The True Cost of Offshore Assembly
Shifting production to China or Mexico can be more expensive in the long run
The action could start in Hong Kong or Taiwan, then shift back and forth to Mexico, China, Brazil and India, with a few other spots in between. All the time, the CFO would be cavorting with local politicians and basking in the praise of shareholders back home.
Like it or not, offshore manufacturing has become a fact of life. Global access to efficient distribution systems and seamless telecommunication links make offshore manufacturing more appealing than ever.
More and more companies are shifting production to exotic locales. Ten years ago, Mexico was the hot spot. Today, it’s China. In 10 years, it could be some nation in central Africa.
And, contrary to popular belief, it’s not just toys, clothing and shoes that are being assembled overseas. Indeed, many high tech devices, such as printed circuit boards, medical devices and fiber optic components, are now produced offshore. And every automaker in the world is pouring millions of dollars into offshore plants and capital equipment. Some observers say it’s only a matter of time before U.S. automakers start importing vehicles made in China.
“American manufacturers are under intense pressure to continually reduce costs and improve profitability,” says Don Penkala, president of Granite Bay Consulting Inc. (Granite Bay, CA). “The slow economy, which has reduced volumes and decimated profit margins, has sharpened the focus on cost reduction, even though other strategies often make more sense. In addition, once a company starts to reduce labor and material costs through offshore production, there is a lot of pressure on competitors to follow suit.”
Whenever manufacturers shift assembly overseas, they always cite lower labor costs. Because wages in the United States are high relative to those in developing countries, there is a perceived cost advantage.
“In order to achieve profitability targets today, manufacturers have to focus on the cost side of the business, which is primarily labor and materials,” explains Joerg Matthiessen, managing officer and director of the Atlanta office of Boston Consulting Group Inc. (New York). “By moving production offshore, you can achieve a 15 percent to 25 percent cost advantage.”
For instance, Maytag Corp. (Newton, IA) announced plans last October to shut its refrigerator plant in Galesburg, IL, and move production to Reynosa, Mexico, due to “cost improvement” initiatives. As a result, 1,600 workers will lose their jobs by the end of next year. By assembling refrigerators in Mexico, Maytag will be able to hire assemblers at $2 an hour, rather than pay the average wage of $15.14 earned by assemblers in Illinois.
“We could not identify a cost-effective solution that would allow us to continue the long-term production of refrigerators in Galesburg,” claims Bill Beer, president of Maytag Appliances.
If Beer and his colleagues didn’t do all their homework before making that decision to shift production offshore, they may learn a lesson that’s not taught in business school: offshore assembly can be more expensive in the long run. Unfortunately, it’s a subject that few executives want to study.
An Established Practice
Offshore production is not a new phenomenon. Indeed, the practice has been going on for a long time. The quest for the lowest production costs has lured American manufacturers overseas for more than 30 years.
Bertil Lindberg, a New York-based electronics industry consultant, says the trend started in the late 1960s among large manufacturers of semiconductors and television sets. “Hong Kong was very popular and after a short time, competition for the available labor drew wages up from seven cents an hour to eight,” Lindberg recalls. “That price difference was enough for U.S. manufacturers to look for alternative locations. The next area discovered was Taiwan, where the wages were still seven cents an hour.
“Several U.S. companies started to assemble television sets in Taiwan,” adds Lindberg. “This could be done at such a low cost that it was even economical to fly the sets back to the U.S. for distribution. The U.S. laws on customs duties helped. American companies paid duties on the value added overseas only. They did not have to pay duties on components exported from and reimported into the U.S.”
Ten years ago, the North American Free Trade Agreement (NAFTA) sparked a rush south of the border. “Immediately after NAFTA went into effect in 1994 the U.S. witnessed an escalation in production shifts to Mexico that has continued to this day,” says Kate Bronfenbrenner, Ph.D., director of labor education research at the School of Industrial and Labor Relations at Cornell University (Ithaca, NY).
During the last 10 years, the People’s Republic of China has unveiled numerous economic reforms that have opened most of the country’s eastern and southern coast to foreign investment. Today, China is the new hot spot for offshore production. According to the United Nations Conference on Trade and Development, foreign direct investment in China totaled $46.8 billion in 2001.
Bolstered by its recent entry into the World Trade Organization (WTO), China’s booming economy is growing at a rate of 7 percent a year. Unlike the U.S. economy, that growth is being fueled by manufacturing, which is attracting a huge influx of technology and skilled labor from all over the world. Of the more than 400,000 Chinese who have studied overseas in the past two decades, one third have moved back to the mainland armed with advanced degrees, experience and venture capital.
In the good old days, when a plant closed somewhere in the United States, its manufacturing capacity was usually absorbed by a facility elsewhere in the country. For instance, if a plant in New York or Ohio stopped assembling a product, that work was typically shifted to a facility in Arkansas, Georgia or somewhere else in the South. Today, even those traditional nonunion plants are closing their doors and moving production overseas.
During the past decade, numerous U.S. manufacturers ranging from Lionel LLC (Chesterfield, MI) to Newell Rubbermaid Inc. (Freeport, IL) have decided to close domestic plants and ship production offshore to exotic locales. A recent study conducted by the U.S. Trade Deficit Review Commission (Washington, DC) reveals some eye-opening data and sobering statistics. Between Oct. 1, 2000, and April 30, 2001, when the study was conducted, more than 80 U.S. manufacturers announced intentions to shift production offshore.
“An increasing percentage of jobs leaving the U.S. are in higher-paying industries producing goods such as bicycles, furniture, motors, compressors, generators, fiber optics, clocks, injection molding and computer components,” says Bronfenbrenner, who was the author of the landmark study. “It is these higher-end jobs that are most likely to be unionized and therefore more likely to have a much larger wage and benefit package.”
But, many white-collar jobs also are slowly migrating offshore. Leading U.S. companies, such as General Electric Co. (Fairfield, CT) and Intel Corp. (Santa Clara, CA) are using China as a key product development center. Motorola Inc. (Schaumburg, IL) has poured more money into China than any other U.S. company. For instance, it has invested more than $3 billion in R&D and production facilities.
According to Bear, Stearns & Co. (New York), 20 percent of Motorola’s revenue last year came from China, where it employs more than 1,000 engineers engaged in research for products such as wireless phones and semiconductors. And Motorola plans to continue investing heavily in China, while closing facilities in the U.S. In fact, by 2006, it expects to achieve a goal of $10 billion worth of production in the country.
Why Go Offshore?
The biggest allure of offshore production is cheap labor. Assemblers in other nations are paid much less than their counterparts in the United States.
According to the Bureau of Labor Statistics (Washington, DC), average hourly compensation rate for production workers in the United States was $20.32 in 2001. By comparison, workers in Mexico earn $2.34 an hour, while Brazilians earn $3.02. Hourly compensation averages $5.70 in Taiwan and $7.77 in Singapore.
But, even those low compensation levels are high compared to China, where wages are six times cheaper than in Mexico. The typical factory worker in China earns an average of 40 to 60 cents an hour. Even technical talent earns low wages. It’s not unusual for a senior engineer in China to earn an annual salary of $10,000.
And the supply of cheap labor appears to be almost endless, which means the phenomenon of persistently low wages amid fast growth should continue to defy the basic laws of economics. According to Chinese government statistics, there are at least 100 million migrant workers from poor rural districts seeking work in booming cities such as Chongqing, Dongguan and Shenzhen. In fact, there are so many people waiting in the wings that economists predict upward pressure on wages will be almost nonexistent for the foreseeable future.
“China can be expected to retain its labor cost advantage for a long time, thanks to its enormous pool of increasingly mobile workers, both skilled and semiskilled,” says Jim Hemerling, vice president and director of the Shanghai office of the Boston Consulting Group Inc. (Boston). “The key to operating in China lies in achieving high levels of utilization while optimizing the tradeoff between automation and labor.”
However, simply comparing American wages to low wages in other countries can be misleading, especially if the differences in employee productivity are not taken into account. There is a direct relationship between wages and employee productivity across nations. Wages in developed nations are high because employee productivity in those countries is also high.
According to the National Association of Manufacturers (NAM, Washington, DC), U.S. manufacturing employees are some of the most productive in the world and, accordingly, earn higher wages. “Participating in world trade imposes unique challenges on manufacturing that other sectors of the economy do not share,” says Jerry Jasinowski, NAM’s president.
The total costs of bringing a product to market include design, engineering, purchasing, production, marketing, distribution and sales costs. “But often, it is the production costs alone that make the case for going offshore,” notes Granite Bay Consulting’s Penkala. “The ability to integrate these functions cost-effectively should drive the decision, not production costs alone. While the United States clearly cannot compete with daily labor rates of $5 a day, labor costs are a relatively small and shrinking component of overall costs in most industries.”
In addition to cutting costs, there are other reasons why China, Mexico and other countries appeal to manufacturers. Often, top management sees it as an easy way to appease shareholders and Wall Street analysts.
According to Cornell’s Bronfenbrenner, the companies that are “shutting down and moving to China and other countries are relatively large, well-established companies, primarily subsidiaries of publicly held, U.S.-based multinationals.” In fact, in her study, 86 percent of the companies moving production from the United States to China were publicly held, while only 13 percent were privately held.
“Many employers use production shifts to impress investors and shareholders,” says Bronfenbrenner. “Money saved by cutting labor costs and outsourcing production has resulted in enormous profit margins. Just the threat of moving can result in increased shareholder investment in the company because they see production shifts as an effective way to improve the return on their own investments.
“Even just the announcement of a planned production shift to China, Mexico or other countries can cause stock prices to soar,” adds Bronfenbrenner. For instance, shortly after Maytag announced that it was closing its refrigerator plant in Illinois and shipping the work to Mexico, shares of Maytag rose 6.2 percent on the New York Stock Exchange. That action pulled the company’s stock price off new 7-year lows set just 2 days before the announcement.
Many companies shift production offshore simply because it’s trendy. If management sees their competitors doing it, they feel they should too. “Some executives see the next guy shifting production offshore and say, ‘Hey, I should be doing that!’” says Don Ewaldz, director of the Bourton Group (Carmel, IN). “Often, the mentality is, ‘It must work because XYZ company did it.’”
Market pressures and perceptions about cost savings make offshore production almost irresistible for many executives. Some executives see it as a quick and easy way to dump operational headaches downstream.
Ewaldz says many short-sighted executives simply say, ‘Hey, let’s go offshore and everything will be OK. We don’t have to pay attention or worry about what’s happening here.’ Unfortunately, many of those decisions are made before any analysis is done.
“Offshore manufacturing is an easy out,” claims Ewaldz, “especially for a management team that doesn’t understand manufacturing. Many CEOs today are ex-accounting, ex-finance or ex-marketing people who don’t understand manufacturing at all.”
According to Bronfenbrenner, many of the companies shifting production out of the United States have had ownership changes in the last 10 years, including one-third of companies shifting to China, 44 percent of companies shifting to Mexico and 55 percent of companies shifting to other countries, such as India, Malaysia, Singapore, South Korea or Vietnam.
Ewaldz says too many new management teams fail to take the time to do a cost justification. “All they say is, ‘We have to do something to cut costs,’ and immediately turn to offshore production,” explains Ewaldz. “The first logical step should be to ask, ‘What’s wrong with what we’re doing now? What causes our costs to be so high? Do we have poor designs? Do we have bad processes? How can we fix it? What’s our optimal production cost?’”
By choosing an offshore strategy, some manufacturers are merely following an age-old business principle: go to where the customers are. Automakers, electronic device marketers and consumer product manufacturers have been seduced by the size of China, which, with 1.3 billion people, accounts for 20 percent of the world’s population. It’s a country that is expected to have high economic growth for years to come. China’s domestic market has been consistently growing at rates near or exceeding 10 percent per year.
That growth is being fueled by a burgeoning middle class, an improved transportation infrastructure and business reforms. According to CSM Worldwide (Northville, MI), annual growth in the Chinese auto industry will average 13 percent over the next 4 years, pushing light-vehicle production to 4 million units by 2007.
Manufacturers simply can’t ignore the fact that China has the fastest growing economy in the world. However, while the potential is huge, in reality the typical Chinese consumer has very limited purchasing power. More than 75 percent of Chinese still survive on less than $300 per year.
Some observers believe the impetus behind offshore manufacturing has been fueled by misguided policy-makers in Washington, DC. “The U.S. and other countries have moved ahead with trade policies and global economic integration based on faulty arguments and incomplete information,” claims Bronfenbrenner.
“President Bush and many members of Congress have received hundreds of millions in campaign contributions from the corporations that benefit from our free trade policies,” adds Rep. Bernie Sanders (I-VT), the only independent congressman in the U.S. House of Representatives. “They have taken those donations and sold out American workers by giving their support to a trade policy that is destroying our economy. We need fundamental changes in our trade policies.”
Despite China’s reputation as a low-cost manufacturing center, some experts claim that its technological know-how is only 5 to 10 years behind U.S. levels. In fact, the country has devoted resources to improving technical and scientific education. In 2000, 37 percent of Chinese university graduates were engineers, compared with 6 percent in the United States. That’s a startling fact that Sanders believes domestic policy-makers should pay attention to.
Look Before Leaping
Offshore production is a very tempting strategy for top management. It’s an easy way to achieve a quick fix and look like a hero to their constituents.
“Employer after employer tells how the lure of cheap labor overseas is, in the end, too hard to resist,” says Bronfenbrenner. Many top executives claim “we have to do it; if we don’t, we’ll be out of business.”
However, companies that take this route may be missing strategic opportunities. While focusing on the short-term benefits of moving production overseas, many companies overlook numerous long-term risks.
“Decisions are often made without a comprehensive review of all the risk, hidden costs and probability of success,” says Richard Ligus, president of Rockford Consulting Group (Rockford, IL). “The biggest myth about offshore production is that you can satisfy your customer requirements at cost much cheaper than you can make the product in the U.S. What most companies fail to realize is that the hidden costs are the most dangerous.
“There is no question when you only compare labor costs and overhead, the analysis will come out in favor of going to China or elsewhere in the Far East,” Ligus points out. “But, this may only be true when you are making repetitive products or positioning as a low-cost provider in a commodity market. If you try to make customized or special parts offshore, the numbers are different and the risks are higher.”
Some companies that have pursued offshore manufacturing strategies have ended up with big headaches. For instance, they find themselves grappling with mind-numbing bureaucracy and logistical nightmares that negate any gains achieved by cheaper labor.
Keeping production fairly close to home can have numerous advantages. For instance, manufacturers gain easy access to their product. That’s especially important for new products, where it’s much easier for engineers to review changes and baby-sit production until a product is mature. Every aspect of the assembly process can be fine-tuned.
Traditionally, design engineering and manufacturing engineering are synergistic. Without access to local manufacturing, some experts warn that design engineers will cease to understand the relationship between their work and the production process. That’s an intangible benefit that is lost with offshore production. For instance, without local production, it’s not always easy to make changes to a design.
Some observers believe response time is the single greatest advantage to manufacturing in the United States. “The rationale behind offshore production depends on your strategy,” says Jamie Flinchbaugh, a partner in the Lean Learning Center (Novi, MI). “If you want to compete on lead time and promise to get your product to the customer as quickly as possible, offshore production doesn’t make sense.”
“When dealing with offshore plants, you cannot simply run down the street . . . to see why your parts are late,” adds Ligus. “Communication is difficult as a result of language differences, cultural differences, lack of responsiveness and time zones. If you manufacture offshore, forget about frequent engineering changes or product customization.”
“Your level of flexibility drops dramatically when you go offshore,” warns Richard Bodine Jr., chairman of Bodine Assembly and Test Systems (Bridgeport, CT). “Your ability to respond to customers on the fly is severely limited.”
Most products assembled in Brazil, China, India and other offshore locations are transported to Europe and North America by container ship. In response to the Sept. 11 terrorist attacks, the U.S. Customs Service has just enacted strict new security rules that could delay shipments. The Container Security Initiative rules are aimed at reducing the risk that a nuclear bomb or other bulky weapon of mass destruction could be shipped to the United States. Shippers in Hong Kong and other key Asian ports are warning of long delays at docks and warehouses on both sides of the Pacific Ocean.
“The logistics in the U.S. are far superior for customers who want just-in-time deliveries or customization of product,” claims Ligus. “Storage and transportation costs should be factored into any evaluation of offshore production. I don’t know what the true cost of pulling your hair out is, but it should be included in the analysis.
“But, the clear and present danger of doing business offshore, particularly in a country like China,” warns Ligus, “is you are dealing with conditions that were similar to those in the U.S. in the 1960s and 1970s: bad parts, wrong parts, inferior parts, late parts or no parts delivered. For instance, an offshore supplier may substitute materials without your knowledge.”
Although China is one of the safest places in the world to do business, intellectual property doesn’t fare as well as individuals and factories. Counterfeits and knockoffs abound in China, where rampant piracy is a fact of life and foreigners have little recourse. China accounts for one half of all counterfeit seizures in the U.S. by the Customs Service.
Chinese officials are struggling to bring their country’s business practices up to world-class standards. That means addressing such issues as abuse of copyrights and trademarks. Many manufacturers that have set up offshore production facilities in China have been unable to prevent duplication of their products, where product designs, assembly processes and other intellectual property are extremely vulnerable.
“Counterfeit parts are very common, because China traditionally does not enforce copyright laws,” says Paul Weyn, sales and marketing manager at Schippers & Crew Inc. (Seattle), an electronics manufacturing services provider. “It’s not uncommon to find flawed boards and substandard parts that fail. Our purchasers won’t buy components from China because of it.”
Some observers argue that those are isolated incidents. Also, a recent court ruling involving Lego Co., the Danish toy company, is hailed as a landmark case that will serve as a precedent. The Beijing High People’s Court ruled in favor of Lego, which was battling Chinese-made clones of its famous plastic building blocks.
The ruling declared that Lego’s copyright over 33 out of 53 items in the case had been infringed. It marked the first time that the Chinese legal system has delivered a judgment that confirms copyright protection of industrial design or applied art.
China pledged itself to uphold international patent laws when it joined the WTO in 2001. Despite progress such as the Lego case, many observers claim there are still major problems enforcing central government policy in China’s huge provinces.
There are also numerous social ramifications that often go overlooked. For instance, some opponents of offshore manufacturing claim that it can cause upheaval and unrest at the grassroots level.
“Contrary to the promise of rising wages and living standards that free trade and global economic integration were supposed to provide, in many countries these global production shifts have to led decreases in employment, stagnating wages and increasing income inequality,” says Bronfenbrenner.
“There is much to be learned from the U.S.-NAFTA experience for those concerned about the impact of U.S.-China trade relations on U.S. trade and employment,” adds Bronfenbrenner. “NAFTA has not delivered on the promise of wage prosperity and better-paying, export-related employment opportunities for workers in any of the three countries--the U.S., Canada or Mexico.”
The Economic Policy Institute (Washington, DC) claims that the United States has lost more than 760,000 jobs to Mexico since NAFTA was passed. Those losses occurred in every state, with California, Michigan and New York suffering the most. But, even Sun Belt states, such as Georgia and Tennessee, have lost thousands of manufacturing jobs. Each year, more than 60,000 jobs are lost to Mexico and another 70,000 jobs are lost to China due to shifts in production from the United States to those countries.
Bronfenbrenner and other observers claim that the impact of offshore production is not limited to the workers whose jobs have been moved out of the country. “Each time a company shuts down operations and moves work to China, Mexico or any other country, it has a ripple effect on the wages of every other worker in that industry and that community,” argues Bronfenbrenner.
“Each plant that closes, each job that is shifted overseas, fosters an overriding sense of insecurity about their economic future,” she adds, “which serves to constrain demands for wage increases, inhibit workers ‘quitting power,’ and intimidate them from exercising their right to organize.”
Crunch the Numbers
An offshore production strategy is not always advantageous. Jim Womack, president of the Lean Enterprise Institute Inc. (Brookline, MA), believes lean manufacturing is the antidote to offshore production. He says he recently received a phone call from a reporter for <I>The Wall Street Journal<$> with a simple but provocative question: “If you are a manufacturer in a high-wage country such as the U.S., can you ever be lean enough that you don’t need to relocate your operations to China?”
“The reporter’s reasoning was that China has an enormous labor pool in its coastal development zones,” explains Womack. “With 300 million additional migrants to these areas expected in the next 10 years, labor costs may stay at their current low levels for decades. He further reasoned that a large fraction of the cost of manufactured goods is ultimately wages--for touch labor plus support staff, managers and engineers, and the workers designing and making process machinery and extracting and processing raw materials.
“The reporter then concluded that no matter how much cost an American or Japanese or German firm removes by getting lean, costs in China, based on cheap labor, will always be much lower. Hence, ‘Won’t you need to relocate?’
“This question has emerged as the largest single issue many managers are wrestling with in high-wage countries,” claims Womack. He says the answer requires management to “do some math before you move and make sure it’s lean math.”
Womack believes the following items should be included in any calculation:
*Start with the piece part cost for an item where you are.
*Compare this with the piece part cost for the same item in Brazil, China, India, Mexico or any other offshore location. Womack claims that it will almost always be much lower.
*Add the cost of slow freight to get it to your customer.
Womack calls this “mass production math.” He says those three steps tend to be “all the math that many purchasing departments seem to perform. To get to lean math, you need to add some additional costs to piece-part plus slow-freight cost to make the calculation more realistic.” Womack suggests calculating the following items:
*The overhead costs allocated to production in the high-wage location, which usually don’t disappear when production in transferred. Instead, they are re-allocated to remaining products, raising their apparent cost.
*The cost of the additional inventory of goods in transit over long distances from the low-wage location to the customer.
*The cost of additional safety stocks to ensure uninterrupted supply.
*The cost of expensive expedited shipments. “You’ll need to be careful here,” warns Womack, “because the plan for the part in question typically assumes that there aren’t any expediting costs, when a bit of casual empiricism will show that there always are.”
*The cost of warranty claims if the new facility or supplier has a long learning curve.
*The cost of engineer visits or resident engineers to get the process right so the product is made to the correct specification with acceptable quality.
*The cost of senior executive visits to set up the operation or to straighten out relationships with managers and suppliers operating in a different business environment. Womack says this “may include all manner of payments and considerations, depending on local business practices.”
*The cost of out-of-stocks and lost sales caused by long lead times to obtain the part.
*The cost of remaindered goods or of scrapped stocks, ordered to a long-range forecast and never actually needed.
*The potential cost, if you are using a contract manufacturer in the low-cost location, of your supplier soon becoming your competitor.
“These additional costs are hardly ever visible to the folks in senior management or purchasing who relocate production of an item in a low-wage country based simply on piece-part price plus slow freight,” says Womack. Lean math requires adding three more costs to be complete:
*Currency risks, which can strike quite suddenly when the currency of either the supplying or receiving country shifts.
*Country risks, which can also emerge very suddenly when the shipping country encounters political instabilities or when there is a political reaction in the receiving country as trade deficits and unemployment emerge as political issues.
*Connectivity costs in managing a product hand-offs and information flows in highly complex supply chains across long distances in countries with different business practices.
“These latter costs are harder to estimate, but are sometimes very large,” warns Womack. “The only thing a manager can know for sure is that they are very low or zero if products are sourced close to the customer rather than across the globe.”
If you do the lean math, will it always mean that you don’t need to relocate production? “Absolutely not,” says Womack. “For example, if you are planning to sell within high-growth, low-wage markets like China or India you will almost certainly need to locate most or all of your production for those markets within those markets. This is simply because lean math works in the opposite direction as well. Transport, inventory and connectivity costs, and country and currency risks, are much lower if you produce within the market of sale.
“However, in my experience, a hard look at the true cost situation will suggest that relocation is not the first line of defense for producers in high-wage countries,” argues Womack. “Rather, it’s to get truly serious about a lean transformation through the entire value stream for the product in question.
“If you find that you do need to relocate, even after doing lean math and applying the full complement of lean methods, my experience is that moving all of the steps in the value stream for a product to an adjacent location in a low-wage country within the region of sale [Mexico for the United States; Poland for Germany; China for Japan] is likely to provide the lowest total cost.”
Where to Next?
Many companies that flocked to Mexico in the 1990s are now shifting production to China. Eventually, China will price itself out of the market. The huge gap in labor cost can’t sustain itself forever. That gap will narrow because of tariffs, exchange rates or other economic restraints.
There also is a possibility that low pay will breed disenchantment among workers. So far, China’s repressive government has quelled potential labor unrest. But, with 18 million people coming into the work force each year, some experts believe tensions could increase due to unemployment and a widening wage gap.
Many observers believe India will be the next offshore production mecca. Some people predict Botswana, Ghana and other African countries will soon begin luring manufacturers. Some Caribbean islands may also be ripe for manufacturing.
Perhaps the ultimate offshore production site would be a floating factory. A large cargo ship could be converted into a seagoing facility that would contain machine tools, stamping presses, plastic injection molding equipment and other production tools in addition to assembly lines. Each year, the ship could sail to a new port to seek out workers in whatever country has the lowest labor rates.
However, no matter the geographic location, the pros and cons of offshore production will confront manufacturers for a long time. “Constantly being in search of the lowest labor cost is not the way to run a manufacturing company,” argues Richard Bodine. “It’s only a short-term solution and you give up too much control of your product.”
“I would advise anyone wishing to go offshore to thoroughly examine the situation and the hidden costs,” adds Rockford Consulting’s Ligus. “Look at others that have tried it—both successfully and unsuccessfully—very closely. Compare the successful circumstances to your own to see if apples are being compared to apples.”
According to Granite Bay’s Penkala, the first consideration should be, “How can we do it better internally? Doesn’t it make sense to maximize productivity, profitability and responsiveness of current operations before considering more costly and risky offshore investment? There are a host of best practices, such as lean manufacturing, that companies can adopt that have proven effective in driving out waste and its associated costs from the business faster and with less risk than with offshore production.”
Penkala claims that lean manufacturing has enabled many U.S. manufacturers to slash unit cost by a third, quality defects by two-thirds, and lead times by 90 percent in a relatively short amount of time.
“For most companies, lean manufacturing with supply chain agility is a better strategy than offshore production,” Ligus concurs. “Customers do not want to wait for their products any more. They will turn to someone that can give them what they want faster, more reliably and cheaper.”
Ligus says he recently conducted a customer survey for an electrical products manufacturer that identified the most important factors in buying a product. “It provides some food for thought” for manufacturers contemplating offshore production, notes Ligus. Reliability and service ranked the highest, followed by availability of product, delivery and quality. Cost was the least important factor.
Of course, simply bringing in new technology, streamlining assembly processes or changing the way people work is not always the answer. Sometimes, even the best efforts fail to cut costs and offshore production may be the only answer.
“Once a decision has been made to produce offshore, consider total costs, not just labor costs,” concludes Penkala. “For example, high turnover or training costs overseas may offset lower wage rates. Shipping costs and lead times to target markets are another major consideration. Exchange rate stability can also make or break an offshore manufacturing strategy.” Manufacturers may be better off pursuing other alternatives, such as licensing, contract manufacturing and joint venturing.