Terence T. Burton | March/April 2013 | 23 | 2
Investigating your outsourcing crime scenes
When the practice began, outsourcing had two primary objectives. One was to enable businesses to set up national presences in countries such as China, Brazil, India, and others with high-revenue growth potential for goods and services. Another major driver was the availability of low-wage workers flooding the global marketplace. Outsourcing was a winning strategy: big incremental revenues, significant cost reductions, and huge profits—right?
At present, however, many of the assumptions behind these initial goals have changed, and some events occurring in today’s marketplace could never have been predicted years ago. But because many executives are reluctant to revisit the decisions of the past, hidden wastes often are covered up by incremental revenues. Complacency, postponement, and procrastination about outsourcing improvement are not winning strategies for future success.
There is a lot of work involved with redefining the best data-driven and evidence-based strategies for today’s global marketplace. Outsourcing is a complex network of transactional processes that includes a lot of unpredictability, personal judgments versus hard data, a high amount of informal activities underlying a formal process, and fuzzy causes and effects in space and time.
It’s time to meaningfully improve outsourcing. There are millions of dollars in new improvement opportunities just waiting to be harvested. The organizations that analyze and eliminate the hidden waste and associated costs in their outsourcing processes will quickly discover these profits. Rapid change
Much of the outsourcing efforts of the past decade are in contrast to actual circumstances. The following illustrates this disconnect:
- Oil prices have risen by three times since 2000, making cargo-ship fuel a much more expensive option than it had been.
- Wages in China are now five times what they were in 2000 and are rising at an annualized rate of about 20 percent.
- Many American unions have learned a painful lesson about the need to refocus their objectives. The previous annual negotiations and strike threats in the absence of economic reality must be replaced with more comparable global competitive strategies.
- The US natural-gas boom has dramatically lowered operating and facility costs in the United States. Meanwhile, in Asia, natural gas now costs four times that of US rates.
- Products now have higher material content, and continuous improvement initiatives have resulted in some impressive productivity gains.
- Much of the labor savings of outsourcing to low-cost countries is trumped by overhead costs necessary to make the supply chain function well.
When organizations look deep into their present outsourcing practices and factor in the previous points, a strong case can be built to return home manufacturing, or at least some part of it. Many business leaders do appreciate the total cost of outsourcing, but have difficulty with where to begin. Following are some clear steps to consider. 1. Reassess and rationalize the outsourcing portfolio often
in terms of revenue topology (where and how products are sold) versus sourcing decisions (where products are made). Markets shift over time, which may drive up logistics and management costs. Also, review the outsourcing content and commitment levels to individual country sites, and plan how to “pick up shop” and respond to emerging market opportunities in other countries. A solid analysis may result in geographical adjustments. 2. Understand the cost of management and coordination.
When the total annualized cost of management and coordination is identified, professionals often are shocked. Make sure to consider the cost of people’s time and travel, as well as lost opportunities. Much of this will be symptomatic of deeper problems in areas such as local leadership, outsourcing strategy, or selection. It takes the right experience to identify these activity-based wastes and their recurring root causes. 3. Apply sales and operations planning
to better manage schedule changes and multiple demand streams to a network of outsourced contractors. The goal is to have more realistic schedules, continuous communication, and frequent performance reviews around the process.
4. Perform product line analysis, rationalization, pruning, and a more segmented and targeted outsourcing strategy in order to increase flexibility. Outsourcing may reduce flexibility in design and the ability to respond to change. This usually translates to inventory in the global pipeline, mismatches between supply and demand, shrinkage, excess and obsolete inventory, and higher risk. Here, Pareto analysis can be revealing.
5. Identify the hidden costs associated with sourcing, developing, and maintaining a supplier relative to expected performance. This includes process capability, quality, reliability, capacity, flexibility, turnover, and retraining.
6. Know what is required to achieve the necessary quality levels. This is a straightforward concept, but the hidden costs can be difficult to quantify. The obvious costs (scrap, rework, repair) can be obtained from financial statements. Prevention, detection, and internal and external failure are more challenging to recognize and require assumptions and an activity-based approach. Total cost of quality could represent as much as 5-to-20 percent of revenues.
7. Avoid unplanned logistics and premium freight. It costs quite a bit to move product around at the last minute. Often, a product is needed for a US customer, but it’s in the European distribution center—or vice versa. This causes expensive expediting and a rush to move product from distributor to distributor—something to be avoided.
8. Address the root causes behind the cost of warranty, returns, and allowances. These often become an institutionalized way of conducting business.
9. Find out how outsourcing affects cash-to-cash cycles, proportional to the number of trading partners in the supply chain. Currency manipulations add even more hidden costs.
10. Consider the cost of unforeseen risks. These expenses are beyond hidden; they are unpredictable. Intellectual property theft, tsunamis, piracy, and many others add irreversible costs to the outsourcing process. Thus, risks and consequences must be integrated into strategy and become key elements of outsourcing decisions and various sourcing options.
Studying the clues
Mining and classifying hidden costs is not easy; it requires a deep understanding of improvement methodologies, multiple key business processes, activity-based management, and information technology. The seasoned improvement practitioner knows how to use the organization’s integrated enterprise architecture and other applications to trace transaction streams like a detective. Conducting these “transactional forensics” makes it possible to reconstruct the crime scene and discover hard evidence of both problems and opportunities.
Transactional forensics—an appropriate name for this approach—involves setting up deliberate process experiments for transactional stream mapping and classification in order to either discover the root causes and magnitudes of problems or verify that issues have been eliminated through data-driven improvement and corrective actions.
The past is the past. Outsourcing is a dynamic process, and circumstances have changed. A serious improvement effort can dramatically affect the bottom line.
Terence T. Burton is president of The Center for Excellence in Operations, a management consulting firm with headquarters in Bedford, New Hampshire, and offices in Munich, Germany. He has nearly four decades of diversified experience in executive leadership, supply chain and operations management, quality, engineering, distribution and logistics, maintenance and repair, customer service, finance, and sales and marketing. To contact Burton, visit ceobreakthrough.com, or email firstname.lastname@example.org.
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