Why Offshoring Manufacturing “To Save Cost” Won’t, but Trying May Compromise Product Development, Delivery and Quality

Many companies are offshoring – designing products here for sale here, but manufacturing them overseas – because they think it will save cost. Their primitive cost systems make such a moveappear to be justified. However, if all that is quantified is parts and labor, then moving to a “low labor rate” country will appear to lower labor cost. If no other costs are quantified, it is a “case closed” decision based on a back-of-the-envelope calculation.

However, when measured on a total cost basis, manufacturing offshore for sale in the U.S. rarely results in a net cost savings,1 considering differences in labor efficiency and all the costs of shipping, quality, inventory, communications, travel, training, transferring products, support and complete sets of equipment needed for any manufacturer. Further, offshore manufacturing compromises six out of eight cost reduction strategies. They are:

1. Cost Reduction by Design
2. Lean Production Cost Reduction
3. Overhead Cost Reduction
4. Standardization Cost Reduction
5. Product Line Rationalization Cost Reduction
6. Supply Chain Management Cost Reduction
7. Quality Cost Reduction
8. Total Cost Measurement to Support All Cost Reduction Activities

For the sake of brevity in this article, you may find more detail on these eight strategies at www.halfcostproducts.com.

Missing the Biggest Opportunity

Eighty percent of a product’s lifetime cumulative cost is determined by product design.2 Unfortunately, offshoring production compromises all future design opportunities because it prevents Concurrent Engineering teamwork, which is the most promising opportunity for achieving truly low-cost products.

Naturally, offshoring prevents this teamwork because design engineers and manufacturing people are not in the same country and not even working at the same time. Without manufacturing involvement, engineers will design products alone, throw them over the ocean and get back parts that will only be as manufacturable as the individual engineer’s Design for Manufacturability (DFM) expertise. Further, dealing with the problems of offshoring (discussed below) will be a resource drain that in some companies consumes two-thirds of product development resources!

No Lean; Slow Responsiveness

Offshore plants, especially contract manufacturers, amortize their setup charges by building in batches (mass production) and shipping across the ocean in batches. It is hard to respond to volatile market conditions when so much forecasted inventory is at the plant and in the long “pipeline” across the ocean. The enormous potential cost savings from Lean Production will not be realized, because products can not be pulled 3 by customer demand across oceans, nor could they be builtto-order. Distance and remoteness will prevent the setting up of flexible plants that could mass customize orthopaedic devices for individual patients4 and, will cause device companies to thus miss out on those paradigm-shifting opportunities.

Quality Takes a Hit, Too

Without lean production and the design-for-quality contribution of good Concurrent Engineering teamwork,5 quality and reliability will not be designed in or built in, so the home office will have to rely on strict and expensive testing of all products, followed by repair costs or scrap costs, followed by extra setup cost to build replacement products and expedited shipping costs. Worse, if contract manufacturers are selected by low-bidding, quality may suffer even more for reasons such as a lack of long-term relationships in which manufacturers work together with suppliers, the unintended effect of driving up other costs many times the assumed savings, and others cited at www.halfcostproducts.com/low-bidding.htm.


Total Cost Considerations for Offshoring Decisions

Labor cost is a small percentage of the selling price, and yet offshoring decisions are usually based entirely on labor cost because it is the only processing cost that is quantified. However, any perceived “savings” for labor are usually exceeded by the following hidden costs. These costs would not be “hidden,” and decisions would be more relevant, if all overhead costs were quantified withtotal cost accounting.9

Labor efficiency alone might cancel out labor rate savings, for instance ,if labor cost is one-third, but labor productivity is also one-third.

Control. It may be harder to exercise effective control and management of overseas operations because of time zone separations, languages, cultural differences, lack of face-to-face communications and the “out of sight, out of mind” syndrome.

Offshore “savings” don’t last. One of the ironies of offshoring is that the savings don’t last long due to rising labor costs, taxes, local currency valuations and other factors like changing trade agreements and local government pressures to force outsourcing companies to move and keep increasing their activities there.

Tax breaks are often cited as an enticing incentive to move manufacturing overseas. These tax breaks can be so intoxicating that they override appropriate cautions, as exemplified by the following true story. One Fortune 500 company was going through the decisionmaking process to select a location for a new offshore plant. One slide listed candidate countries; someone noted that there was one country being considered that he had never heard of. The response was,“For those tax breaks, we will find it!” However, tax breaks will probably not make up for the increase in total cost mentioned herein, and furthermore, they usually expire after so many years unless the company “ups the ante” and increases the commitment – for instance, by moving engineering there, too.

Labor-intensive designs. Many decisions to move production to low-labor-rate countries are based on labor-intensive designs. However, DFM2 can reduce labor content to the point where moving to low-labor-rate areas is no longer needed and can no longer be justified.

Technology introduction delays. New product or processing technologies are usually introduced in the home plant first and overseas plants later. While working at Intel’s Systems Group, I estimated that such technology transfers delayed the volume ramp by a year. The alternative, trying to launch new-technology products or new processing directly into an offshore plant, is extremely risky and the projected “savings” could be eaten up by extra travel costs alone. In addition, transferring new technology offshore can have significant intellectual property risks, including teaching partners, suppliers and possibly even employees how to become your future competitor.

Supply vulnerabilities. Jeffrey E. Garten, Dean of the Yale School of Management, raised the issue of the vulnerabilities of moving too much production to one country. His concern was that the world economy is becoming “dangerously vulnerable to a major supply disruption caused by war, terrorism, social unrest, or a natural disaster.”6


Hidden (Unquantified) Costs         

Quality costs will likely also rise, sometimes catastrophically, because of new learning curves, local quality culture shortcomings, required high levels of skills and judgment, difficulties in remotely implementing quality improvements and batch production combined with long shipping pipelines that can produce “defects by the batch.” (For more information, please refer to the Mass Production article at www.halfcostproducts/articles.htm.)

Shipping and expediting costs. Remote manufacturing will incur more shipping cost than will manufacturing closer to customers and suppliers. In addition to the cost paid to the shipper itself, there are costs of shipping insurance and for fees, permits, duties, tariffs, compliance with import/export restrictions and so forth. Longer shipping “pipelines” increase carrying costs for inventory in the pipeline and queuing at both ends. The viability of a business case based on surface freight may not survive with significant expediting or a need to shift to air freight. It is hard to go back to surface freight after shifting to air freight.

Training costs may exceed projections, as it is usually hard to attract, train and retain workers with adequate skills. Further, lack of loyalty results in higher retraining costs in addition to the wage escalation necessary to retain valuable employees in such an environment. This has been noted to occur in Singaporre. High turnover can also cause quality problems and limit effects of training efforts.

Offshore setup costs add overhead cost to find and qualify contract manufacturers or arrange the startup of new manufacturing plants. Support costs continue for the ongoing administration of offshore arrangements. These headquarters’ expenses are rarely subtracted from the computed savings of offshore manufacture.

Indirect labor support costs alone could exceed the labor rate “savings” if high-cost engineers have to solve problems arising from an unskilled workforce or even higher-cost headquarters engineers who may have to deal with remote production or transfer issues.

Transfer costs are incurred by every product transferred, including tooling tear-down, packaging, shipping, tooling reinstallation, documentation translation and travel for people who may have to personally supervise the transfer at both ends. These headquarter engineers could save the company a lot more money by designing low-cost products, making operations more efficient or lowering the cost of quality. Trying to transfer all products presents several dilemmas for the lowest-volume products. Instead of building low-volume products on-demand in a headquarter plant, using Build-to-Order techniques,7 batch-oriented offshore plants will either charge large setup charges per product or incur large inventory carrying costs and obsolescence risk by building large batches. Further, many products will cost more to transfer than they will ever make in profit, so they should be rationalized away.8 If these must be retained, continuing to building them at a local headquarter plant would be more cost effective and less draining on resources.

Travel costs to solve problems related to the above issues usually end up being higher than anticipated. After one aerospace company moved all of its CNC machine tools to the Philippines, a manufacturing engineering manager noted that one extra problem-solving trip would “blow the case for the offshoring decision.” Travel to plants greater than nine time zones away may need to be increased to compensate for product development teamwork or for other communication difficulties cause by out-of-phase work schedules.

Unanticipated local costs may offset much of the expected cost savings of offshoring. In addition to anticipated local fees, licenses and permits, there may be “other” local costs that pose ethical and legal dilemmas and cause resistance to total cost measurement, which seeks to quantify and categorize all expenses for better decision making, like offshoring decisions.

Subsidizing offshore costs. The cost of setting up offshore manufacturing and dealing with these hidden costs is usually paid for by support people at the company headquarters – otherwise. the business case for offshoring would collapse. Ironically, these support costs make headquarters look even less efficient which, perversely, encourages yet more offshoring, thus resulting in a downward spiral.

The final hidden cost. Sadly, the final hidden cost of offshoring is the cost that of moving operations back to the where the products are designed after realizing all these costs or realizing how offshoring distracts from real cost opportunities in product development, operations and quality programs.

Conclusions

Setting up and operating offshore manufacturing doesn’t save money on a total cost basis, but trying to do so may compromise quality, delivery and product development, which could otherwise provide real cost reduction and the pursuit of new high-profit opportunities, like mass customizing of products.4 Rather than weakening operations with the burdens of offshoring, local operations could pursue more effective cost reduction by designing low-cost products, eliminating waste through Lean Production, lowering the cost of quality and setting up flexible factories that could build standard products and mass-custom versions on-demand without the costs and risks of inventory.

If all of this does not make good financial sense, you may need a better cost system.9

Portions excerpted from Build-to-Order & Mass Customization, Copyright © 2008, Dr. David M. Anderson, P.E., FASME, CMC


REFERENCES

1. David M. Anderson. Build-to-Order & Mass Customization; The Ultimate Supply Chain and Lean Manufacturing Strategy for Low-Cost On-Demand Production without Forecasts or Inventory. CIM Press, 2008. Chapter 6, “Outsourcing vs. Integration.”

2. DM Anderson. Design for Manufacturability & Concurrent Engineering. CIM Press, 2008. Chapter 1, Figure 1-1.

3. James P. Womack and Daniel T. Jones. Lean Thinking. Simon & Schuster, 1996. Chapter 3: “Pull.”

4. DM Anderson, Build-to-Order & Mass Customization. Chapter 9, “Mass Customization.”

5. DM Anderson, Design for Manufacturability & Concurrent Engineering. Chapter 10: “Design for Quality.”

6. Jeffery E. Garten, “When Everything is Made in China,” Business Week, June 17, 2002.

7. DM Anderson, Build-to-Order & Mass Customization; Chapter 8, “On-Demand Lean Production.”

8. DM Anderson, Build-to-Order & Mass Customization. Chapter 3:“Product Line Rationalization” or Design for Manufacturability & Concurrent Engineering. Appendix A.

9. There are quick and easy ways to quantify all these hidden costs, which are present in Activity-Based Costing: Making It Work for Small and Mid-Sized Companies, Doug T. Hicks. Wiley, 2002. Also see “What is the ‘abc solution’™” at Doug Hicks’ website, www.dthicksco.com.

Dr. David M. Anderson, P.E., CMC, has been presenting customized in-house seminars for the last 25 years on Design for Manufacturability & Concurrent Engineering and on Build-to-Order & Mass Customization, the subject of four books. (See References.) His vast training and consulting experience includes multiple engagements at Hewlett-Packard, Boeing, Smiths Aerospace, LG Electronics, NCR, L-3 Communications, Freightliner, etc., plus seminars at United Technologies, John Deere, Crane and PRI Automation. Medical product clients include Beckman-Coulter; Invivo, which has been acquired by Philips; Becton-Dickinson; Medrad; Guidant; Origin Medsystems; Salient Surgery Technologies; Biolase; Baxter Healthcare; Bausch & Lomb; Hollister and divisions of HP’s Medical Products Group, which have been acquired by Philips.

Dr. Anderson has more than 35 years of industrial experience in design and manufacturing. As the ultimate concurrent engineering experience, he personally built the equipment he designed in his own machine shop. He is a Fellow of the American Society of Mechanical Engineers and has been certified for 13 years as a Certified Management Consultant by the Institute of Management Consultants. His credentials include professional registrations in Mechanical, Industrial and Manufacturing Engineering and a Doctorate in Mechanical Engineering from the University of California, Berkeley.

Dr. Anderson’s web-sites include www.design4manufacturability.com, www.build-to-order-consulting.com and his book-length website on cost reduction, www.halfcostproducts.com, which presents eight cost reduction strategies for achieving half the total cost. Dr. Anderson can be reached at 805-924-0100 and This email address is being protected from spambots. You need JavaScript enabled to view it..

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