Outsourcing Competence

Continuing on a supply-chain theme from Doing Outsourcing Right and Don’t Lose How To Make Things, I found this Reuters article carried on MSNBC interesting.

Surging China costs forces some U.S. manufacturing companies back home


Like a lot of popular press articles, the title and even the lead kind of miss the point. They are focusing on simplistic factors such as costs and whether or not the high automation type solutions are going to create more jobs or not.

This isn’t to say that costs aren’t important. Of course they are. And the article correctly points out (as we have said here as well) that many times the full costs of outsourcing are not understood.

As for the automation – though I can’t speak for the solutions cited in the article, what I often see is overboard with high-tech / high-maintenance solutions. That is a subject for another day when we really start digging into “right sized automation” and 3P.

With all of that, what caught my eye was the last three paragraphs, and in my mind, they are the true lead here:

"If you’re going to go into the high-tech electronics business here in the States, most likely a big portion of your high-tech electronic components are going to be sourced from China," said Cort Jacoby, a principal in the supply-chain group at Archstone Consulting, a unit of the Hackett Group Inc . "Then the question becomes, what is the true value-add that’s going to take place in the United States?"

Beyond that, a company that has outsourced most or all of its manufacturing may find that it no longer has a pool of engineers, plant managers or other workers with the experience to resume production.

"There was always this notion that if you controlled the design and the brand, you could park your production somewhere else," said GE’s Campbell. "I’m not sure that’s completely true anymore. Because what happens over time is you lose competency."

[Emphasis added]

The key point is that you can always outsource what you do today, but what remains is what are you going to do tomorrow?

Today’s markets and technology change so fast that unless you are SO good at supply chain management, AND retain the knowledge so you know how to manage production – like Apple – you end up outsourcing your entire future for a short-term cost “savings” that might not even show up.

Bottom line: You can’t outsource basic business competence. What are you striving to be best in the world at doing? If you don’t know, you are in trouble.

Doing Outsourcing Right

In a previous post, “Don’t Lose How To Make Things,” I discussed some of the perils of outsourcing either your production or your production technology.

Yet there are many successful companies that manage to do just that. One of the most successful is Apple.

We all know Apple as a cutting-edge innovator. Their products have created, and destroyed, entire industries and changed social paradigms.

What is behind that cutting-edge innovation, though, is one of the best (if not the best) supply chain management systems on Earth. Lets look at a couple of key characteristics of how they do this, and you can compare them to the more common mindsets about outsourcing.

First, Apple understands intimately how an iPhone works and how to make one. While they may outsource actual production, they do not outsource their core knowledge. They know their product and their process.

But what really got my attention (and inspired me to write this) was a fascinating anonymous response to a question about a logical strategic investment for Apple.

The comment describes how Apple uses their resources and supply chain knowledge to stay on top of the cutting edge and maintain competitive advantage.

When new component technologies (touchscreens, chips, LED displays) first come out, they are very expensive to produce, and building a factory that can produce them in mass quantities is even more expensive. Oftentimes, the upfront capital expenditure can be so huge and the margins are small enough (and shrink over time as the component is rapidly commoditized) that the companies who would build these factories cannot raise sufficient investment capital to cover the costs.

What Apple does is use its cash hoard to pay for the construction cost (or a significant fraction of it) of the factory in exchange for exclusive rights to the output production of the factory for a set period of time (maybe 6 – 36 months), and then for a discounted rate afterwards.

He goes on to describe how Apple first has exclusive access to the latest technology, then as it becomes commoditized, maintains cost advantage as they are searching for the next paradigm shift.

What I think this does is allow Apple to use their supply chain savvy to change things up faster than their competitors can respond.

Apple is not just crushing its rivals through superiority in design, Steve Jobs’s deep experience in hardware mass production (early Apple, NeXT) has been brought to bear in creating an unrivaled exclusive supply chain of advanced technology literally years ahead of anyone else on the planet. If it feels like new Apple products appear futuristic, it is because Apple really is sending back technology from the future.

Here is the bottom line: If you want to outsource, that is actually OK. But only if you are using that as an opportunity to continuously improve your process of supply chain management while striving to become the best in the world.

If it is a short term ROI problem, rather than working hard to develop a key strategic advantage, well, good luck with that.

Offshore Hazards

When doing the financial analysis of “low cost labor” off-shore production or outsourcing, some simple assumptions are often made.

One of those assumptions is that a country that has a history of political stability will continue to do so.

While those of us in the USA may not be all that aware, Tunisia has been a popular location for offshore production for companies in France. On the surface, it makes a lot of sense. The overwhelming majority of educated Tunisians, and a large percentage of the population, speak French.

I can only imagine, in one company in particular, the scramble going on as critical parts of an already weak supply chain are being disrupted by the sudden political upheaval there.

Then, of course, there is China. As my long time readers know, I spent a great deal of time there a few years ago, and started to develop a better sense of what they are about. The USA and China will be sorting out their relationship for the next few decades because China is changing fast.

And that is the point. Those careful financial analyses tend to assume that the future will be much like the present, or at least there will be a linear progression.

Of course the Chinese themselves are interested in moving things along much more quickly, but in their own way.

The government takes a much more active role in the economy, and we are seeing a new model emerge – “government sponsored capitalism” for lack of a better term. There is a clear industrial policy, and bluntly, a stable supply of cheap plastic “stuff” for U.S. consumers is only a side effect, not the purpose.

So it did not surprise me to read this story:

American businesses are nervous about the Chinese New Year


There are a couple of key points, the gist of the article is about the annual two week shutdown of just about everything in China as factory workers go home for the holidays.

This time, though, the concern is that many of them will not return as there are new government incentives for rural workers to remain in rural areas.

The low-cost factories that sprung up everywhere in the run-up to the recession died off just as quickly when we stopped buying stuff. The infinite capacity model no longer holds.

But the long-term ramifications are actually at the end of the article:

Manufacturing of high-margin clothing goods such as denim and swimwear is growing in southern California.

"Ordering these items from China can take 12 to 16 weeks," Cohen said. But by making these items domestically, retailers can replenish their inventory much faster.

Some electronics manufacturers are shifting some production to Mexico. Others are bringing production of household goods back to the United States.

The Container Store is looking for alternatives to China, including Vietnam, Indonesia, India and Thailand.

"We also source 30% of our plastic products in the United States," said Williams.

"We want the best quality products. Sometimes that’s still only found in China," she said. "But for us, a delay in shipment, or no shipment is also a serious problem."

What we are seeing is businesses starting to wake up to some realities. Unit cost means nothing if you can’t get the stuff when you need it. And three and four month lead times means your sales and operations planning had better be dead-on, because you HAVE to sell what you predicted.

If you are relying on your supply chain management to substitute for the bulk of your production, then your supply chain management had better be world class. Sadly, companies with weak production management – the ones who see offshore as the “solution” tend to also have weak supply chain management.

We can also see Chinese companies quickly starting to emerge in their own rights, designing and selling innovative products rather than just being a contract manufacturer. They are learning, and learning fast… much faster than the Japanese learned in the time leading up to the late 1970’s when “Made in Japan” came to mean all of the best stuff.

What this means for business in the USA and Europe is that they, too, have to learn fast how to (again) stand and compete on our own – they have to decide to become good at operations rather than pretending they can simply design something, and have someone else make it for them to sell. If they are competing against another company that can design AND produce, they will be at a disadvantage because most of the value is created in production.

The next ten years will be interesting times. I’d suggest taking a page or two from a global company that, while it has certainly had its problems lately, succeeds while building product in the same labor market where they sell it.

Reducing Inventory

Yesterday’s post on vendor managed inventory touched on a couple of things about “lean” and reducing inventory that I’d like to explore further.

All too often “inventory reduction” has been a way to “sell” a lean manufacturing implementation. The reduction of inventory becomes the objective. While this isn’t inherently a bad thing, it is all to easy to get caught up in the trap of “management by measurement” and do it the wrong way.

Reduced inventory is a result of good kaizen, but it isn’t the justification for doing it. The purpose of kaizen is to solve problems, specifically the problems that disrupt the smooth flow of work and creation of value. Solving those problems saves time – worker’s time, customer’s time, leader’s time because everything runs more smoothly and predictably.

The primary reason that inventory is there is because things aren’t smooth and predictable. Once they are, you can take some of it out.

The necessity to have inventory at any given point in the system is evidence of a problem that has not yet been solved. (Including, sometimes, simply having poor inventory management, which is another way of saying “overproduction.”)

By asking “What must we do to live without this piece of inventory?” you can uncover the next problem to solve, and then make a decision to solve it.

If it is solved, then inventory can be reduced. But it doesn’t happen automatically, you have to actually take it out of the system and keep it from coming back.

But in any case, this is a lot different than just shoving the ownership of the inventory onto someone else.

Vendor Managed Inventory vs. Less Inventory

Almost every shop I have visited has, or is thinking about, initiating a “vendor managed inventory” program of some kind.

The pressure to do this is especially strong when there is a big push to improve working capital positions and increase inventory turns. And, to be honest, the way traditional accounting counts inventory turns, getting the inventory “off the books” is certainly one way to do it.

It follows, then, that vendor managed inventory can improve inventory turns, at least on paper.

In reality, though, unless the inventory itself is actually removed from the value stream, all that has happened is the valuation has been slid from one ledger to another. All of the costs are still in the system, they are just in different columns now.

It is the physical presence of inventory, not who owns it, that is evidence of some kind of problem. So “reducing” inventory by transferring ownership really doesn’t change the system at all.

The “documented cost savings” are often only an “on paper” artifact of traditional cost accounting, when the actual cash outlay of the organization doesn’t really change very much.

Then there is the added cost (often hidden) of managing distribution from a consignment stock, a tendency for supplier’s representatives to “sell” by stuffing bins as full as possible, and a host of other little things that can add up.

Don’t get me wrong, vendor managed inventory can, in theory, be done superbly and truly help. The problem is that it usually isn’t, and doesn’t.

Don’t push your problems onto your suppliers.
Solve them instead.

Outsourcing Profit

This post on Kevin Meyer’s Evolving Excellence blog brings up some good challenges to the traditional “avoid fixed costs” rationale for outsourcing. The post (and the comments) point out Wall Street’s obsession with achieving a total variable cost model.

There is certainly a lot of appeal. Traditional cost accounting works hard to “assign” fixed costs  to individual units of production so that they can then pretend to calculate unit costs and unit margins. But rather than going into a long rant on accounting, I will just refer you to the experts.

Instead, I want to go beyond the cost accounting rationale that is usually put together, and look at some of the other issues with outsourcing.

Here’s a question for you: Where is the value added in your value stream?

That means what stage of the value stream has the steepest difference in value between what is purchased and what is transferred to the next stage? Put another way, if all you do is final assembly, what is the difference between what you pay for the parts and what your customers pay for the finished product? Keep in mind that this number is the most money you could make. All of your expenses come off this delta. Given any particular level of costs, it makes sense to add as much value as possible.

What is the difference between the cost of components and what you pay for your outsourced sub-assemblies? That is the value your supplier adds.

If, for the sake of argument, your kaizen activities made space and labor available – space and labor that you are already paying for today – how much more profit would you make if you used those resources to bring some of those outsourced sub-assemblies under your own roof?

Remember, in this little exercise, your labor costs stay the same. Your production area stays the same. Your overhead stays the same. The only thing that changes is this: Instead of buying completed sub-assemblies from a supplier, you are buying the components that the supplier buys and assembling them yourself.

If you would pay less for the components than you do for that sub assembly, your total cost of goods sold goes down, and all of that difference goes straight to the bottom line. (I am sticking with assembly here because the capital requirements, in most cases, are modest here.)

This is a different answer than you would get in a traditional make-vs.-buy analysis which assumed that all of the burdened direct labor costs would be shed with the work. It isn’t that clean in reality.

Supplier Selection: Beyond Quality, Delivery, Cost

Do you have a responsibility to make sourcing decisions on anything other than Quality, Delivery, Cost? This news item about a mass-fatality industrial fire in China opens up some interesting thoughts about sourcing over here.

For future reference after the link dies, the lead of the story is:

A fire at an illegal shoe factory in eastern China has left 34 people dead..

That, by the way, is a great lead. It summarizes the whole thing in a few words:

  • China
  • illegal factory
  • fire
  • 34 dead

The rest is just syntax glue. But, as usual, I digress. What the hell is the point?

Just to be clear, by the way, the original breaking-news story in no way implies that this factory was producing for export, or for that matter, for any other company. So the story is just a lead-in for this post.

Back to the lead of this article: What is your obligation, as a purchasing company, to consider things other than quality, delivery, cost in your sourcing decision?

With the rush to source in China, it is very easy to overlook even obvious things like quality. Just ask Mattel. But if gross violations of China’s internal health, safety and environmental regulations give a potential supplier a cost advantage, do you know it? Do you make a conscious decision to let that “advantage” stand? Or do you go and look for yourself, and include only suppliers which comply with the letter and the spirit of the law – as well as “do the right thing?”

Chinese health, safety and environmental regulations, by the way, are in many cases stricter than what you find in the USA or Europe. Compliance and enforcement, though, is… ah… spotty.

This is, in my mind, an ethical decision, not a legal or financial one. I can only raise the question and let you answer it in your own mind.

One more thing. This was reported on the BBC. The only way I can read BBC news on the internet in China is to go through my corporate VPN. If you try to access BBC News on a normal internet connection, you will get a “Server not responding” error because BBC is not considered appropriate for the Chinese people to read. Frankly, it seems a little arbitrary since every other news service is more or less accessible. Maybe I will start another blog sometime and just talk about “other stuff.”

“Packaging” is spelled M-U-D-A

In Mike Wroblewski’s blog “Got Boondoggle?” he comments on just how much packaging and dunnage is not visible in Toyota’s Industrial Equipment plant. Of course that is remarkable because of just how common it is to find the opposite condition. Factories (and offices) have lots of packaging around, and spend lots of time dealing with it.

Toyota has been working on this a long time. They have the added advantage of being an 800 pound gorilla with most of their suppliers. They can specify packaging and insist on things being done a certain way. In a lot of cases it is the supplier that is the 800 pound gorilla, and a lot of small companies have a hard time being heard. But you can still make a lot of difference if you apply the principle that packaging is muda.

A frequently invoked (and overworked analogy) is the assembler or operator as a surgeon. Everything must be ready for the value-add operation to be performed waste free. If there is waste in the process, keep it away from this point. Surgical instruments come in packages. But I can assure you the surgeon is not unwrapping the scalpel. So who is?

The instruments are prepared and made ready for use by the staff.

Now take this to your factory floor. The first step is to keep dunnage and packaging out of the production area. There are actually a lot of advantages to doing this. The chief one is obviously optimizing your value-add time. But all of that packaging also takes up space. EVERYTHING that enters the production area MUST have a process (meaning a person!) to get it OUT of the production area. Since you have to unpackage that stuff anyway, do it before it gets to production. This means that someone else picks the part and prepares it for use just like the staff in the operating room.

Do this and you have applied one of the principles Liker and Meier point out in The Toyota Way Fieldbook – if you can’t eliminate sources of variation, then isolate them. In other words, set up a barrier that contains the waste so that your value-adding operation sees the result of a perfect supplier.

You can then take the next step: Do this at receiving. If the parts do not arrive from the supplier packed the way that your internal material conveyance system needs them, then put the resources into receiving to convert what you get from your suppliers into what you wish you got from them.

This is applying the principle of systematically pushing waste upstream, closer to the point where it originates. The other thing you have done is force yourself to dedicate resources to deal with this waste instead of spreading it so thin the cost is hidden. You will know what it costs you in terms of people, time, space, etc. to deal with the fact that your suppliers don’t ship what you need. By highlighting the problem instead of burying it, you have the opportunity to address it.

One more thing – it might seem easier to take these little wastes and spread them thin. After all, if everybody just does one or two trivial tasks, it doesn’t seem so bad, does it? It is those trivial wastes, those 5 second, 30 second, 1 minute little things that accumulate to half your productivity. It takes work to see them and eliminate them. Don’t add more to the process on purpose.

Trust, Then Verify

This article NPR : Mattel Recalls More China-Made Toys highlights one of the problems with doing business with an unproven supply chain.

In this case, the OEM in China had specified the correct paint to their supplier – who was a friend of the owner – but the paint supplier had given them less expensive lead based paint. (Some friend, huh?)

As the story reports, the owner of the OEM company took the coward’s way out and hanged himself.

So – Mattel probably trusted that their OEM supplier in China would deliver what they specified (and would continue to do so after first article inspections). The OEM, in turn, trusted their paint supplier would deliver as specified. Now Mattel’s reputation is in recovery mode and China itself is internationally embarrassed. (Believe me, they do not like it when that happens. On second thought, maybe suicide wasn’t a bad strategy after all.)

The awful truth is that the world out there has people in it who either do not understand that a particular specification is important (which is pretty common here), or worse, are out to make more money (less common, but it happens).

Lean Thinking Question:
What would you learn from this if YOU were Mattel?