Bananas Made in China - Making Outsourcing Work

It seems that there is not a board room in the world that has not been tempted to "go offshore" with their manufacturing, and most have done just that!

Has it worked?   In most cases yes, but in many cases it has exposed downsides that were not anticipated.  These drawbacks have occasionally had catastrophic results with some companies having to withdraw from their newly-discovered low cost supply sources, and others, most others, having to wear the newly-discovered consequences at a much reduced margin. 

In actual fact, the "downside" could have been predicted if only they were carefully analysed before proceeding.  In an age where "risk assessment" and risk management rule, this is a surprise.   The risks can easily be identified, now and before.

Inventory management practitioners and professional procurement specialists have always had doubts about the validity of the enormous savings being quoted to boards of directors over local supply.  But then, how often do professional practitioners get a hearing in a board room?

There's no doubt that the low wages and living conditions of the developing countries provide a goldmine for the manufacture of consumer goods, and this will be the case for generations.  But when the on-costs, quantifiable and unquantifiable, are considered it soon becomes apparent that "not all that glitters is gold!"

The following page shows a reproduction of the summary sheet of a cost modelling excel program. The page shown invites the input for all variables for a fictitious product sourced locally and sourced from off-shore.

The model compares the ex. Factory unit cost for a single product from a local source and an off-shore source.  Although using a contrived example it closely reflects a common scenario with costs drawn from JBMS files on freight tender management assignments.

The conclusion from the example is that, at least a 30% discount has to be on offer in order to break even at the unit cost level.
In addition to this the warehousing and inventory holding-related costs will almost treble!

This is before the risk from other factors involved are considered but can't be quantified.

 Cost model showing that a 30% discount is required to break even at unit cost level and that inventory related costs increase almost 3-fold.
Safety stock and "average inventory" are calculated using long established APICS Body of Knowledge formulae.

Assessing Risk
In many cases the largest cost factor associated with third world suppliers is the relationship rather than the on-costs and inventory burdens.  Quality is the biggest among these and there is a common tale among companies receiving goods either damaged, faulty or not to specification, some of these make front page headlines!  What can you do with a shipment that fails your quality inspection when it has arrived at your door?  Providing for this risk will only add to the safety stock provision shown above, along with a hefty write-off provision!

Unreliable delivery promises are the next biggest risk issue.  As always, it doesn't pay to be the small fish in a big pond.  Nothing is more expensive than lost sales due to stock outs.  Again, the only insurance is a further addition to safety stock.

Mitigating Risk
Overcoming the challenges of language, culture and time difference is a big task but are the only ways to "equalise" a supplier relationship in most third world countries.  Even having achieved this there remains the question of business ethics, which have proven to be problematic on many occasions.