Are You “Off-Shoring?”
Businesses are “in the business” of making money.
As Goldratt says in “The Goal” they are in the business of making more money “now and in the future.” Unfortunately, as part of the efforts to achieve that goal, often the focus narrows down to just money, and it is possible to lose sight of the numerous activities and qualities of the product or service that actually “MAKES” the money. This is perhaps clearest when we step back and look at the processes of procurement.
For decades now we have seen the shift to “offshore” moving manufacturing from higher cost first world nations to nations with lower labor and material costs. When your decision is made on unit price, and when the procurement division is evaluated (and rewarded) for finding the lowest price, it only makes sense. No real surprise here, and we all bought into it.
Lower costs for labor and materials means a lower cost product. The economics are deceptively simple--this allows the manufacturer and distributor to either have a higher margin, or compete more effectively in a market increasingly commoditized and focused on price. Unfortunately, we are seeing now the true costs, and the effects, of this race off shore, and it’s not just in lost jobs.
Often the true costs of relocating manufacturing overseas is not captured. The additional costs of procuring from offshore locations include shipping costs, increased inventory costs, and more qualitative costs associated with longer lead times and slower responses to quality problems. Volatility in international markets, for fuel, labor, and materials, also creates instability and uncertainty. For a period of time, lower oil prices make shipping long distances quite economical, but then, as prices climb, the costs of transportation seem to make an immediate case for “reshoring.”
Other cycles are at play in this process. Moving manufacturing from first world nations to locations offshore has served a noble purpose, improving the standard of living for citizens of the countries that are now the new homes for manufacturing. This improved standard of living causes upward pressure on labor costs, as the workers strive to improve their living situation and begin to purchase many of the goods they are now manufacturing. This then places pressure to once again move manufacturing to locations with lower (more affordable) labor costs, and the cycle resumes once again.
Tools such as the “Total Cost of Ownership Estimator” developed by Harry Moser have been developed to capture the quantitative impacts of offshoring. The TCO Estimator seeks to capture, as a percentage of unit price, the various costs of offshoring identified above. In addition, this tool attempts to translate some of the more qualitative elements, such as impacts on innovation, political risk, currency volatility, and risk to intellectual property.
This approach to capturing costs was discussed in 2010 in a paper “Adapting Baumol’s Inventory Theroretic to Landed Cost Decisions” essentially working to extend the equation (most commonly known as the basis for “EOQ” or the Economic Order Quantity) to include the additional costs of sourcing from various locations. As with EOQ, this approach sought to provide a mathematical framework for determining the optimal sourcing locations among a discrete selection set. You can find the article here: http://www.deltanualpha.org/pdfarticles/2010/spring/adapting.pdf
So here’s the challenge--are you “off-shoring?” If so, what decision processes have you incorporated into the reshoring decision? Are your decisions based solely on the purchased unit price, or are you incorporating a more robust analysis?
These are not rhetorical questions--these may well be the questions that determine the long term viability of your business.