| In the increasingly competitive global marketplace, | | | | legal recourse for American companies |
| manufacturers need to continually strive to reduce | | | | In the past, my experience was that once |
| costs to keep or increase market share. This is one of | | | | manufacturing moved out of the United States, it rarely |
| the key factors in making the decision of whether to | | | | came back. However, in the past two years, we have |
| make parts in-house, outsource to domestic suppliers, | | | | seeing more companies coming back from doing |
| or outsource offshore. | | | | business in China. The main problems these companies |
| Even after a company makes the decision to | | | | encountered were: |
| outsource to a supplier, most don't look beyond the | | | | · Substitution of materials |
| quoted unit price in making the decision about which | | | | · Inconsistent quality |
| supplier to select. This is especially true when | | | | · Stretched out deliveries |
| comparing the quotes for domestic vs. offshore | | | | · Communication problems |
| suppliers. Some companies choose to outsource | | | | · Inability to modify designs easily and rapidly |
| offshore because the price is cheaper than a | | | | · Unfavorable purchase order and credit terms |
| domestic supplier. They don't add in the costs for | | | | Quality/Substitution of Materials: |
| transportation, much less all of the other "hidden costs" | | | | In late 2007, SeaBotix Inc., a San Diego-based |
| of dealing with an offshore supplier. | | | | manufacturer of miniature underwater vehicles, told me |
| In order to make the correct decision for outsourcing, a | | | | that their Chinese molder was substituting 10 percent |
| company needs to understand the concept of "total | | | | glass-filled ABS (a plastic material used in injection |
| cost of ownership" for outsourcing manufacturing. | | | | molding) for the specified 30 percent glass-filled ABS. |
| What is "Total Cost of Ownership?" It is an estimate | | | | The vendor claimed that the parts were made in the |
| of the direct and indirect costs and benefits related to | | | | specified material, but an independent lab test |
| the purchase of any part, subassembly, assembly, or | | | | confirmed that they weren't. The 10 percent glass-filled |
| product. The Gartner Group originated the concept of | | | | material caused the parts to shrink more in molding so |
| (TCO) analysis several years ago, and there are a | | | | that the parts were smaller, didn't fit mating parts |
| number of different methodologies and software tools | | | | properly, and were not as strong. After their Chinese |
| for calculating the TCO for various industries, products, | | | | vendor refused to take the parts back or give credit |
| and services. | | | | for the defective parts, SeaBotix decided to bring their |
| Total Cost of Ownership includes much more than the | | | | tools back to the United States and sourced them at a |
| purchase price of the goods paid to the supplier. For | | | | molder in southern California. |
| the purchase the types of manufactured products we | | | | Don Rodocker, president, SeaBotix, said, "The Chinese |
| are considering, it should include all of the other costs | | | | tooling was one-third the cost of tooling in the U. S., the |
| associated with the purchase of the goods, such as: | | | | delivery was one-third the time quoted by U. S. |
| · Geographical location | | | | companies, and the piece part price was one-third the |
| · Transportation alternatives | | | | quoted U. S. price, but each time we reordered the |
| · Inventory costs and control | | | | parts, the Chinese molder increased the price until they |
| · Quality controls | | | | were three times the price we could get the parts |
| · Reserve capacity | | | | molded for in San Diego. We would probably go to a |
| · Responsiveness | | | | Chinese toolmaker in the future for the molds, but |
| · Technological depth | | | | would bring the molds back to the States to be run." |
| The search for low cost areas for manufacturing isn't | | | | Cost of Inventory |
| something new. Fifty years ago, northern and New | | | | In 2002, Vaniman Manufacturing, which makes dental |
| England companies started moving manufacturing to | | | | equipment in Fallbrook, California, shifted most of their |
| the southern states. Twenty-five years ago, many | | | | sheet metal fabrication offshore to China to save |
| West Coast manufacturers started moving | | | | money (a 50 percent cost reduction in piece price). |
| high-volume production to Hong Kong, Singapore, and | | | | However, they were required to purchase significantly |
| the Philippines. The next lower cost area was Mexico | | | | larger lots of parts resulting in a higher cost for the |
| with the advent of the maquiladoras in Mexico. | | | | larger inventory. In turn, the larger inventory required |
| "Offshoring" refers to relocating one or more | | | | more storage space. In addition, transportation costs |
| processes or functions to a foreign location. For the | | | | for shipping from overseas were higher. These |
| past 15 years, many manufacturers have sought to | | | | additional costs and other "soft" costs, such as travel |
| reduce costs by offshoring all or part of their | | | | expenses to visit vendors and communication costs, |
| manufacturing processes in China. In the last decade, | | | | make up what are referred to as the Total Cost of |
| outsourcing offshore has evolved from a little-used | | | | Ownership. |
| practice to a mature industry. Even conservative | | | | After realizing that these additional costs were eating |
| companies are now willing to experiment with going | | | | up the cost savings in the piece pricing, this company |
| offshore to gain a competitive edge. The concept of | | | | brought their sheet metal back to a local supplier in the |
| globalization has become part of the fabric of today's | | | | fourth quarter of 2007. Don Vaniman, who heads the |
| business. | | | | company, cited several reasons for his move: shipping |
| Many times, the decision to outsource offshore is | | | | delays, security hassles, and poor quality control. "If you |
| based on faulty assumptions that can have unpleasant | | | | order a thousand widgets in four shipments, three |
| consequences. In some cases, the basis for the | | | | shipments might be all right, but the fourth might be |
| decision is well intentioned, such as to win new | | | | totally wrong." Vaniman said, "In the U.S., a supplier |
| business by being close to a customer. | | | | would jump through hoops to fix that kind of problem, |
| But, with every business decision comes an | | | | but in China, it could take six months to work out the |
| assumption, and more often than not, the related | | | | details." |
| assumptions are erroneous. Here's a list of well | | | | Vaniman said that the local supplier was able to nearly |
| intentioned but often-faulty assumptions: | | | | match the Chinese costs by developing more efficient |
| · Longer lead times won't affect our cost calculations | | | | and creative production techniques, using recyclable |
| very much. | | | | packaging for parts delivery, and utilizing larger lot sizes, |
| · Overseas suppliers have the same morals and | | | | delivered on a just-in-time schedule. Vaniman was able |
| work ethics as we do. | | | | to significantly reduce their inventory and the space |
| · Overseas laws will protect our proprietary | | | | required for inventory, due to smaller lot sizes being |
| information. | | | | delivered just in time. |
| · We can teach our suppliers to reach our quality | | | | In addition, rising costs in China erased much of the |
| needs and to build our product reliably and efficiently. | | | | price gap. Vaniman said that six years ago, the cost of |
| · Communication will not be an issue given daily | | | | producing its parts in the U.S. was as much as 50 |
| conference calls, the Internet, and the fact that the | | | | percent higher than in China. Now it's only five percent |
| supplier speaks English. | | | | higher - a premium that he's happy to pay. |
| · Assessment and travel costs won't change our | | | | These stories from San Diego County are just a |
| cost calculations very much. | | | | microcosm of what's happening nationwide. |
| · The increase in delivery and quality costs won't be | | | | Intellectual Property Theft |
| significantly different than our cost calculations. | | | | There is increasing wariness by upper management of |
| · Lean manufacturing and Six Sigma methodologies | | | | companies regarding sourcing in China, especially with |
| can be taught to suppliers before our company's | | | | regard to sourcing all the component parts and/or |
| bottom line is affected. | | | | subassemblies for a product because China doesn't |
| In actuality, many case studies have shown that these | | | | honor U.S. patents. They have heard about companies |
| assumptions were orders of magnitude off from | | | | that have sourced a product in China only to have a |
| reality. The problems with making these assumptions | | | | product identical to theirs appear on the market, made |
| are: | | | | by a Chinese company at a much lower price. |
| · It doesn't capture a reasonable amount of variation. | | | | Companies that haven't paid attention to this danger |
| Each lot takes weeks more time than anticipated to | | | | and sourced their whole product in China have |
| get to the U.S. or customer site for evaluation. | | | | suffered the consequences. |
| · The overlying methods for producing product or | | | | There's also a growing realization that when it comes |
| service have gotten more complex, not less. In general, | | | | to quality and location, location may be the best |
| costs rise with complexity. | | | | guarantee of all. It's hard, very hard, to outsource |
| · The company doesn't know how many or even | | | | quality, particularly to a distant land many miles and |
| most of the hidden costs that exist (i.e., process | | | | time zones away. Many companies are returning their |
| stability, process capability over time, potential for | | | | call centers to the U.S. because of customer |
| future deviations from the current process). | | | | complaints, and I believe that a growing number of |
| · The company loses complete control of quick | | | | manufacturers will realize that "you get what you pay |
| changes to react to hidden costs. It's like trying to | | | | for" from their offshore suppliers. Applying good quality |
| control production via remote control. | | | | principles takes money, education, and experience, |
| · The company is making wrong assumptions. | | | | many of which are in short supply in the low-wage |
| Hidden Costs Grow Geometrically | | | | countries capturing the majority of offshoring dollars |
| Accountants deal with hard costs such as material | | | | these days. |
| costs, material overhead costs, labor costs, labor | | | | "Made-in-China" Becoming Undesirable: |
| overhead costs, quality costs, outside services, sales, | | | | As toys, electronics, pharmaceuticals, and other goods |
| general and accounting costs, profits, etc. What they | | | | manufactured in China have been and are being |
| don't measure are the intangible costs associated with | | | | recalled month after month due to contamination, |
| business such as the true costs of delay, defects, and | | | | inferior and/or poisonous materials, the loss of |
| deviations from standard or expected processes (the | | | | consumer confidence in all China-made products is |
| three D's). | | | | serving as a wake-up call to every company sourcing |
| These costs are often called hidden factories because | | | | in China. Tainted, defective, and poor-quality products |
| they keep everyone busy generating absolutely | | | | have made many consumers leery of buying goods |
| nothing of any tangible or openly measured value. | | | | produced in China and have awakened people to the |
| Another way to understand these costs is that they | | | | seriousness of the offshore manufacturing issue. |
| produce results that no one, especially the customer | | | | Advantages of Sourcing Domestically |
| would want to pay for. In addition to obvious direct | | | | More and more companies are realizing that there are |
| costs - such as additional meetings, travel, and | | | | worthwhile advantages to sourcing in the United |
| engineering time - hidden factories also indirectly | | | | States. The main ones are: |
| produce many forms of "soft" costs, such as loss of | | | | · Ease of communication - same language |
| good will, loss of competitiveness, extended warranty | | | | · Same or close time zone |
| costs, and legal costs. | | | | · Flexible delivery - Just-in-time or Kan Ban |
| When it comes to outsourcing, there's more to | | | | · Rapid turnaround for tooling or prototypes |
| consider than the quoted price. Some outsourcing | | | | · Many reliable choices for transportation |
| costs are less visible - or downright hidden. Here are | | | | · Smoother design changes - easier to make |
| the top hidden costs of outsourcing offshore: | | | | changes understood and more willingness to make |
| · Currency Fluctuations - last year's invoice of | | | | changes |
| $100,000 could be $140,000 today. | | | | · Lower cost of inventory from lower minimum buys |
| · Lack of Managing an Offshore Contract - | | | | · Consistent higher quality - materials and dimensions |
| underestimating the people, process, and technology | | | | match specifications |
| required to manage an outsourcing contract. | | | | · Lower Travel Expenses |
| · Design changes - language barriers make it difficult | | | | · No Intellectual Property Infringement |
| to get design changes understood and implemented | | | | · More favorable Purchase Order and Credit Terms |
| · Quality problems - substitution of lower grade or | | | | "Outsourcing Offshore" will Continue |
| different materials than specified is a common problem | | | | There is no question that "outsourcing offshore" will |
| · Legal liabilities - offshore vendors refuse to | | | | continue for the next ten to twenty years, especially |
| participate in product warranties or guarantees | | | | for the multinational countries that have products to sell |
| · Travel Expenses - one or more visits to an | | | | within the countries in which they set up manufacturing |
| offshore vendor can dissipate cost savings | | | | operations. In fact, manufacturing products locally for |
| · Cost of Transition - overlooking the time and effort | | | | consumption within a foreign country will be crucial to |
| required to do things in a new way. It takes from three | | | | profitability as transportation costs continue to increase. |
| months to a year to complete the transition to an | | | | The "desirable" locations for cheaper outsourcing will |
| offshore vendor. | | | | change over time just as they have in the past fifty |
| · Poor Communication - communication is extremely | | | | years. The purely financial benefits of lower pricing will |
| complex and burdensome. | | | | erode over time. The challenge for America is to keep |
| · Intellectual Property - foreign companies, particularly | | | | as many companies as possible growing and |
| Chinese, are notorious for infringing on IP rights without | | | | prospering within the United States. |