Manufacturing Outsourcing - Managing the Trade-offs of Low Cost and High Risk

The rate of manufacturing outsourcing to contract manufacturers worldwide is showing no signs of slowing. By most estimates the level of outsourcing will increase 15% year on year for next five (5) years thru 2010. Asia continues to lead in contract manufacturing production followed by the Americas and Europe. However most analysts expect Asia to grow at an increasing speed over the next five (5) years while the proportions in the Americas and Europe to shrink.

Many of the world’s leading electronics Original Equipment Manufacturers (OEMs) are continuing to outsource and are now developing an increasingly more complex network of Electronics Manufacturing Services (EMS) companies as suppliers who are manufacturing in a growing number of regions/countries.

As reported by Lehman Brothers Global Equity Research, companies such as 3COM, Alcatel, Apple, Cisco, Dell, Ericsson, HP, NCR, and Philips are all still outsourcing a high level of Printed Circuit Board Assembly (PCBA) production. The penetration rates for outsourced manufacturing are highest for industries such as Computer Systems, Communications, and Medical Instrumentation.

Market analysts who have accepted the arduous task of trying to predict the future are forced to consider the potential factors that might "change the tide" of outsourcing with respect to volumes, geographies, industries, or even which production processes are outsourced.

The typical list of factors being watched, scrutinized and analyzed includes: Labor rates, political and economic climates, monetary currency exchange, or even the likelihood of a natural disaster.

One factor that is not often under the watchful eye of the analyst but is likely to yield a strong impact is simply the ability for company decision makers to make an informed decision on the potential impact of an outsourcing decision - the level of adequate and accurate "due diligence" which can now be done even before an outsourcing decision is ever made.

Companies investigating outsourcing all or a portion of their manufacturing must take more than a casual look at the impact factors associated with their decision.

Why is the level of due diligence now being demanded increasing in both breadth and depth- "lessons learned from being burned!" Many of those leading companies doing the majority of the outsourcing today can easily state that the decision making done previously to determine the design of a supply chain that included manufacturing outsourcing was not considered fully before implementation and in some cases the results have been disastrous.

How do we know? Simply talk to those customers who experienced the low levels of resulting On-time delivery (OTD) or examine the financial results where the inventory write-offs have been buried – its not hard to find clear evidence of the situation where outsourcing went awry!

Simply talk to those customers who experienced the low levels of resulting On-time delivery (OTD) or examine the financial results where the inventory write-offs have been buried – its not hard to find clear evidence of the situation where outsourcing went awry! But now enabling tools exist to make running scenarios a less laborious process and provides the outsourcing decision makers with a fact-based analysis on the impact to critical areas impacted by outsourcing such as Inventory and Customer Satisfaction and the "trade-offs" between these two.

The conventional wisdom used for making outsourcing decisions in the past has primarily centered on the desire to reduce the overall Cost of Goods Sold (COGS) in order to increase the product and/or company’s profitability. Of course, COGS is important aspect for consideration – however a focus on the Total Supply Chain Cost is likely to yield a much better input for decision making. According to the Supply Chain Council the definition of the Total Supply Chain Cost includes "costs associated with the supply including execution, administration and planning" as opposed to COGS which focuses solely on the costs associate with buying raw materials and producing finished goods.

In recent months, the attraction of lower COGS has been illustrated by many companies who made a quick shift of manufacturing to China because they were tempted and teased but what came to be known as "The China Price".

As Peter Engardio and Dexter Roberts, stated recently in their article in Business Week (6 December 2004, p. 102) – "The China Price" are the three scariest words in U.S. industry! Although the authors speak more to the potential trade deficit and political issues facing such a shift of the manufacturing epicenter to China – it is also "scary" because so many companies can be tempted by the hype of lower costs (COGS) without fully considering the total supply chain cost impacts that can result – not to mention the customer service impacts

It is indeed interesting for some companies (especially for those with products which have a high labor cost component) to realize a COGS which can be 30-50% lower than what is possible in the US or in Western Europe.

However, such a shift may result in lead times which are 3-4 times longer in order to manage the demand and supply uncertainties and the transportation issues. The end result may be lower COGS, but a higher inventory level and lower levels of customer satisfaction as for many who have made such a shift – On-time Delivery (OTD) to the customer has been negatively affected.

A study by the Economist Intelligence Unit (EUI) reveals that China and India are topping the list for offshoring destinations. However the Czech Republic was not far behind in third place. Factors taken into consideration were labor costs and skills, regulation and political and economic security. India and china will likely continue to reign as choice destinations due to their low labor costs, developed legal system and ready supply of English-speaking graduates (higher for India than China). Eastern European and Latin American countries have on the other hand – attractive regulatory environments and close proximity and cultural ties to those companies considering outsourcing, working in their favor.

At eKNOWtion, we use a simple methodology that leads to an informed decision for outsourcing considerations. With eKNOWtion partner, Optiant we have developed a Strategic Outsourcing Solution (S.O.S) methodology which includes 4 major steps:

1. Create a geographical map of the supply chain(s)
2. Gather/validate/input the data required (e.g. production/procurement lead-times, direct labor and material costs, demand characterization, desired service levels)
3. Optimize and analyze by building several scenarios and various sensitivity analyses to determine the optimal result
4. Implement the chosen solution

Our eKNOWtion engineering expert team does not perform this task without the much needed enabling tools to allow this analysis to be performed quickly and accurately. We use the award-winning and customer-proven Optiant tool – PowerChain Inventory (PCI).

With PCI, eKNOWtion can typically run a fact-based analysis of your outsourcing options within an 8 week period delivering back to you:

• Inventory position model within various supply chain structures for selected products
• Optimized inventory levels and locations
• Impact overview (through various scenario analyses) of the structural changes to the supply chain for the outsourcing options
• Alternate supply chain operating scenarios which quantify the supply chain cost and service tradeoffs such as:
• Lead-time versus inventory
• Service performance versus inventory
• Production versus freight cost

Conclusion

With the advanced enabling tools such as PCI and a simple but comprehensive methodology employed, a fact-based due diligence can be easily accomplished within a short period of time – successfully managing the trade-off considerations of low cost and high risk.

By running various supply chain scenarios of different outsourcing options and a series of sensitivity analyses on these options, a company can make an informed decision on outsourcing without the risks of making a bad decision which results in either lost profits or lost business due to an unhappy customer.

Take the time to do the analysis today. eKNOWtion remains eager and able to assist you on your journey.