Smart Outsourcing

It's more than just contracting with lower-labor cost offshore suppliers. Pay attention to hidden costs. And after optimizing your production processes, ask whether offshoring still makes sense.

Wishing the advice he was getting were simpler and more decisive, Harry S. Truman expressed the desire to hear from a "one-handed" economist. The 33rd president of the United States would be dismayed and frustrated by outsourcing, a decidedly two-handed proposition -- especially when it comes to the matter of manufacturers shifting of jobs from the U.S. to such lower-wage countries as China

India and half a dozen places in Eastern and Central Europe, a practice that's become known as offshoring.

On the one hand, "there are genuine concerns that [U.S.] jobs are being lost to India and China," relates Sunder Kekre, a professor at Carnegie Mellon University's Tepper School of Business in Pittsburgh. "But on the other hand . . . companies are becoming global, and they will go to the best place where they can get the resources," he says. "The question is what is the net in terms of what we lose and what we gain [from] selling our products and services all over the world." A better question for competition-driven U.S. manufacturers is: "What constitutes smart outsourcing?"

There seems little doubt that manufacturing job shifting will continue from U.S. shores and borders to the rest of the world. "Industrial goods will travel the path consumer goods did over the past two decades," says the Boston Consulting Group. "Already in the United States, some 70% of footwear, 60% of audio and video equipment, and 45% of apparel come from low-cost countries." And the Boston-based management-consulting firm figures that industrial goods sourced beyond U.S. borders account for more than 10% of U.S. industrial consumption, and even in a flat economy would be growing at the rate of 30% per year. A recent survey of 500 senior finance and HR leaders in manufacturing and other companies by Lincolnshire, Ill.-based Hewitt Associates, shows the percentage of jobs being shifted will roughly double during the next three years, with an average of 13% of jobs already relocated and an additional 12% at each company being considered for relocation. "With more than three-fourths of companies indicating that their global sourcing arrangements are permanent, it's clear that global sourcing is a fundamental and permanent change in the way business is conducted," states Mark Arian, corporate restructuring and change practice leader for Hewitt.

But how strategically smart are they really being? "Outsourcing is said to be the answer, if only we knew what the question was," quips Paul Davies in his book, "What's This India Business?" (2004, Nicholas Brealey International).

Why Outsource?

Among the senior executives responding to the Hewitt survey, cost reduction is cited as the primary reason for shifting jobs from the U.S. However, "companies reap less savings from offshoring than expected due to hidden costs," states Hewitt's Arian. Among the people-related costs not sufficiently considered: training, taxes and the impact of plant shutdowns. "In the early rush to lower costs, companies have been grabbing people to fill seats where the supply of workers greatly exceeds demand. But demand will quickly catch up," says Arian. "As their operations mature, companies that have invested heavily in offshore markets will see projected profits disappear if they haven't fully examined issues around scaling, as well as future opportunities for labor arbitrage, developing leaders and retaining workers."

To minimize hidden costs and maximize return, Arian recommends companies give their HR professionals a seat at the global sourcing table to address such issues as skills and language requirements, labor costs in specific markets, alternative talent pools, and "workforce training, retention and change management at both ends of the global sourcing spectrum -- those being displaced and those receiving the work."

Consultant Tom Devane of Tom Devane & Associates, Downingtown, Pa., is not anti-offshoring. There will always be situations in which offshoring "is the most economically viable solution," he says, naming call centers, with their simple processes, few handoffs and short duration of transactions as a prime example. "But too many manufacturers are offshoring in a 'knee-jerk' fashion," he asserts. "What many of them are discovering the hard way is that for an operation to work smoothly overseas, the business process must be in tip-top shape so it can be executed well by locals. And the irony is this: If a company gets the process into tip-top shape prior to moving it, it may find that it doesn't need to offshore after all!"

Before you commit to moving a segment of your corporation overseas, pour your energy into significantly improving it, says Devane. Specifically, he recommends combining "the best parts" of Lean Enterprise, Six Sigma and High-Performance Organizations to help eliminate waste, reduce process variation and redirect the work culture. You may find that your efforts make the operation so cost-effective and so high-quality that you don't have to send it overseas. And even if you do end up offshoring, you've created a process blueprint that will make the transition as quick, efficient and profitable as possible.

For instance, an optimization project at StorageTek, a maker of data storage systems and one of his clients, demonstrates the work that needs to be done before determining what outsourcing offers, says Devane. In two and a half years, beginning in 1998, the company went from a mean time-to-failure of 200 months to a mean time-to-failure that exceeded 2,000 months. Workmanship errors decreased by 90%, and scrap costs were reduced by 85%. Rework costs were reduced by 73% and process yields improved by 80%. The optimization process reduced manufacturing cost by 60%.

"Offshoring -- and even domestic outsourcing -- ultimately reflects management's commitment to business excellence," he contends. "Work hard to improve the efficiency of the process and to instill motivation in your people, and you may find that offshoring is not only unnecessary, but also undesirable. And for manufacturers who've just assumed they must move overseas, knowing that an alternative just might exist for them will come as a huge relief."

Countering Counterfeiting

For Hayward Pool Products, an Elizabeth, N.J., maker of heaters, pumps and other swimming pool equipment and a division of Hayward Industries Inc., an offshoring strategy did not begin with the search for a low cost producer in a country half way around the world. Quite the opposite -- the strategy began with a low-cost Chinese manufacturer finding Hayward products ideal for counterfeiting, says Paul Adelberg, vice president, technology. The Chinese firm was illegally copying its products right down to using the same part numbers, adds Adelberg.

The Chinese firm did its best to fool Hayward's global market, he alleges. "They copied our packaging including the actual logos on the bags and the result, superficially at least, was so convincing that our largest customer referred the competitive price of the pool components to the attention of our sales and marketing vice president," says Adelberg.

The customer noted that while the counterfeit pool components duplicated appearance and function, pricing averaged 25% lower. That jeopardized more than $20 million in sales to this one customer, he says.

In addition to potential revenue loss, Hayward's other major concern was the reputation of the product. "We knew that the material specifications were inferior -- definitely not the same grade used by Hayward. That would severely curtail product service life.

"Issues of reputation and market share compelled us to add an offshore strategy even though we were well along in our implementation of the lean manufacturing and Six Sigma practices of the Toyota Production System."

Although its optimization efforts produced significant process benefits for Hayward, they weren't enough to counter Chinese mainland labor costs equivalent to 40 to 60 cents per hour.

Nevertheless, for Hayward, the optimization made possible by its lean and Six Sigma initiative has played two pivotal roles. Since the company's offshoring strategy is one of augmenting, not replacing the capabilities of its U.S. plants, it is important for the company to have its U.S. operations as efficient as possible, explains Adelberg. Hayward's strategy is to use its Chinese supplier for the longer, more stable product lifecycles while the U.S. facilities smooth out supply logistics and concentrate on new product introductions. Significantly, to gain employee commitment for its initiative, Hayward adopted a no layoff policy at the time of the offshoring decision. "We need our people to grow our company through product development and customer service programs," insists Adelberg. And the lean and Six Sigma initiative is playing a critical role at Hayward in administering its offshoring program. "It helps us decide which products to offshore and how to best help our supplier achieve quality, cost and production goals."

Focus on Strengths

Rather than get too worried about jobs we are losing, we have to ask ourselves what we are really good at and how we can do it better," stresses Carnegie Mellon's Kekre. "We should look ahead in terms of asking ourselves how can we increase our capability in terms of innovation, in terms of systems capability. And we should leverage the best resources we can get -- it might require dipping into some resources in China and India in terms of manufacturing and sourcing of parts -- on the other hand we can service their markets."

Agreeing with Kekre is Robert J. Graves, senior professor for emerging technologies at Dartmouth College's Thayer School of Engineering in Hanover, N.H. "I think [innovation] will go a long way to help U.S. manufacturers recover if not a lead position, a closer position to the forefront in the global marketplace," Graves says. "A reenergizing of American industry, but looking at different and better ways to do things [by] relying more on disruptive types of technology to shake up the status quo."

While U.S. manufacturing has been a frontrunner in innovation and design, resting on laurels may prove to be a bigger issue than outsourcing. According to Kekre, other countries, such as Singapore, have created infrastructures to train their companies in advanced computer-aided design and manufacturing.

"It is that infrastructure where they are allowing these small companies to not only be good in manufacturing, but they are also becoming very good in design," says Kekre. "Ironically, these countries are getting help from U.S. companies [that offer] licenses for using these advanced machines and software at a price you just can't get in the U.S. . . . Those countries are going to develop capabilities that are going to . . . challenge [U.S.] companies to compete in those markets where not only is manufacturing cheaper, but also the design capability is going to be very high. We are resting on the premise that the American companies are good at innovation, but you are slowly finding that these countries are going to build up their design capability, and then the game is going to get even tougher."

And that means engineers can't just throw a design "over the wall" to the production people. What is happening now, in terms of outsourcing, is a disconnect between the engineering and manufacturing components. If one part of the puzzle is located thousands of miles away, over the wall is no longer an option. There have to be open, detailed lines of communication.

"[Companies need] to improve their levels and depths of communications and tool support so that they can truly jointly develop new products with their outsourced suppliers," says Dartmouth's Graves. "Such as integrated networks that make use of databases on equipment, assembly lines on the shop floor and spacing issues so that the designer back here in Connecticut or California or Florida can access the information he or she needs to tune the design to fit that supplier's capabilities. We don't do that today. But if we were to do that we could manage the instabilities in a new-product development process through the use of technologies."

All-shore sourcing is a fact of business and life, and so is the notion of going forth with thought.

"In order to access markets, we have to outsource in the country that commands the market," explains Graves. "If we have to do that, let's do that intelligently. Let's look at not only the costs of it, but also look at designing our organizations and our processes -- product development. Let's look at fixing those processes so that we are doing this intelligently, that we really can support it."

"Are we going to be a country where we just consume everything that is going to be made overseas or are we going to be a country where we are going to innovate and dream of new products and services and bring in partners from all over the world?" asks Kekre. "I think the latter is what we want to do. And I think we have to go back to the good old American way -- fostering innovation and creativity."

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