The True Costs of Offshore Assembly
Today, offshore assembly is a fact of life. By shifting production to China, India, Mexico, Eastern Europe and other locations, manufacturers can reduce operating costs, improve return on invested capital, appease shareholders, and quickly enter and exit growing or mature markets.
For many manufacturers, assembling products in Asia, in particular, appears to be the most direct path to dramatic cost cutting. But, while countries such as China offer an abundant supply of cheap labor, a pro-business environment, a productive workforce, and strong government support for manufacturing, that does not mean doing business there will automatically improve your bottom line.
"While labor rates and material costs are easy to quantify, many other costs are not," warns Kevin Keegan, lead director of the Atlantic region communications and electronics practice at Pittiglio Rabin Todd & McGrath (PRTM, Waltham, MA). "These include the somewhat intangible-but very real-costs associated with managing cultural and language barriers, overcoming limited supply chain expertise, and coping with a supply chain rendered far less flexible because of the physical distance between the company and its manufacturing partner. In fact, the savings associated with lower labor and materials costs in China may be offset by these incremental costs."
"One needs to look at the total cost of producing, shipping and distributing," agrees Don Penkala, president of Granite Bay Consulting Inc. (Granite Bay, CA). "In my estimation, using an offshore manufacturing strategy is cheaper maybe 75 percent of the time, but certainly not 100 percent.....For high-volume, labor-intensive, commodity products, it is likely that offshore manufacturing will yield lower overall costs. But, this is often not the case for other types of products."
When looking at lead-time costs, manufacturers need to ask themselves a number of questions. For example, will they need to substantially increase inventories to keep from running out of stock? How will longer lead times impact warehousing and expediting costs, including air transportation? What is the potential for lost sales due to excessively long lead times or increased quality defects?
Companies also need to factor in costs like severance pay for displaced workers; shipping costs to and from Asia, which can add 15 percent or more to the cost of a product; travel costs to establish and maintain relationships with suppliers and customers; currency fluctuations; and various administrative costs.
"All of these must be well understood before the decision is made to go offshore," Penkala says. "Then, estimates must be made for the total system costs for offshore scenarios. The results are often surprising. Sometimes, the analysis confirms the efficiency of producing offshore. But, this analysis has resulted in some companies bringing operations back to the United States once the true costs are recognized."
For instance, in 2001, Epson Portland Inc. laid off 75 percent of the workforce at its printer cartridge plant in Hillsboro, OR, and shifted production to China. But, after looking at total delivered cost, Epson determined that tariffs, currency fluctuation, freight charges and other costs often negated offshore labor savings. The company has since ramped up production at its U.S. plant again. In fact, the facility is now producing five times as many cartridges per worker as its sister plant in China.
According to Penkala, the labor cost differential between a product made in China and one produced in the United States can be a factor of 10. However, the overall true costs can be much closer. In a study of 29 companies, Granite Bay Consulting found that the true cost savings with moving production to China was between -3.7 percent-meaning that there was a 4 percent cost disadvantage-and 20.6 percent, with an average savings of 11.4 percent.
"On the surface, this looks like good news for those contemplating offshore manufacturing," says Penkala. "But, for companies that embrace lean principles, 11 percent improvements are conservative. When a company successfully adopts lean principles, annualized gains of 10 percent to 25 percent are common. So the question that must be asked is ‘What is the benefit of offshore manufacturing vs. lean manufacturing here in the United States?'"
In addition, many companies fail to anticipate initial costs accurately, says Dave Young, senior vice president of Boston Consulting Group Inc. (Boston). "But, the paradox is that if companies don't face up to these initial costs and risks, their long-term costs will devour the companies' competitive standings."
According to Young, one-time expenses to identify low-cost suppliers, establish a logistics chain and train workers typically add 10 percent to 40 percent to the cost of goods sold in the first year. "Offshore production can be fraught with risk and potential missteps," he warns. "Seeking new markets and increased capabilities via globalization can be a difficult, complex process."