supply chain techniques,” says the Aberdeen report. “Their ability to meet the initial product quality and availability requirements, communicate effectively (and electronically), ramp up new product designs quickly, and learn to increase cost efficiencies and product reliability over time are vital to your success, and must outweigh cost as a decision factor.”
Rockwell’s Eisenbrown agrees that there is more to successful outsourcing than just finding the lowest price. U.S. manufacturers must be prepared to make significant investments in finding and working with the right suppliers, he says. “You’ve got to have the right technical people, either traveling, or preferably, indigenous, close to your sources to make sure that you can manage the communication with suppliers, ensure the design to specification and also the quality,” Eisenbrown advises. “And if you’re really going to get the benefit out of strategic sourcing, it has to be almost a simultaneous engineering mentality, not just a shopping trip to look for different sources.”
Chris Jones, Aberdeen Group senior vice president, notes that one way to optimize outsourced manufacturing performance is to involve contract manufacturers in product enhancement and new product development. But on the other hand, he concedes, providing too much information to an offshore contractor can sometimes put intellectual property (IP) at risk. “There’s an old adage that says, ‘How do you create a competitor overnight? Outsource your manufacturing,’ ” Jones relates.
Jones and others recommend vigilance by U.S. manufacturers regarding IP issues, and that IP safeguards be built into outsourcing contracts and practices. One approach is to outsource only subassemblies to multiple contractors, and then do the final goods assembly in your own facility, says GartnerG2’s Miklovic. “That way, you parcel out the IP, so that nobody can completely replicate your product on their own.”
Tough contracts
Contracts should also contain strong IP protection provisions, he says. “If you’re outsourcing in China, and you’re sharing IP, make sure that you have good representation from people who are familiar with both Western and Chinese law, and write contracts that are truly enforceable in China,” Miklovic advises.
Rockwell’s Eisenbrown adds that careful selection of offshore contractors and partners plays a role in IP protection. “You’re always at risk of losing your IP,” says he. But that risk can be minimized by “understanding the kind of company you’re dealing with.” Eisenbrown recommends selection of sourcing partners that have more to lose than they have to gain from the theft of intellectual property. “If they want to be suppliers to other companies besides yours, and the word gets out that they can’t be trusted, then that could be the death to some of these suppliers,” he explains.
Others advise that the selection of which products or processes to outsource must play a key upfront role in global strategy formulation, and can be key to IP protection as well. “By all means, never outsource your core competencies, the things that make you successful,” says Valpers’ Teegarden.
And neither should companies view offshore outsourcing as way to get rid of manufacturing problems. “One of the first things you have to do is fix your processes and streamline them before you offshore them, because the last thing you want to do is send your processes that are broken 10,000 miles away and expect that somehow they’re going to fix themselves when they get there,” says Dan Quinn, president and chief executive officer at Aon/Rath & Strong, a Lexington, Mass., consulting firm.
Quinn, whose firm specializes in process optimization techniques such as Lean Manufacturing and Six Sigma, says he’s seen an increase in business lately from North American companies that are preparing to move more production offshore. And in some cases, U.S. firms are using process optimization to try to keep manufacturing at home. “There are organizations that feel they can still compete with foreign entities by really optimizing their processes, by keeping them really lean and fully automated, and by using the latest and best technology,” Quinn relates.
See sidebar to this article: Keeping Shoe Production at Home
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