Recriminations the need to reevaluate manufacturing offshoring and outsourcing -my purchasing center 080912.pdf

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Business & Mgmt

Published on March 7, 2014

Author: Tanel



It is increasingly popular now for companies to reevaluate offshoring and the outsourcing of manufacturing and other services. Now we hear about onshoring, near shoring and right shoring. Are you dazed and confused? Who’s right and who’s wrong? More importantly, organizations need to do the necessary due diligence as part of their sourcing decision. It has been my contention that in addition to the basic item’s purchase price; we need to seriously
consider the ultimate cost of delivering the goods to the buyer's facility.

Recriminations: The Need to Reevaluate Manufacturing Offshoring and Outsourcing By Guest Editor August 09, 2012 at 12:18 PM By Thomas Tanel, C.P.M., CTL, CCA, CISCM It is increasingly popular now for companies to reevaluate offshoring and the outsourcing of manufacturing and other services. Now we hear about onshoring, near shoring and right shoring. Are you dazed and confused? Who’s right and who’s wrong? More importantly, organizations need to do the necessary due diligence as part of their sourcing decision. According to Stephanie Neal, in a blog entitled Made in the U.S.A, about a recent story in the Minneapolis Star Tribune, she highlights the trend of onshoring, or bringing manufacturing back in-house. The story included examples of a number of companies. Here’s the best quote in the article (in her opinion), [which is] an indictment of overzealous outsourcers: “It was a goofy, sophomoric idea,” said Fred Zimmerman, a retired business professor at the University of St. Thomas, “of the wholesale move by companies to outsource functions. It was based on the principle that it was always cheaper to do things overseas. But the ease of outsourcing—both internationally and domestically—was overestimated.” UNDERSTANDING TOTAL LANDED COSTS It has been my contention that in addition to the basic item’s purchase price; we need to seriously consider the ultimate cost of delivering the goods to the buyer's facility. This will generally include, in the composition of total landed cost the following, according to my colleague, Dr. LeRoy Graw, of the International Purchasing and Supply Chain Management Institute: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. Costs of assists, if any are required Escalation cost, if permitted by the purchase order terms Cost of special, export packaging appropriate to the item Transportation from the seller's facility to the port Port handling costs (wharfage, loading, warehousing, freight forwarding, etc.) at the port of debarkation Export processing fees assessed by the exporter's government Certificate of inspection at the port of debarkation Ocean shipping costs Marine insurance premiums Port handling costs (wharfage, unloading, and warehousing, etc.) at the importer’s port of entry Customhouse broker fees Customs duties (depending on the item and country of origin) Inland transportation costs (including demurrage, if appropriate) Financing charges, including bank charges for processing documents and issuance of a letter of credit Costs of foreign exchange conversion, as appropriate Hedging (forward or futures contracts, or purchase of currency or commodity futures) Telecommunication expenses Travel, lodging, meals, and miscellaneous expenses for trips to supplier countries Metrication (English to metric conversion) costs Increased costs of postage and correspondence Translation expenses whenever the off-shore supplier insists that the contract be written in the supplier's native language

22. Increased contract administration and legal time (contracts with off-shore suppliers often require time and effort of higher level personnel not generally involved with domestic transactions) 23. Extra inventory investment and carrying costs that may be incurred because of lead times and contingencies By way of example, let us take a typical off-shore transaction, in this case, for a particular printed circuit board (PCB) built to buyer specification. Assume the contract is for 10,000 units per month for a period of 12 months from a firm in China with terms CIF, Port of Los Angeles, CA and the purchasing lead-time from China is 15 weeks. Let’s assume that the purchaser must provide buyer-provided material (assists) amounting to $6,000 to the Chinese supplier. Total Purchase Price per Month: $300,000 Direct Cost of Manufacturing $30 x 10,000 Units = $10,000 Export Packaging $1 x 10,000 Units = Transportation to Port of Debarkation $200/Container x 6 Containers = $1,200 $100 Freight Forwarder’s Fee (by competitive supplier contract) = $13,800 Ocean Shipping $2,300/Container x 6 Containers = $1,663 Marine Insurance ($0.50 per $ hundred)($32.67)(10,000) = $326,763 Total CIF Purchase Price per Month = $3,921,156 Total Annual Purchase Price with Assists: $326,763 x 12 = $3,927,156 Plus $6,000 = ADDITIONAL COSTS PER MONTH: $4,200 Port of Entry (POE) Terminal and Handling $700/Container = $13,068 Customs Duties (4% of Unit Cost) ($32.67) (10,000) (4%) = $30,000 Inland Transportation—POE to Facility ($20.00/100#)(15#/Unit)(10,000) = $200 Customs Broker Fees (according to competitive contract) = Additional Inventory Carrying Costs: Warehouse, Insurance, & Taxes ($2/cu.ft./month)(10,000 cu.ft.)(.5 months) = $10,000 $65,340 Interest/Investment Capital Foregone ($32.76)(10,000)((20%) = $1,000 Bank Fees for Forward Contract = $150 Additional Contract Administration costs 5 hrs x $30/hr. = $3,267 Additional Legal Costs 16.34 hrs x $200/hr. = $200 Additional Communication Costs (10 long distance calls) = Total Additional Costs Per Month = $127,425 Total Annual Additional Costs = $1,529,100 Total Annual Purchase Price with Assists: $326,763 x 12 = $3,921,156 + $6,000 = $3,927,156 + Total Annual Additional Costs of $1,529,100 Equals ANNUAL "TOTAL LANDED COST" = $5,456,256 Source: Dr. LeRoy Graw of the American Certification Institute Are these costs considered in your decision to offshore your supply or outsource your manufacturing? Are they individually captured as a line item in your cost accounting system? Are they the components of your total landed cost calculations? TO OFFSHORE OR ONSHORE-THAT IS THE QUESTION Unfortunately, those enamored with lower labor costs and lax environmental conditions have moved a sustained portion of our manufacturing base overseas. In William Holstein’s article The Case for ONSHORING that appeared recently in Chief Executive Magazine, he says, “signs suggest that CEOs should give greater consideration to "onshoring," meaning never moving some critical functions offshore in the first place. Instead, they should deepen their investment in clusters that state and local regions

have already created, or are willing to create.” According to Holstein, “Therefore, where competitive advantage resides—it is best to manufacture the most advanced products in a place that allows it to maintain the feedback loops among internal and external constituencies.” “That implies a rebalancing of strategy, a rethinking of the impulse to offshore and outsource at the drop of a hat and to rely on supply chains reaching around the world,” states Holstein. For example in Holstein’s article, Intel Capital Vice President, Keith Larson, thinks that some CEOs are too quick to chase cheap offshore labor. "What happens is that people often don't do a thoughtful evaluation of why it makes sense to invest overseas versus the U.S.," he says. "A lot of times, there is a very quick judgment." Let’s define some of the counterstrategies to offshoring. We have what is known as onshoring which is the transfer of a business process or service to the non-metropolitan areas in the same country as the business, but where the costs of labor and operations are lower. While nearshoring is moving the business process to a foreign country that is relatively close by, for example American businesses nearshoring to Mexico. On the other hand, backshoring is the trend of returning manufacturing from an offshore location to the home country where it was originally based. And reshoring is backshoring which can lead to onshoring (lower cost locations in the home country) or nearshoring (lower cost options in a home country’s specific geographic region). According to published information, many large companies have made public plans to reshore portions of their manufacturing to the U.S. over the past two years, including Hurst, Master Lock, GE Appliance, NCR, Peerless Industries, Otis Elevator, and Shinola. Taken together, total supply chain costs consume about 7 to 12 percent of corporate annual revenue across all industries. Now with the global economy forcing many to reevaluate the supply chain, there can be a good business case to bring manufacturing back on-shore or to the USA! However, according to statistics recently released by the Federal Reserve Bank of Philadelphia, it shows that onshoring has declined over the past two years. Only 4.5 percent of manufacturers surveyed indicated that they had brought work back to the U.S. since the beginning of the year, compared to 6.2 percent in a survey two years ago. A recent 2011 survey of 287 manufacturing companies conducted by Accenture found that they needed to rebalance their existing supply footprint to better match with demand at various locations in order to compete effectively. The majority of the respondents (61 percent) said they were currently considering shifting their manufacturing operations closer to customers to provide better service and accelerate growth. “Companies are beginning to realize that having offshored much of their manufacturing and supply operations away from their demand locations [has] hurt their ability to meet their customers’ expectations across a wide spectrum of areas, such as being able to rapidly meet increasing customer desires for unique products, continuing to maintain rapid delivery/response times, as well as maintaining low inventories and competitive total costs,” the Accenture report noted. THE “SHOULD COST” CHALLENGE By way of illustration, let’s assume a customer located in Pennsylvania approaches its screw machine supplier (screw machines allow turned parts to be produced on a time-efficient, fully mechanized schedule while still retaining a high degree of precision), a job shop near Minneapolis, with a "cheaper Southeast Asia supplier price" in hand for a key part that they currently make. In response, the Minneapolis job shop points out a quality issue—that screw machines allow turned parts to be produced on a time-efficient, fully mechanized schedule while still retaining a high degree of precision. And, they ask does the Southeast Asia supplier use a Swiss screw machine like they do. Why is this important? Usually, Swiss screw machine products and turned parts have very tight tolerances which are different from the parts produced by other screw machines.

Therefore before relocating the work, we decide to do a quick "should cost analysis" together. Our breakdown looks beyond the piece price plus a slower intermodal freight cost from Southeast Asia and counts such factors, among others, as: • • • • • • Increasing lead time from 12 days to 95 Exorbitant additional inbound freight charges Customs duty and brokerage fees Extra inventory investment Carrying costs for additional safety stock inventory Increased warranty and scrap costs Based on the above analysis, instead of re-sourcing to Southeast Asia, the customer pursues the total landed cost, quality, and lead time savings with its current screw machine supplier in Minneapolis. As reported in the Cherokee Chronicle Times, Mark Buschkamp, CAEDC (Cherokee Area Economic Development Corporation in Cherokee County, IA) Executive Director, says “So the seemingly initial cost savings (price)—the reason why many, if not most, U.S. manufacturers jumped into an offshore strategy with both feet—are no longer that great. In fact, they are diminishing.” Harry Moser, founder of the Reshoring Initiative, for example, argues that if U.S. manufacturers take into consideration the “total cost of ownership” for products made in China but destined to be sold in America—transportation costs, reject rates, foreign wage inflation, potential intellectual-property theft and other factors—the United States compares favorably with China and other so-called low-cost countries. To help quantify his argument, Moser has developed a software tool—TCO Estimator V.5—that compares the costs of manufacturing parts and tools five years into the future in 17 countries, based on 29 factors (such as freight and wage rates). The Hackett Group's 2011 Supply Chain Optimization Study which focused on how manufacturers are responding to rapidly changing supply chain cost drivers found that companies are exploring reshoring as an option for nearly 20 percent of their offshore manufacturing capacity between 2012 and 2014. Based on the study, “Total landed manufacturing cost continues to be the leading factor in companies’ site selection. The key components of this cost are raw-material and component costs, manufacturing costs, transportation and logistics, inventory carrying costs, and taxes and duties.” According to The Hackett Group, the cost differential between other developing nations and the United States is as much as 20%. As long as the majority of manufacturers—85%, according to the study— measure cost as the main driver in site selection, manufacturing is likely to remain offshore. SUPPLY BASE RISK DEPENDENCY The World Economic Forum’s 2012 Global Risks Report suggests that the events of the past years have highlighted the systemic nature of global risks and the need to rethink how to manage and respond to them—indicating a shift of concern from environmental risks to socioeconomic risks compared to a year ago. Respondents worry that further economic shocks and social upheaval could roll back the progress globalization has brought, and feel that the world’s corporations, institutions, and countries are ill-equipped to cope with today’s interconnected, rapidly evolving risks. Reverting to “business as usual” could have serious implications in the long term. Warren Buffet famously said that "risk comes from not knowing what you're doing". Does your organization? In 2008, the majority of supplier markets became more volatile, as uncertainty increased because of the financial crisis. Panjiva, an objective information source on global suppliers, in February 2008 released a startling analysis that highlights the dramatic impact of the economic downturn on global suppliers. Panjiva’s analysis of the apparel industry in the second half of the 2008 reveals staggering statistics, including: • The number of suppliers actively serving the U.S. market dropped over 70% in just three months; from 22,099 suppliers in July to 6,262 suppliers in October.

• Of those factories still active in October, 40% are now on the Panjiva Watch List as a result of suffering a year-over-year drop of 75% or more in volume shipped to U.S. customers. • The Panjiva Pain Index, a measure of the risk present in the global supply chain, stood at 43 at the end of October, up from 24 at the end of July. The results of a recent survey, covering 35 countries, released by the Business Continuity Institute (BCI) shows that over 70 percent of organizations recorded at least one supply chain disruption in 2010. In BCI’s survey where businesses have shifted production to low cost countries they are significantly more likely to experience supply chain disruptions, with 83 percent experiencing disruption. The main causes of supply chain impacts on business continuity were transport networks and supplier insolvency, as BCI’s survey points out. The increasing velocity and length of global supply chains has left many with more questions than answers; therefore, organizations need to get a better handle on the risks and interdependencies in the supply chain. And as the supply chains get leaner, there is less ability for the supply chain to absorb or “soak up” the shocks that occur. For procurement, risk management represents the process of measuring or assessing risk and then developing the right strategies. Unfortunately, according to many, including AMR Research, such ideal circumstances don’t always occur. The research firm says companies—especially those that frequently buy from smaller and potentially more vulnerable organizations—need to be on the lookout for symptoms that a supplier might be unable to weather the current financial storm. AMR Research suggests keeping an eye out for the following ten warning signs of a supplier at risk: 1. The supplier has a large part of its businesses in depressed industries 2. It has raw material shortages, or cannot meet the agreed upon lead-times because of late purchase order placement 3. It has heavily cut investment in R&D, IT, capital equipment and/or resources 4. The quality of supply is deteriorating 5. The supplier has entered into significant contracts with new customers 6. Staff is being laid off, and your salesperson is nowhere to be found 7. Additional discounts are offered for early payment or require cash in advance 8. The supplier is restating earnings and outlooks 9. It has high labor content that requires a large weekly payroll 10. The supplier has absorbed heavy, upfront R&D and manufacturing tooling investments on new products that are delayed—therefore extending the time to break even As reported in ICIS Chemical Business in September 2011, “The financial upheaval of 2008-2009 has also resulted in some producers shutting down, making it more difficult to find sustainable, consistent suppliers for many products.” "Companies have gone out of business and some have decided it is not economically viable to produce a certain product any more. The number of producers is quickly diminishing, especially in Western markets," another buyer says. "You can usually find someone in China or India willing to supply the product, but you have to make sure the supply chain and lead times are going to work. This creates more challenges." Smaller suppliers have been hit harder by the downturn, creating lingering concerns about their stability. "You become concerned about whether they are going to go out of businesses, or will be able to meet your requirements," another purchasing professional says in the article. As we face the potential for a shrinking supplier base will this also impact supplier capacity to meet customer demand? It appears that the smaller, independent suppliers are going out of business or being discontinued, while the big supplier corporate families seem to be getting bigger through mergers and

industry consolidation. For those that frequently buy from smaller, and potentially more vulnerable organizations, you need to be on the lookout for symptoms that a supplier might be unable to weather the current financial storm. CONCLUSION As organizations have outsourced or low cost country sourced to developing countries, they unknowingly have taken on greater exposure to risks and uncertainty as well as the hidden costs of offshoring and outsourcing. Let’s start doing the necessary sourcing decision due diligence that includes a supply risk assessment and a ‘true’ total landed costs calculation before offshoring or outsourcing. So please get this discussion going within your company before you start re-sourcing some of your overseas based manufacturing. If so, make sure it’s based on a sound re-evaluation of your offshoring and outsourcing strategies as well as a ‘true’ numbers based “should-cost” challenge. About the Author: Thomas Tanel, C.P.M., CTL, CCA, CISCM is the President and CEO of CATTAN Services Group, Inc. headquartered in College Station, Texas, a supply chain advisory, counseling and training firm. He has an international reputation as a Subject Matter Expert, Consultant, and Seminar Leader in Logistics and Supply Chain Management. With over 38 years of experience, he offers a seasoned perspective on purchasing, supply management, and logistics through his line, teaching, staff, and consulting positions. Tanel is a Certified Purchasing Manager, a Certified Cost Analyst, and a Certified International Supply Chain Manager, as well as being certified in Transportation and Logistics, Tom is a seasoned, global veteran with experience spanning the United States, Asia, Australia, Canada, Mexico, the Caribbean Basin, Europe, Middle East, and South America. A respected practitioner, his more than 80 articles and insights have appeared in numerous professional magazines and trade journals.

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