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Offshoring and the tough questions to answer

Written by: Jack Greene

Article Overview: Are you thinking of taking your manufacturing offshore? Can you spell Melamine? Lead paint? SARS? Tough questions that will probably lead you to realize that Asia is not for your U. S. company.

Offshoring and the tough questions to answer

Offshoring and the tough questions to answer

Are you thinking of taking your manufacturing offshore?

Can you spell Melamine? Lead paint? SARS? Tough questions that will probably lead you to realize that Asia is not for your U. S. company.

As in all relocations, there are many site sensitive costs involved. While offshore labor rates may be much less, most other incremental costs will be greater. And in 2008, one of those skyrocketing costs is energy, to return the goods to North America.

To see whether an offshore move may be right for your manufacturing, your brand and your company, JPR proposes the following questions. Since you may not get this guidance from major consulting groups at all, we give it away.

How much will you save?
Labor
For most manufacturers, loaded direct labor cost is typically less than 10% of the cost of goods sold. If you move to South East Asia where labor is one–fifth the U. S. cost, you might save 8% of the cost of goods sold.
But that’s not the only consideration: For example what is the cost of benefits to workers? Are there mandated holidays, housing, meals, transportation and 13th month benefits costs to take into account?
Next, consider the two types of labor variance, price and usage. Although your labor price will almost certainly go down, what about the usage variation and hours worked?

Equipment / Facilities
What will you do about equipment? If available offshore, add acquisition and startup costs and perhaps a stateside write-down. Next, throw in the maintenance cost charge (how well will equipment be maintained; how much down time can be anticipated?)

Next, ask what the learning curve might be like for an offshore facility with respect to labor and material losses as it approaches a steady state.

Finally, what will the steady state output be? What about utilization, efficiency, productivity, material usage? Don’t forget direct to indirect labor factors, expatriate workers and their costs, turnover rates, theft and security.

Materials tend to be priced at a worldwide level, and so may not vary much. (There are exceptions: raw sugar is priced much higher in the U. S.)
However, you will need to factor in import duties for raw materials. And what about import duty on manufacturing process equipment?

Shipping
Freight, insurance, product damage, obsolescence, tariffs, and brokers fees all contribute to the cost of the landed product. But in 2008, the cost of fuel to return the goods to the USA may overwhelm any saving. ABC World News on June 24 reported “As the cost of shipping continues to soar along with fuel prices, homegrown manufacturing jobs are making a comeback after decades of decline.

While it once cost $3,000 to ship a container from a city like Shanghai to New York, it now costs $8,000, prompting some businesses to look closer to home for manufacturing needs.”

They reported that companies as varied as furniture manufacturing, small appliances, batteries, and steel have brought manufacturing back to the U. S. from China. "Cheap labor in China doesn't help you when you gotta pay so much to bring the goods over," says economist Jeff Rubin.

Product recalls
Regulation within the United States, and Canada, is frequently the target of criticism.
However, that regulation does not allow the use of unauthorized materials; melamine, lead based paints and industrial grade chemicals in food products, and outlawed antibiotics for instance. People are paid a higher wage in North America, but the manufacturing climate can more than justify that wage rate because products are kept on the market. When a company has no products on the market, and lawsuits are filed because of customer injury, wage rate savings are quickly lost.

Health Issues
Health issues have occurred in areas of the world such as Southeast Asia, for instance bird flu strains and SARS. When these issues arise, workers are affected, plants are shut, production in stopped, and shipments held up.
My crystal ball is not clear enough to predict when and where in the world the next major health issue will arise, and the overall impact may well be much greater than missed shipments. But history of the first part of the 21st century indicates that North America will not be the center of the problem.


How will your U. S. operations change?
Will you incur costs to phase out a North American facility?

Consider higher executive and technician travel to support the offshore location as well as special mail and priority shipments of documents, models, specs and products. Modern communications technology can only do so much to mitigate distance,
language barriers and the lack of face to face meetings.

Who in the organization will perform product design, new product development and engineering; what about the model shop and pilot plant? Remember, too, that new product transition is problematic even when headquarters is in the building next
door.

Who will perform Human Relations oversight. Who will exercise quality oversight and how?

What about procurement? Will you see the product and its components for the first time when the product is in the stores or your warehouse?

Who will provide financial oversight within the new company? How about independent auditing? Although US auditors hardly have a pristine record, they do function under a (more or less) transparent regulatory regime.

Lastly, consider the political vagaries of U. S. tax law. What happens if the deduction of expenses to transfer jobs offshore is
disallowed?


Can you continue your business strategy?
Can you practice Just in Time with product on the high seas, subject to port work stoppage? Have you planned additional inventory to cover transportation lead times? With extended inventories, will scrap and obsolescence costs increase?

What is the label "Made in the USA" worth to your company and to good will?

Can the new overseas employees and vendors purchase your products on par with your former employees and former vendors who may feel disinclined to buy more?

Will you be able to integrate vertically in an offshore setting as easily as you can here in the US?

How will your Time-To-Market change? Stateside manufacture offers the shortest time-to-market, from product design to prototype to test run to manufacture to ship to customer, especially considering reaction times to changes inherent in the process.

For a company like American Apparel, the advantages of vertical integration, lower shipping costs and the ability to advertise "sweatshop free" were decisive in convincing them to continue manufacturing in Los Angeles.


Off shore legal and political considerations.
Will practices and laws in the new country limit executive actions?

Can you eliminate jobs in the future? At what cost? Emerging nations tend to be much more protective of jobs than the U. S.

How will you establish and defend your real and intellectual property rights?

Is foreign ownership possible? Are you ready to partner with a local entity. Remember, disputes will most likely be adjudicated
in the country of implantation.

Is the local banking system healthy and vigorous?

Is the legal system friendly to investors?


Tax and Accounting issues
What are profit repatriation tax rules in both the host country and the U. S.?

Whose rules will apply to inter-company accounts such as transfer pricing?

Has there been approval by your CPA under the Sarbanes - Oxley Act?


Foreign Exchange
Are your ready and able to predict accurately and respond effectively to fluctuations in exchange rates that affect raw materials and operations? Do you plan to use common currency hedging strategies to minimize exposure?

Jack Greene, Jackson Productivity Research Inc.

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Article Tags: cheap labor rates, offshore, offshoring, onshoring



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