Count the cost of changing direction

It's clearly tempting to cut costs by outsourcing production. With wages in central and eastern Europe at one-fifth, and those of China less than a twentieth, of UK rates, companies might reasonably expect it to bring substantial advantages in product pricing and profit margins. But experience suggests that serious pitfalls for the unwary may well outweigh the benefits of cheap labour. Those of us with a fervent wish to preserve our industrial identity and manufacturing jobs have to be careful here. It is only too easy to weight the evidence. Honesty compels us to admit that it can work. Some companies are only alive today because they hived off some processes with a high labour content, while retaining high-value activity and ultimate product control at home base. Informed advice On the other hand, 25% of offshore projects fail. If you don't want to be among the casualties, it's worth taking advantage of informed advice. And one of the best is a new decision support tool produced by The Manufacturing Foundation, in partnership with the Manufacturing Advisory Service (MAS). Offshore? Be Sure!* was launched following concerns that a lack of information and insufficient consideration has led industry into costly decisions. Written by KPMG, it combines a vast amount of important advice and background analysis of the opportunities offered, with a very practical workbook to make sure you take into account all the risks involved. The focus on the Far East means that there is one tried-and-tested alternative that often doesn't get a look-in today: contract manufacture within the UK. Yet, carefully managed, it is capable of yielding many of the benefits without the tears. That's exactly what happened when Astucia, part of the Clearview Traffic Group, outsourced its entire product supply chain and manufacturing to Ruston Electronics' plant in Luton. Astucia had its own dedicated manufacturing facility, some distance from corporate HQ. Although the business was growing, the management team was concerned about the time and cost involved in managing peaks and troughs in demand. Moreover, the supply chain was too fragmented, and managing these issues was starting to affect the ability to focus on developing new products and markets. It was certainly wasting money. Ruston helped to analyse the entire supply chain side of the business, creating an end-to-end solution for the complete production environment. The transition took nearly 18 months. The results, however, have included direct product savings through Ruston's manufacturing efficiency and significant purchasing power, indirect cost reductions through a plant closure and product improvements based on suggestions from Ruston's technical staff. One UK company convinced of the virtues of outsourcing is Premier Percussion, which supplies wooden drums for top pop groups internationally. Based in Wigston, Leicestershire, the company employs around 60 people worldwide and has a turnover of $15m. MD Nigel Sims says that although Premier still produces a high proportion of its instruments in the UK, it has integrated overseas contract manufacturing into its business strategy. This outsourcing now covers two distinct business areas. Taiwan and China produce the vast majority of the company's high-volume products, while the low-volume specialist drums and drum kits are still manufactured in the UK. The company has also outsourced its freight movement, warehousing and distribution activities to a third party logistics provider (3PL). Complex business models like this can only be managed successfully by clear visibility of what's happening at both the production and distribution end, regardless of location. Premier uses a Syspro system from McGuffie Brunton to plan worldwide requirements, run internal manufacturing, drive the contract manufacturers and oversee the management of all logistic movements and warehousing. 3PLs have on-line access to relevant information on the same system. Tellingly, however, Sims says: "We have our own employees, located all over the world, who constantly monitor production quality, with the emphasis being on inspection at source." Some at the top of the food chain have gone a great deal further. The virtual factory is a reality for the few. Take Nike, for example. Ron Ireland, managing principal of Oliver Wight Americas, points out that it doesn't own its own manufacturing facilities. Its goods are produced in China, Mongolia and Vietnam, in factories mainly owned by Koreans. This appears a comfortable situation until a company is hit by the kind of child-labour scandal that pounded Nike's profits a few years ago. Today, he says that Nike does what many outsourcing conglomerates (and a few thoughtful smaller companies like Premier) do. It puts its own people into the country to watch the quality of the product, check conditions and, in some cases, make changes to the production processes that affect their own costs. In his view, this approach is not limited to the really big players. He advises a Minnesota tool producer called Malco which, although only 150-strong, has a member of the home team in China to audit quality and sort out the customer service issues that frequently arise in a country where short or late ships are commonplace. He has severe reservations about the wisdom of outsourcing to China, unless you are prepared to make this kind of provision. "Increased lead times are a huge issue. You have to work with 30 days' extra transportation time to the US and the overall inefficiencies of the Chinese supply chain sometimes add two to three months on top of that. Many companies are now re-evaluating the wisdom of a decision merely based on the cost of labour. It may only cost $35 a month in Vietnam or $100 in China, but the trade-off in quality, lead times and poor service levels are making more people re-evaluate their options." Sims increasingly sees a reversal of the Far East flow, in the USA's case to Mexico. "Companies are also discovering that the Chinese government is not exactly easy to do business with and some manufacturers who have transferred to China are actually taking their factories out again and moving them to Malaysia or Vietnam." End point Gordon Colborn, director at management consultancy PRTM, thinks the ill-judged rush to outsource is coming to an end. He maintains many firms do it simply to become lower cost operators, rather than considering whether it will actually make them better competitors. In particular, he recalls a major European electronics company that felt its products had become such commodity items it made sense to stop making them themselves. So it moved the entire production responsibility to contract manufacturers. It assumed the contractor's phenomenal buying power across its operations would generate lower material costs than the company could ever achieve for itself. It actually didn't realise that it had a highly partitioned operation that precluded this. "Ironically, this was partly caused by OEMs retaining design control to protect their IP," states Colborn The company also overlooked the implications of an extended supply chain on ever-shorter product lifecycles. "Once you've stuck the stuff on the boat from China, you've pretty much used up your lead time. So your ability to make product changes to satisfy your customers is highly compromised. What's more, the Chinese weren't that interested in making changes that altered their volume production runs." Huge mistake The chief procurement officer frankly admitted to Colborn they had made a huge mistake. "But he also said he couldn't go back to where they were before. They had been operating under the illusion that it was going to get better, but hadn't really understood what they were getting into." Colborn is convinced he could have prevented them from going that route, if he had been involved from the outset: "But for a lot of organisations, this is a one-way trip." He believes businesses need to ask themselves three questions before making a long-term commitment - and the order in which they ask them is fundamentally important. First, what should we make? If it's not a core competence critical to the future of the business or the customer, and there's no central IP in it, you probably don't need to make it yourself. Secondly, where do we have it made? "The answer could be China or India - but you make the decision in the context of your overall operational strategy and the basis of your competition, not just to cut costs." Finally, how do we make it? "So if you have chosen to retain a piece of the manufacturing footprint, how do you make it in the best, most efficient, way? I have seen a lot of organisations getting the sequence of those questions completely wrong. It leads them to source products that are strategically very important." Colborn believes financial people, of which he was once one, must shoulder a large chunk of the blame. "We have never really had sufficiently adequate accounting tools to help us understand the total costs of the products we manufacture." He recalls an early experience where finance simply didn't understand why, when the cost argument for outsourcing was so strong, the manufacturing people were telling him it was totally the wrong thing. "I said this is one of the most expensive products we make. They said, 'why is it expensive when it's one of the simplest things we make?' It was the way we were allocating overhead to it." It took virtually no overhead support, yet the costing system decreed it must carry its full share. "They were right - if we outsourced it, none of the overhead was going away. It would just go into the other products that were left. So they would get more expensive and we would look to outsource them, too. We were heading for a vicious circle where we would outsource everything and all that would be left is overhead." He is still regularly surprised by how many organisations don't have a good feel for what it takes to manufacture. He is far from believing the outsourcing concept is flawed. "We have to recognise that parts of the world will inevitably be more effective manufacturers than we are. But there are so many things you have to look out for - and most organisations don't. You can really screw this up very badly. You can end up not improving what you have got - in fact, making it worse."