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Copyright 8 2011 by Dr. David M. Anderson, P.E., CMC
Outsourcing article below.
Outsourcing manufacturing for cost, as a rule, will not result in a net cost savings because of hidden overhead costs and because it inhibits, compromises, or thwarts 6 out of the 8 cost reduction strategies presented on the home page: Half Cost Product Strategy.
Outsourcing manufacturing separates manufacturing from engineering and thus thwarts Concurrent Engineering and compromises the 80% of the cost determined by the design. Further, transferring, supporting, and dealing with quality problems of remote manufacturing absorbs many resources in engineering (in one case, 75%), manufacturing, and purchasing whose time would be better spent developing low-cost products. See Cost Reduction by Design summary and the article Design for Manufacturability
Outsourcing manufacturing to distant contract manufacturers increases the delivery time, which makes it hard to pull parts just-in-time. Further, parts may be batched for shipping, which is opposed to the one piece flow aspects of Lean Production. Finally, outsourcing manufacturing removes production from the control of the OEM manufacturer. All of these effects conspire to:
Make it hard to implement standardization because contract manufacturers' preferred parts probably won't correspond to your standard parts, so, in order to realize the production benefits of standardization, part numbers may have to be changed, which may increase a company's part proliferation.
Make it hard to optimize supply chains; see Supply Chain Management Cost Reduction summary and details below
If all 8 cost reduction strategies are implemented, the cost
savings will be much greater than appeared possible through outsourcing.
From the book A Build-to-Order & Mass Customization@ Copyright 8 2008 by Dr. David M. Anderson
Lately, there has been a lot written about core competencies, usually presenting the seemly logical argument that companies should focus at what they are A good at@ and outsource the rest to someone who is A better at it.@ However, this cart-before-the-horse strategy results in the corporate business model being determined by a collection of A whatever everyone happens to be good at the time.@ This often leads to the conclusion that manufacturing is not a core competency or that contract manufacturers could A do it better.@
Rather, the business model should decide the set of core competencies that are needed and decide which core competencies need to be developed to support the business model. If the company wants to enjoy the benefits of the Cost Reduction Strategy then it will have to make conscious decisions about core competencies that optimize the degree of outsourcing and internal integration.
For the past several years, many companies have been outsourcing more and more of their operations in order to focus on A core competencies,@ such as research, development, sales, and only the final assembly aspect of manufacturing.
Some companies have even outsourced manufacturing altogether. Here is an example the logic that justifies such a move. The head of third party manufacturing for a major food company, in discussing core competencies, used the following analogy: AFor example, maintaining roofs and parking lots is not a core capability of ours, so we would look to an outside company to provide this service. The same applies to manufacturing operations.@1 What this company is saying is saying is that manufacturing is being compared importance to roof and parking lot maintenance!
In the last several years, much of part manufacture and material processing was outsourced to A specialists@ who were assumed to be A better at it,@ thinking that this would save cost and increase profits. Jeffrey E. Garten, Dean of the Yale School of Management, referred to an A obsession among global CEOs to lower production costs by outsourcing whatever they can to large-scale specialists.@2
Some companies have outsourced production in an ill-advised attempt to minimize the money tied up in capital equipment to try to maximize return on capital, as summarized by a recent Business Week article:3
A In the bid to boost return on capital and hone their core competencies, even the staid industrial giants of Germany and Japan are starting to sell off factories. They then award long-term contracts to outside suppliers B often the same companies that bought their plants.@
Unfortunately, too much outsourcing has complicated the supply chain with more A links in the chain,@ more transfers, and longer lead-times, especially when there are sequential A tiers@ through which materials and parts must pass on the way to the assembler. In the slow, stable days of mass production, this worked all right, since assembly could be safely scheduled in advance and there was plenty of time to order and deliver batches of parts from outsourcers. But now markets are changing so fast that the most competitive companies will need to build products on-demand and will need their parts and materials delivered quickly on-demand. Thus, the long-lead times created by far-flung supply chains will be no longer acceptable. Further, outsourcing is at odds with the inventory-less aspect of lean production and build-to-order, since outsourcing is usually a batch operation.
And in many cases, excessive outsourcing makes it hard for manufacturers to control costs and quality and to optimize profits which often drift away from assemblers to suppliers. Furthermore, the illusion of outsourcing saving A cost@ will be shattered, as will be shown below, when companies measure total cost and consider the value of responsiveness, customization, and the A opportunity costs@ that are not lost with advanced business models.
Outsourcing. The dictionary definition of outsourcing is A the procurement or services or products, such as the parts used in manufacturing a motor vehicle, from an outside supplier or manufacturer in order to cut costs.@4 The myth of saving cost from outsourcing has even crept into dictionary definitions!
In order to help managers overcome popular hype and understand how outsourcing affects business models, a more precise definition will be needed for manufactured products:
Outsourcing is the procurement from outside suppliers of non-standard parts, subassemblies, modules, or manufacturing or warehousing services.
This definition would not apply to raw materials and off-the-shelf parts (that are encouraged in the DFM article), which are considered to be standard, meaning that they have no variations and have widespread use throughout lean factories. This is an important distinction since standard parts and raw materials can be procured from the outside through steady flows or automatic resupply techniques, like kanban and therefore support spontaneous supply chains.
Integration. The word integration has varied and misleading definitions and is often considered outmoded or associated with the obsolete paradigm of mass production. The phrase vertical integration usually brings to mind memories of Henry Ford= s enormous River Rouge plant that had iron ore coming in one end and finished Model T= s driving out the other.
However, in the rapidly changing world of build-to-order and mass customization, certain operations that affect speed, cost, variety, innovation, or quality may need to be brought in-house, in other words, integrated, to (1) avoid delays through long, possibly multi-tiered, supply chains, (2) mass-customize parts as an integral process of product customization, (3) maintain control over innovative parts, products, or processes, (4) assure quality first hand, and (5) minimize the total cost of all operations, especially with coordinated efforts to eliminate inventory and setup. Therefore, integration would be defined as:
Integration refers to the production of parts or related manufacturing operations in-house or by a nearby supplier in which such operations are integrated into subsequent steps to the point where any needed parts could be quickly built on-demand based on spontaneous pull signals in any quantity without forecasts or inventory.
A supplier that operates in an integrated mode, according to the above definition, would not be considered outsourcing, since the supplier would function more like an integral part of a cohesive manufacturing operation than the typical arm-length outsourcing arrangement.
Labor and materials, the focus of most outsourcing decisions, are a small part of the only A cost@ that matters B selling price, as will be discussed in the article, Total Cost Measurements. And the selling price contains many cost elements besides labor and materials, such as all the costs of inventory, setup, change-over, material overhead, customization, quality, product development, equipment, tooling, and distribution. Having control of the supply chain enables manufacturers to drastically reduce all of these costs in the following ways:
$ Labor costs (both direct and indirect) can be greatly reduced by Lean Production and Design for Manufacturability (DFM).
$ Quality costs can be reduced by these plus effective quality programs that can reduce quality costs from a substantial percentage of revenue5 to the insignificant levels of six sigma (which represents the statistical goal of about three defects per million).
$ Material overhead, procurement, and information system costs can be greatly reduced by standardization, product line rationalization, and automatic resupply techniques line kanban.
$ Product portfolio planning, standardization, and modular design can reduce product development cost.
$ Build-to-order and mass customization can reduce the costs of customization and distribution and eliminate the costs of finished goods and WIP (work in process) inventory, inventory obsolescence, setup, kitting, scheduling, tracking, and inefficient utilization of people and equipment.
In order to reap all these potential cost savings, the manufacturer must ensure that all costs are minimized throughout the supply chain. Even if it appears that most of a product= s cost comes from purchased parts and subassemblies, total cost reduction opportunities abound at every subcontractor and part manufacturer; see Cost Throughout Outsourced Supply Chains.
In an article discussing IBM= s sale of its PC assembly operations to an outsourcer, the Wall Street Journal observed that IBM often took a loss on PC sales and A hasn= t been able to match the low costs of market leader Dell Computer Corp.@6 But, ironically, Dell gets its cost advantage from its ability to assemble PCs to-order and ship directly to customers from factories that are dedicated to the flexible assembly of their own products (see Introduction), not contract manufacturers that build a batch of products for one client and then shift to building another client= s batch.
It may be difficult or impossible to arrange an outsourced
supply chain that is proficient in lean production, DFM, six sigma quality,
standardization, automatic part resupply, and on-demand built-to-order of parts.
So unless the supply chain consists of extremely cooperative suppliers in close
physical proximity, it will be necessary to keep in-house enough operations to
gain control of cost and speed.
Some recent business books, like Slywotzky and Morrison= s Profit Patterns,7 recommend that companies A reintegrate the chain to capture the profit in the system.@ The authors state:
A When value shifts occur up and down the value chain, the challenge is to expand the scope of the business model to include activities that were once viewed as upstream or downstream from your own position.@
Excessive outsourcing has had a profoundly negative effect on
profits in certain industries. Personal computer manufacturers continue to
struggle with very low profit margins, and yet their suppliers of
microprocessors and operating systems reap the highest profits in the industry.
And now, with all that profit, both Intel and Microsoft are able to expand out
of their traditional roles to capture a bigger share of certain electronic
One of the great ironies in the outsourcing/integration debate is that as assemblers outsource more and more, the outsourcers themselves are buying up their suppliers to become more integrated. Lear Seating Corporation, Johnson Controls, and Magna International, major tier one suppliers of seats for automobiles, have been buying up related suppliers to be able to offer entire car interiors.8
Similarly, Solectron and Flextronics, leading electronic contract manufacturers, who has benefitted greatly from the outsourcing craze, have themselves been pursuing an integration strategy by acquiring some of their parts suppliers. A recent Business Week article on outsourcing summarized the trend:9
A While many gurus rave about virtual corporations, Flextronics and its rivals have been quietly picking up the abandoned brick-and-mortar pieces and reassembling them into new versions of vertically integrated empires.@
This may start two trends: First, reintegrated contract manufacturers may eventually become competitors as they migrate to building and selling their own products, as many outsourcers have begun to do including Korean= s giant LG Electronics.
At one time Schwinn was such a dominant manufacturer of bicycles that when asked about competition, their reply was A We don= t have competition; We= re Schwinn.@ 10 But a series of bad decisions ruined the company and led to its bankruptcy in 1992. One of those decisions was Schwinn= s ill-fated attempt to cut cost by outsourcing to China. The quality was poor, so Schwinn taught the suppliers how to build bicycles. But in the process, Schwinn enabled the Chinese supplier, Giant, to become a formidable competitor.11
The second likely trend is that OEM assemblers, who might
have shed parts operations to concentrate on
A core competencies,@ now may
want to selectively acquire, or reacquire, parts manufacturers to ensure part
availability and exercise control of supply chain cost and speed. However, speed
may still not be adequate if the acquired part producer is too far away, as will
be discussed next.
Outsourcing slows down supply chains if any of the following conditions exist, which are quite common for outsourcing:
(1) If suppliers are too far away, then the shipping time would slow down any attempts at rapid responsiveness and build-to-order. And even if the supplier could build batch-size-of-one parts on-demand, those parts may have to be A batched@ into a daily shipment, or greater interval.
When increased border security in late 2001 caused shipping delays in the U.S., the popular press commented that this A exposed like never before the risk inherent in > just-in-time= manufacturing.@ Deloitte Consulting said A some of its clients are beginning to question the fundamental tenets of just-in-time.@12 However, rather than challenging the wisdom of just-in-time, whose value been proven for decades, companies should be challenging the wisdom of far-flung supply chains and outsourcing all over the world to get the A best cost.@ Overseas shipping will slow down as on-going security procedures are implemented to force shippers to list contents of shipping containers;13 if inspections become required, overseas shipping will encounter even more delays. Thus, as the manufacturing speed becomes more important, vertical integration and having nearby suppliers will provide another advantage B immunity from long-distance transportation delays.
(2) Multi-tiered supply chains slow down responsiveness even more, when each supplier must wait for parts and subsystems to arrive from its suppliers. Every additional tier can add days or weeks to response time.
(3) If locally outsourced parts are made in batches (as is usually the case), this would not only take too long, but it would also be contrary to the inventory-less aspect of build-to-order.
(4) If production has to wait for the outsourcers to finish other jobs, then there will be additional delays.
Outsourcing high-volatility parts can cause product shortages because contract manufacturers may not be flexible enough to rapidly increase production due to the above reasons. Theoretically, an outsourcer could set up another general-purpose line to meet demand spikes, but only if the order was large enough to justify the conversion and other lines were not already committed to, and set up for, other jobs. In contrast, flexible factories could shift demand to other lines without such large step-function inhibitions.
Even financial analysts are starting to realize the shortcomings of outsourcing, for instance, when they questioned the wisdom of British telecom equipment maker, Marconi, which sold off most of its manufacturing plants to a contract manufacture. Analysts questioned the long term sense of such a move pointing out that A many companies believed it important to retain control of manufacturing to ensure speed-to-market and high quality.@14
Similarly, Hewlett-Packard is selling its PC operations to
outsourcer Sanmina-SCI to focus on A
core competencies,@ including,
ironically, supply chain management and supplier management.15
Any yet HP= s biggest challenge is
competing against Dell Computer, which assembles PCs to-order in its own
factories and whose Build-to-Order and ship-direct model is the source of its
significant cost advantage.
Typically, contract manufacturers make parts or products in batches as specified by contracts, hence the name. They usually build or assemble several clients= products in the same facility on general-purpose production equipment. Each A run@ will be set up with each customer= s unique parts and procedures and possibly with unique fixtures and tooling. As in any mass production operation, the setup costs must be amortized over whatever is built, thus encouraging large batches of identical products and discouraging variety. In addition, the response time may be lengthened if the production run has to wait for lengthy setups or other jobs to finish first. Furthermore, if the outsourcer is far away, there may be more delays to wait for enough parts to fill a shipping container or truck.
Responsiveness will be significantly delayed if the outsourcer has to wait to order and receive its parts and material. If the outsourcer tries to order parts and materials ahead of production based on forecasts, it will encounter the usual problems of forecasting: shortages, expediting, excess inventory, missing parts, and delayed production.
Accommodating even a moderate range of standard product variety will be difficult and mass customization will be almost impossible at the mass production contract manufacturers.
Outsourcers may argue that they can shift production to many lines to accommodate peaks and valleys of demand, but only if the lines are not busy or contractually obligated to other customers. In addition, expanding to another line would require costly and time-consuming setups; even quick change tooling and common fixturing would not avoid the setup to load each customer= s unique parts.
Contract manufacturers could avoid setup changes by dedicating a line or even a plant to one customer. But the outsourcers may require linear demand (or charge for lack of it) to avoid low equipment utilization or having to change the setups of other lines, as discussed above.
To become flexible, outsourcers would need to implement Lean Production, Build-to-Order, and Mass Customization principles. This would include the ability to pull in materials and parts on-demand, if necessary, from its suppliers who also practice Build-to-Order. Of course, for the outsourcer to be able to do this, the customer would have to cooperate by designing products around standard parts and materials that could be pulled into production and available at all points of use.
Such an arrangement would require the customer to commit to
enough long-term work so the outsourcer would commit to implementing the
customer-specific lines or plants.
In order to produce high quality products, the quality of parts and materials must be assured throughout the entire supply chain. Internal production is under the direct control and influence of the manufacturer. And all the aspects of quality can be assured as part of a holistic approach. Under these conditions, Six Sigma programs have the best chance of achieving six sigma quality levels.
On the other hand, it is often hard to consistently assure the quality of outsourced production. An alarmingly large percentage of the quality problems that occur are caused by outsourced parts or product manufacture. This is because most manufacturers try to control the quality of outsourced production indirectly through specifications, which are usually too simplistic to assure all the aspects of quality or, if specifications try to A nail down@ all aspects of quality and reliability, the process becomes so cumbersome that it adds more cost, delays production, and strains relationships. Outsourced quality is even worse when suppliers are selected based on low-bidding instead of a supplier= s reputation for quality production (see the section in Chapter 7 on low-Bidding).
One of the common reactions to poor outsourcing quality is to dispatch teams from the assembler to A fix the problem,@ but this can be difficult to fix completely. The effort to try will expend money and consume valuable calendar time. This may delay new product launches or keep the assembler from to meeting demand. One of the author= s clients outsourced all its printed circuit board production, but at one time the quality was so bad they had to stop the line. Being a Six Sigma company, they sent their A black belts@ to analyze the data and apply six sigma principles. But, the outsourcer didn= t keep enough records to analyze!
In general, outsourcing makes it harder, maybe impossible, to achieve Six Sigma quality levels because of the lack of control and disconnects caused by distances, different time zones, and varying quality cultures. Further, it is unlikely that the outsourcer will be using dedicated, one-piece flow lines since outsourcing is usually a batch operation with frequent changeovers from one assembler= s products to another (see Defects by the Batch and Assuring Quality with One-Piece Flow. Outsourcers that brag about A six sigma quality@ operations may have only achieved that performance for their highest volume operation that has enough volume to warrant a dedicated line and enough effort to please an important client.
The most time-consuming, expensive, and risky response to
solving outsourcer quality problems is to teach the outsourcer how to
make your products. As Schwinn found out the hard way, after they taught their
suppliers how to build bicycles, the suppliers became formidable competitors.
Outsourcing manufacturing usually has the unfortunate result of separating it geographically from product development engineers. This can thwart both design for manufacturability and concurrent engineering and compromise product development success.
In Design for Manufacturability, design engineers must design products to be easy to manufacture in existing processes, which is hard to do if the manufacturing processes are far away for two reasons:
(1) Most design engineers are not very familiar with manufacturing processes, so being able to observe them and talk to plant people can greatly improve the manufacturability of their designs; and
(2) Multi-functional product development teams optimize manufacturability with early and active participation by manufacturing engineers. This is only feasible when they are working nearby in the manufacturing environment that will actually build the products being designed and, as company employees, can be assigned to actively participate on product development teams. Design for manufacturability is even more difficult when outsourcing arrangements keep changing when foolish companies chase cheap labor and change vendors for a new low-bidder.
In concurrent engineering, design engineers need to concurrently develop both products and new processes that do not already exist or may have to be modified from existing processes. In order to do this, it is imperative that design engineers work closely with manufacturing personnel and equipment developers from the earliest design activities through equipment/tooling development to product launch. Again, the only feasible way to do this is if manufacturing operations and the appropriate people are nearby. Separation is even worse for overseas manufacturing where the time zone difference is greater than nine hours, in which engineering and manufacturing people will not be working at the same time, thus limiting communication to one round of e-mail per day.
Sometimes companies are forced into outsourcing because of the design itself. Any time engineers design parts, modules, or subassemblies that are outside the capabilities of internal processes, they eliminate the option for internal production. If this occurs for a significant portion of the design, the company will lose control of a significant portion of cost, quality, variety, and delivery.
In the worst cases, engineers base the product architecture around a custom A mega-piece@ with few, maybe only one, supplier who can build it. This means that a large percentage of the product= s production will be outside the control of the OEM (Original Equipment Manufacturer). If the outsourcer is not good at DFM and doesn= t work with well the OEM, costs may be high. Similarly, quality, delivery, and ability to handle variations may be insufficient. Trying to A reduce cost@ or improve quality, delivery, or variety may be difficult, if not impossible, especially if your business is a very small percentage of your supplier= s business.
A sad example is a robot company that developed a robot based
on a combo electric motor unit that had three electric motors stacked end-to-end
with three concentric shafts coming out one end. After the product was designed
and outsourced, the company realized the robot cost was too high, so they went
to the supplier to ask for cost reductions on the motor unit, but they were
unsuccessful because (1) cost is designed into the product and very hard to
remove, which is a key principle of Design for Manufacturability, and (2)
this company represented less than one percent of that supplier=
s business, so it could not get enough of the suppliers attention to initiate
Many companies have drawn an arbitrary line between
and A them,@
simplistically defining their companies as assemblers and their suppliers as
part manufacturers. Usually these policies evolve from naive notions about core
competency. However, such arbitrary demarcations can significantly raise cost by
eliminating opportunities to optimize manufacturability. Outsourcing itself may
require excessive modularization with more interface problems. This may preclude
opportunities to fabricate monolithic structures on-site. For example,
outsourcing strategy can dramatically compromise manufacturability when large
chunks or airplanes are outsourced, thus eliminating the possibilities for a
Not only is it important to have nearby and A on-board@ support to concurrently engineer special processes, the actual production may need to be done in-house because it may be too difficult or proprietary for outsourcing (sometimes called virtual operations) to perform. Outsourcers may not even bid on challenging processes, since they prefer predicable jobs that use their standard processes. According to Harvard= s Clayton M. Christensen, author of The Innovator= s Dilemma:
A When companies have to push the frontiers of performance, managerial coordination is essential. That= s right - virtual operations won= t work on the bleeding edge.@
A Also, engineers don= t yet understand how changes in design affect manufacturability or how subtle changes in manufacturing methods affect performance.@16
Professor Christensen cites examples of IBM choosing to build in-house their leading-edge magneto-resistive (MR) disk drive recording heads for these reasons. He draws the same conclusion about Cisco Systems, Inc., which has so far has outsourced most of its manufacturing as well as new product development:
A But as Cisco
has moved into the most performance-demanding tiers of its markets
B particularly optical networks
B it is being forced to integrate,
performing many product design and manufacturing activities internally.
Cisco= competitors are finding
that they have to become less virtual in order to compete.@
Companies that selectively outsource must decide which products to outsource, but most companies outsource the wrong products and parts.
Many companies outsource their newest products and the cash cows B even the A crown jewels@ B while retaining older legacy products, spare parts, and oddballs. However, the latter group consumes excessive resources and makes the least profit on a total cost basis. Ironically, many of them should have been rationalized away.
Given the compelling reasons presented in herein, one might ask why companies outsource their cash cows while retaining the losers and the oddballs. One answer might as simple as jumping on the bandwagon A because everyone else is doing it,@ even though they only think they are saving money and don= t realize the competitive consequences. Perhaps another reason is that outsourcing may be a way to avoid systematic improvements with a seemingly easy A silver bullet@ solution.
Another reason might be that the new designs are A cleaner@ with better documentation. Granted, older products may have poor documentation and this is a corporate karma that comes back to haunt companies sooner or later. But that does not mean it should dictate outsourcing strategy. Rather, the business model should determine which products should be outsourced, even if some documentation has to be cleaned up to accomplish this.
The Lean Production/Build-to-Order business model works best when internal operations assemble products in synergistic families with standard parts flowing in or high-variety parts built on demand. This has two important implications on outsourcing strategy:
1) Outsourcers are unlikely to be able or willing to do Lean Production and BTO as well as could be done internally.
2) Internal Lean/BTO operations should not be compromised
with older legacy products, spare parts, or oddballs that are not compatible
with such an operation because of unusual parts, materials, processes, and
Savvy companies that develop half cost products have different criteria for outsourcing with the following situations benefitting from outsourcing.
Oddball products. One of the best uses for outsourcing is to outsource A oddball@ products to free flexible plants from the burden of building the low-volume, unusual products that have the most unusual (and longest lead-time) materials, the least optimized processing, the most setup times, and the highest overhead demands. Some of these may be simply dropped by implementing product line rationalization because they really aren= t making enough money. The remaining oddballs that still must be in the catalog should be outsourced.
One of Dr. Anderson= s clients, Hoffman Engineering, constructed a plant to build a wide variety of electrical enclosures on-demand. The operation was so good that when competitors saw it, they realized they couldn= t compete directly, so they made a deal to be the outsourcers for products that do not fit into Hoffman= s BTO plant.
Spare Parts. Companies need to assure that spare parts are available to customers, even on products that are out of production, but that does not mean they have to build spare parts in their own plants. Some companies keep building them A at any cost@ because of inertia or because they fell they are only ones that know how to do it. Often managers believe that spare parts are profitable, because their reported costs were calculated when the product was manufactured at high volume. However, many spare parts are big money-losers, especially after sales decrease for the associated products or they go out of production. Further, spare parts production can be disruptive to ongoing operations, especially if the manufacturer has implemented lean production, build-to-order, or mass customization. Spare parts production should be outsourced except for certain parts that can be produced quickly and cost-effectively on current flexible lines. Documentation may have to be cleaned up and some transfer effort may be required. But these one-time costs will be paid back several times over by avoiding the costs and disruptions of the fire-drills caused by spare parts production. Further, focusing Lean/BTO factories entirely on suitable product families will enhance the business model and generate higher corporate profits.
Older Legacy Products. As products age, volumes decrease and that usually causes more setup changes. Supply chain costs will go up from less purchasing leverage, greater efforts to locate hard-to-find parts, enormous efforts to design and locate replacements for obsolete parts, and significant costs and risks to arrange A end of life buys@ for parts that are soon to go out of production. Low volume part and materials that are different from current parts may not be suitable for automatic resupply techniques, like kanban and dock-to-line deliveries (Ch.7).
Older legacy products may no longer be compatible with current processing equipment or require excessive setup changes. Further, the fire-drills to gear up to build unusual parts would be incompatible with the operations, staffing levels, and talents of a lean plant.
One consequence of outsourcing oddballs, spare parts, and older legacy products is that their cost will appear to go up because outsourcing costs are total costs by definition. However, the apparent A low@ cost of in-house production of these low-volume products was an illusion created by conventional costs systems that failed to allocate the inherently higher overhead caused by these products.
Standard parts. It may be advantageous to outsource the production of standard parts that have widespread use, no variations, and are not likely to go obsolete. If these conditions are met, these parts can benefit from mass production economies-of-scale, especially if the parts have been standardized around high-volume industry-standard parts. These can be A procured@ by pull-based automatic resupply techniques, like kanban or steady flows, since these parts will be used one way or another. Thus, these parts may be suitable for outsourced batch production and less-than-rapid shipment.
Modularity. To eliminate interface complications, outsourced production should only be allowed for parts and modules with consistent, clearly-defined interfaces that are easy to integrate.
Skill, talent, and costly equipment. If the assembler lacks special skill, talent, and costly equipment, it may take advantage of a supplier= s capabilities providing all the other issues discussed herein are adequately addressed. Try to specify standard versions or suppliers= products. If these need to be customized, be sure to work together to make sure the customization can be done quickly and easily. It may be advantageous to encourage suppliers to implement mass customization techniques.
Company-specific lines. An innovative outsourcing arrangement would be for specialized outsourcing companies to set up company-specific parts production lines in or nearby assembly plants. These lines would build on-demand any part needed, be it mass-customized or standard products. The greater the range of parts, the more would be the need for the outsourcer to use Build-to-Order principles. The assembly plant would get near-instantaneous delivery in a seamless integration with their operations. Of course, for this to work, the demands of product assembly would have to be satisfied by the flexible capabilities of the parts lines, which would be structured to accommodate all the products in that facility. This may require that products be designed around these part lines or that product families and flexible part lines be concurrently developed.
Cooperation. For outsourcing to be successful, very good
cooperation is imperative in the form of supplier partnerships, where all the
suppliers work closely with the assembler to optimize cost, delivery, and all
aspects of quality and reliability. Outsouring proposals should be carefully
scrutinized for any suppliers whose relationships have been adversarial or in
any way uncooperative.
Many articles and books have proclaimed vertical integration as A out@ (as being so twentieth century!) and virtual integration as A in@ for the twenty first century.17 Books on about virtual integration define the virtual organization as A an opportunity-pulled and opportunity-defined integration of core competencies distributed among a number of real organizations.@ But such a distribution can: (1) slow down the supply chain if suppliers are too distant or build outsourced products in batches, and (2) add unnecessary shipping, inventory, and other overhead costs, as discussed above.
The supply chain requirements for spontaneous Build-to-Order are that all the parts and materials must be made available spontaneously. In order to accomplish this, the supply chain must be tightened by (a) arranging rapid on-demand delivery of parts and materials from suppliers or (b) bringing in-house any processes that have lead times or batch sizes incompatible with assembly responsiveness and inventory goals. Material cutting-to-shape
The supplier base needs to be narrowed to those who can make parts to the A pull signals@ of the assemblers. In fact, Product Line Rationalization will help shrink the supplier base by eliminating or outsourcing the most unusual products with the most unusual parts and suppliers. However, suppliers may not be suitable if (1) they are too far away for adequate delivery speed, (2) they are too entrenched in batch mass production, or (3) they are unwilling to make the necessary commitments and changes.
If it is not possible to arrange suitable suppliers, certain
operations may need to be selectively reintegrated in-house to eliminate
order/delivery lead-times and permit batch-size-of-one flexibility. This would
greatly simplify or eliminate the MRP-based purchasing normally needed to
procure these parts and materials from a diverse supply base. Further, in-house
production of parts on-demand can immediately feed assembly lines.
Old decisions about A core competencies@ will have to be revised to include supply chain responsiveness and operational flexibility as the basis of a new definition of core competencies. In some cases, long lead-time or large batch part production will have to be brought in (and streamlined) just to A complete the system,@ even if it is not considered a core competency.
For example, one of the Dr. Anderson= s clients, Badger Meter, of Milwaukee, Wisconsin, found it was able to manufacture a wide variety of water meters flexibly except the printing of the face plates, which had to cope with several ways of measuring water flow plus the logo of every utility customer. So they learned how to print face plates in small quantities to complete the plant= s flexible capabilities.
If a complete flexible manufacturing system represents the only such capability in the industry, then the assembler has a competitive advantage, which would help to justify such a move. In fact, the BTO&MC company could offer to build these parts on-demand to other companies, even competitors, thus expanding sales and widening its dominance of the industry.
Integration can improve profits because the integrated manufacturer has much better control over quality, variety, delivery, and many categories of total cost. One of the A profit patterns@ that Slywotzky and Morrison identify is a selective reintegration to maximize profits:
are increasingly facing situations where a partial reintegration of the
value chain is necessary if they are to earn an acceptable return on their
investments. As value migrates from one value chain link to another, players
are being forced to reintegrate in order to maintain strategic control.@
The following specific criteria can be used to determine what is best to integrate internally:
Cost. Pure assemblers usually assume that most of their A cost@ is part cost and therefore ignore opportunities to lower overhead costs. However, considering the total cost pie charts through an outsourced supply chain reveals that each subassembly breaks out into its own pie chart (with a higher percentage of overhead) and each of those parts again breaks out into its own pie chart with most of the cost being overhead. But, with an outsourced supply chain, the assembler has little visibility or control over these overhead costs throughout the supply chain. Cost A reduction@ efforts usually end up focusing on beating up suppliers; even more enlightened efforts, which try to work together to lower cost, are often stymied by lack of total cost data and resistance to change caused by suppliers not understanding their total cost situation.
Integration lets the assembler understand, measure, and thus control all the costs within its scope of operations. All these cost reduction strategies can be applied to minimize total cost not just at assembly, but also at subassembly production and parts fabrication.
Quality. Similarly, having control over production leads to complete understanding, measurement, and control over all aspects of quality, whereas outsourced production seeks to create an acceptable specification to quality, such as defects per million. However, quality cannot really be specified, especially by a single number; rather, quality needs to be assured by meaningful quality programs. Some suppliers do have effective quality programs, but many do not and may try to meet the specs through dubious measures like screening parts, which is expensive and results in a higher proportion of parts at the A hairy edge@ of not working.18
Variety. High-variety parts may need to built on-demand in-house. The Build-to-Order and Mass Customization techniques may be the only way to quickly and cost-effectively build high-variety parts. It is more likely that these capabilities will be much more effectively implemented internally than at suppliers.
Lead time. Product delivery time will suffer if suppliers cannot build parts on-demand, if the suppliers are too far away, or when there are many links in the supply chain. This may be a critical consideration when products are to be built spontaneously for rapid delivery to customers. However, lead time may be less important for capital equipment.
Availability. Internal production of parts may be able to ensure a steady supply of parts.
Size. Instead of outsourcing large modules, like airplane fuselage segments, in-house fabrication could build monolithic structures to minimize cost, weight, delivery time, flow time, shipping damage, and integration difficulties.
Interface complexity. If outsourcing forces more modularization, this may result in more interface complexity. This complexity and its problems can be eliminated by fabricating more monolithic parts in-house.
Special/flexible tooling. If special or flexible tooling is required, it would usually be better to develop and operate it in-house. Concurrent engineering of the product and tooling can produce both better tooling and better product designs B and keep improving them over time. Suppliers may be reluctant to develop such tooling without comprehensive contracts that, in turn, may not be in the best interest of the assembler. Further, such arrangements may be complicated by issues involving tooling ownership and access if the assembler wants to change suppliers or reintegrate the tooling later. In extreme cases, assemblers have been denied access to tooling that they own during bankruptcy or any other seizure when authorities paddle-lock the suppliers facilities and sort out tooling ownership issues later B usually much later.
Innovation. The higher the levels of innovation in both
product development and processing, the greater the need for in-house
manufacture, as Clayton Christiansen pointed out above.
The effect of distance applies equally to outsourced suppliers and company owned plants, many of which have been moved far from other supply chain links and customers A to save cost.@ However, in addition to not really saving cost on a total cost basis, creating great distances in supply chains slows down the flow of parts and products, in addition to eliminating the benefit of any flow in plants at either end since everything has to be batched to be shipped. This problem might have not been noticed in the mass production era of large batch forecasted production, but will become the A weakest link in the chain@ for quick-response endeavors like Lean Production, Build-to-Order and Mass Customization.
Womack and Jones, writing in Lean Thinking19
summarize it succinctly: A Oceans and
lean production are not compatible.@
They go on to say that smaller and less-automated plants close to assembly and
markets will yield lower total costs, considering the cost of shipping, the
inventory carrying costs, and the cost of obsolescence when products built weeks
ago no longer satisfy customers.
Another sobering consideration of getting parts from overseas is the vulnerability of major supply disruptions. The labor strife that caused the 10-day west coast port shutdown of 2002 was one example. A more ominous scenario was explored by 80 federal, state, and private industry representatives who participated in a two-day simulation on the economic effects of radioactive A dirty bombs@ discovered in American ports. After two hypothetical discoveries in three days, ports were closed and the estimated backlog of shipping containers grew within two weeks to 56,000 containers in the port of Los Angeles alone! The entire scenario took 60 days to recover and resulted in $60 billion in losses. One of the effects was that A inventory shortages spread throughout the manufacturing industry and factories began closing.@20 The vulnerabilities of building entire products overseas could be even greater. The bottom line is that companies that manufacture their products near their markets and build their parts internally or get them from nearby suppliers will be immune from overseas shipping disruptions.
While its competitors were moving high-volume production to low-cost countries overseas, Timken committed $150 million to build its most sophisticated factory in Asheboro, North Carolina. Not only is the plant closer to customers, but it is flexible to be able to efficiently manufacture in small batches without lengthy setups between batches (Ch. 8). Timken= s strategy is to build small runs of high-margin products in flexible domestic factories. Timken has remained profitable through the current recession.21
ENDNOTES/REFERENCES (See below)
For more information call or e-mail:
Dr. David M. Anderson, P.E., CMC
Cost Reduction Strategy (home page) Seminars Consulting Articles Books Site Map
1. Maria A Ferrante, “Outsourcing: Gaining the Manufacturing Edge,” Food Engineering, 69 (4): 87-90, April 1997.
2. Jeffery E. Garten, “When Everything is Made in China,” Business Week, June 17, 2002.
3. Rete Engardio, “The Barons of Outsourcing,” Business Week, August 28, 2000, p. 177.
4. Outsourcing definition from The American Heritage Dictionary of the English Language, Third Edition (1992, Houghton Mifflin Company).
5. Phillip Crosby, Quality is Free (1979, Mentor Books).
6. William M Bulkeley, “As PC Industry Slumps, IBM Hands Off Manufacturing of Desktops,” Wall Street Journal, January 9, 2002, p. B1).
7. Adrian J. Slywotzky and David J. Morrison, Profit Patterns, 30 Ways to Anticipate and Profit From Strategic Forces Reshaping Your Business, (1999, Times Business/Random House), pages 116-123, “Reintegration.”
8. Carliss Y. Baldwin and Kim Clark, “Managing in the Age of Modularity,” Harvard Business Review, September-October 1997.
9. Rete Engardio, “The Barons of Outsourcing,” Business Week, August 28, 2000, p. 178.
10. Sandra D. Atchison, “Pump, Pump, Pump at Schwinn,” Business Week, August 23, 1993, p. 79.
11. Sydney Finkelstein, Why Smart Executives Fail, And What You Can Learn from Their Mistakes, (2003, Portfolio/Penguin Group). pages 43 and 74.
12. Jeffrey Ball, “Chrysler Averts a Parts Crisis,” Wall Street Journal, September 24, 2001, p. B1.
13. “Shipping industry in Hong Kong May Fail U.S. Test,” The Wall Street Journal, January 3, 2003, p. A6.
14. Madeleine Acey, “Marconi Sells Plants; Shares Rise; Outsourcing Deal Will Net Jabil Circuits $4 billion; FT Market Watch, London, January 12, 2001
15. Mike Tarsala, “H-P plans to Outsource more PCs.” CBS Market Watch, January 17, 2002.
16. Clayton M. Christensen, “Limits of the New Corporation,” Business Week, special issue on The 21st CenturyCorporation, August 28, 2000, p. 180.
17. John A. Byrne, Business Week, August 28, 2000; Table: “What a Difference a Century Can Make,” page 87.
18. Anderson, Design for Manufacturability & Concurrent Engineering, Chapter 10, Design for Quality, p. 199.
19. James P. Womack and Daniel T. Jones, Lean Thinking, Banish Waste and Create Wealth in Your Corporation (1996, Simon & Schuster), p. 224
20. Gary Fields, “An Ominous War Game; Outcome of Dirty-Bomb Scenario Is an Economic Catastrophe,” The Wall Street Journal, December 4, 2002, p. A4.
21. Adam Aston and Michael Arndt, “The Flexible Factory; Leaning heavily on technology, some U.S. plants stay competitive with offshore rivals,” Business Week, May 5, 2003, pages 90-91.