Sunday, January 2, 2005

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Sexing up offshore outsourcing

Great, just great. Bruce Bartlett says in the Washington Times that yours truly is "an indispensable blogger" on matters of international trade, "especially outstanding on the so-called outsourcing issue and excels in staying on top of the research in this area."

So now I've got expectations to meet. How do I satisfy my expectant readership? [Sex up the topic!!--ed.]

With that suggestion, it's worth highlighting a McKinsey Quarterly analysis which concludes that even in a world where offshore outsourcing is possible, location still matters a great deal. This is especially true when trendy undergarments are involved:

We found compelling evidence that in a number of cases, offshore manufacturing isn't all it's cracked up to be. One reason is that for many manufacturers, the importance of direct labor is declining rapidly. Since it often accounts for just 7 to 15 percent of the cost of goods sold, hard-goods and high-tech manufacturers often say that wage rates are hardly the most critical determinants of their overall economic performance.

Consider the case of one fashion apparel company based in Los Angeles. Its 1,500 workers, paid at rates well above the minimum wage, make casual wear in an old, multistory downtown brick warehouse. The executives view labor costs, currently 3 percent of the retail price of these goods and heading lower, as a secondary concern to the company. If it were to move its operations offshore, logistics costs might well swallow up any savings from lower wages. Another example: A consumer electronics manufacturer we interviewed has stripped away roughly 60 percent of its labor costs from production and reduced lead times from weeks to days. Even if an offshore competitor drove down its own labor costs close to zero, this manufacturer would still have an insurmountable advantage in logistics—a fact that has emboldened the company to reverse-engineer low-end Chinese goods for manufacture in California.

Since keeping plants near customers shortens lead times, it facilitates greater responsiveness to changing market conditions. The Los Angeles apparel maker can fill orders for up to 160,000 units in 24 hours, since the entire supply chain--including weaving, dyeing, and sewing—is located downtown. The company carries less than 30 days' worth of inventory and could even become a build-to-order producer. Another Los Angeles garment maker produces hand-sewn fashion accessories with a lead time of less than five days.

This kind of speed can be a competitive weapon--and its absence a trap. In the fashion apparel industry, with its spiky, unpredictable demand, the five-month lead times that accompany offshore production can leave manufacturers with excess inventories of fading styles or shortages of hot items. When a brief fashion craze ended before one California designer's shipment of goods had arrived from China, for instance, the company was left with a boatload of velvet knickers that could be sold only at a high discount. And with mass retailers penalizing suppliers for late orders by as much as 2 percent a day, the cost of miscalculation can be high....

Not that all U.S. manufacturers should make their goods at home; offshoring will always be a valuable component of manufacturing strategies. And for companies that make goods such as socks or spark plugs--for which demand is stable, inventory-holding costs low and labor a high proportion of total costs--overseas production in low-wage countries is a very attractive idea.

Nonetheless, offshoring often isn't the right strategy for companies whose competitive advantage comes from speed and a track record of reliability. And with buyers in advanced markets like California becoming more sophisticated--demanding shorter product life cycles, quicker delivery, and lower inventory costs--slow, unreliable manufacturers forgo valuable opportunities to gain market share or revenues. (emphasis added)

Read the whole thing.

UPDATE: Gary Rivlin penned a less-sexy but similar-themed piece on Dell's decision not to engage in much offshoring in a New York Times piece behind their archive wall. Fortunately, the Charlotte News Observer republished it. Key paragraph:

Dell's decision to expand its U.S. manufacturing presence, however, has nothing to do with patriotism. Executives here say their decisions are based on the bottom line as well as on geography; it is simply more efficient to stamp out computer equipment closer to the customer. "The reason we continue to manufacture in the United States is that it's the optimal place to do so, and we can do it most cost effectively," said John Hamlin, who oversees Dell's consumer line.

posted by Dan on 01.02.05 at 11:25 PM


Damn. I saw the title, and thought there would be a Salma picture.


posted by: Independent George on 01.02.05 at 11:25 PM [permalink]

The McKinsey report makes a good point, but unless I miss my guess they used a really, really terrible example. It sounds a lot like the fashion apparel company mentioned--the one that pays "well above the minimum wage" and is housed in "an old, multistory downtown brick warehouse"--is none other than American Apparel, a company whose entire brand revolves around its being a socially progressive anti-sweatshop company. So while it might well be true that logistics costs alone make it worthwhile to locate where it does, it's also true that outsourcing would be about as smart PR-wise as the AFL-CIO having an Indian-operated call-center.

Again, I'm not questioning the larger argument of the article, it just seems that, if I'm right about who this is, the example was about the worst one they could possibly have used.

posted by: Peter on 01.02.05 at 11:25 PM [permalink]

Over the weekend CNN had an upstate New York manufacturer of Teak Garden furniture outline the same reasons for maintaining procuction in the US.
In a seasonal businees lead times make it impossible to ousurce prodction overseas. The owner warehouses less and maintains high standards on quality control. With good machinery and quality employees he can produce with 1 employee and a machine what it takes 5 laborers to produce offshore.

posted by: Merrill Bender on 01.02.05 at 11:25 PM [permalink]

Speed counts -- yes and sometimes. Contrast the examples you give with high tech production where the value of items in inventories fall
because of deflation. But if the item has a high enough value the domestic producer-- like Dell -- are able to air freight components and
essentially eliminate the distance -time factor you were discussing.

What you are really talking about is the Dell model.. They assemble the final product close to the final customer, but essentially all of their components are produced in Asia and air freighted in.

An entire new industry of "tramp" air freighteres has come into existence to facilitate this model.

posted by: spencer on 01.02.05 at 11:25 PM [permalink]

Agree with Independent George: "ed" tells you to "sex up the topic", and you respond by including a legthy quote from the McKinsey Quarterly? Yikes!

posted by: Al on 01.02.05 at 11:25 PM [permalink]

Note to "ed": why don't you suggest that Dan link to this story to "sex up" the topic of outsourcing our most important industries to Indian workers?!?

posted by: Al on 01.02.05 at 11:25 PM [permalink]

Lots of good points, but incomplete. Maybe direct labor is 3% of cost at this apparel what is the rest? I'd guess:

1)Supplies (fabric)..which itself has a labor cost much does the equation change when the fabric is manufactured in a low-cost area?
2)Capital equipment...when looms and sewing machines are themselves manufactured in (say) India, won't they be cheaper if installed in that region than if installed here? Those differences will show up in the "depreciation" part of the income statement.
3)Product design..speaks for itself.
4)Factory indirect labor (industrial engineers, plant general manager, supervisors, etc)..wouldn't these also be cheaper in location X?

posted by: David Foster on 01.02.05 at 11:25 PM [permalink]

Now if only Dell would realize what their customer support in Bangalore does to us. And SBC's DSL support as well. Yes, they speak English. But some of them don't speak it that well. Personally as a former theatre major who loves listening to accents I always found the accents of Indian English speakers to be charming and fairly understandable. But...when discussing technical issues it's quite easy to talk past one another. While helping out our company's attorney with some computer problems one time I solved the problem myself while trying to get the Dell Tier One support agent to understand what the problem was. (Dell has only brought back their support for corporate machines back to the U.S. The models bought mostly by home users and small businesses still have offshored support.) SBC's Tier One people drive me up the wall. For one thing they operate off of a script and getting them to understand that I am not their average residential customer and they should direct me immediately to Tier Two support (SBC doesn't have different departments for residential and business support.) is always fun.

Onshoring doesn't always have to involve a completely rural area, either. The difference in many costs between Silicon Valley and anything in the Kansas City metropolitan area where I live is amazing. Today I was reading an article about the difficulty faced by Bay Area companies to get the right skilled people now that their job market is recovering from its implosion. I may not be the best and the brightest by their lights but I certainly know that even the salaries they were quoted as offering wouldn't go that far with the Bay Area's cost of living compared to where I live. One story I heard from a Sprint executive I knew was that years ago when they were in full growth mode and were consolidating IT in their headquarters here they would bring people they wanted to keep here and show them a nice lakeside 2500+ square foot home and explain that yes, it did cost less than $250,000.

posted by: Jim S on 01.02.05 at 11:25 PM [permalink]

Jim S. That reminds me of a story from a financial management firm in San Fran that during the bubble actually paid a receptionist a salary of $100,000.

posted by: spencer on 01.02.05 at 11:25 PM [permalink]

Excellent points raised in the article. It's not labor costs but technology and superior management that make the difference for most consumer companies today. In other words, supply chain management skills and technology are probably the most important source of competitive advantage for any retailer today, and this applies to a lesser degree for producers of increasingly commoditized consumer goods, be they sneakers or laptops.

Keep telling the truth, Dan.

posted by: thibaud on 01.02.05 at 11:25 PM [permalink]

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