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A Manufacturing Renaissance: Determining whether to insource

by Mike on Wednesday, January 09, 2013 12:00 AM


“Those jobs aren’t coming back.” Really? Yes, they are really starting to come back…. Stanley, GE and Apple to identify a few, have realized that manufacturing can successfully be done right here in the good old US of A!





Why Insource

There are a growing number of reasons to manufacture some if not all of your products in the USA, be it because of marketing, profitability, or a hedge against risk of poor delivery performance or quality. The USA is becoming much more in tune with implementing transformational lean and thus more attractive. In addition, industry experts are advising businesses to examine the potential savings of insourcing products that in the past were outsourced.

Insourcing typically follows two paths: 1) manufacturing new products locally, and 2) looking at products that were in the past outsourced where now it makes sense to rethink an earlier decision. While the financials are important, when looking at your supply chain, seriously consider flexibility and risk as significant drivers for success. Identify ways to reduce your longer supply chains into smaller more nimble supply chains. By doing so, you can enhance your ability to react more quickly with products that experience considerable volatility; this will also reduce uncontrollable risk or unforeseen problems like natural disasters or political upheaval. Another thing to consider, if the supply chain goes through several countries the risk of disruption goes up, the cost of “just in case” inventory goes up, freight costs go up, finger pointing when quality issues arise goes up, etc., all of which add ZERO value to the product.

Each product line within the Supply Chain must be evaluated individually to determine the best go forward strategy. Ideally the company should analyze where to locate manufacturing by using a real value options analysis to determine the value of being local and flexible.

Doing the math

To make a determination to insource (or outsource for that matter) you need to do some math before you move and make sure its “Lean Math.” Here are the items you need to include in your calculation:

* Start with the piece part cost for an item where you are currently making the product.

* Compare this with the piece part cost for the same item in the US.

* Subtract the cost of slow freight to get it from where you are currently making the product to your customer.

Please Note: at this point, you have now done the entire math that many purchasing departments seem to perform. This is what I would call “Mass Production Math”. To get to “Lean Math” you should subtract some additional costs to piece-part plus slow-freight cost to make the calculation more realistic:

* Identify the additional overhead costs to be allocated to production in the higher-wage location, when production in transferred. Consider the impact on the current products being produced in the US. This should reduce their overhead costs.

* Subtract the historic cost of the additional inventory of goods in transit over long distances from the low-wage location to the customer.

* Subtract the historic the cost of additional safety stocks to ensure uninterrupted supply.

* Subtract the historic cost of expensive expedited shipments. (You'll need to be careful here because the plan for the part in question typically assumes that there aren't any expediting costs, when a bit of casual empiricism will show that there always are.)

* Add the cost of warranty claims if the new facility or supplier has a long learning curve.

* Subtract the historic cost of engineer visits or resident engineers required to get the process right so the product is made to the correct specification with acceptable quality.

* Subtract the historic cost of senior executive visits to set up the operation or to straighten out relationships with managers and suppliers operating in a different business environment. (Note this may include all manner of payments and considerations, depending on local business practices.)

* Subtract the historic cost of out-of-stocks and lost sales caused by long lead times to obtain the part.

* Subtract the historic cost of remaindered goods or of scrapped stocks ordered to a long-range forecast and never actually needed.

* If you are using a contract manufacturer in the low-cost location, subtract the historic potential cost of your supplier soon becoming your competitor.

Almost all of these “costs” need to be considered when doing productivity improvement justifications. A caution… by themselves, individually, it is almost always impossible to cost justify doing the improvements; sometimes you must just take a leap of faith.

This is becoming quite a list and please note that these costs are hardly ever visible to the people in senior management or purchasing who relocate production of an item in a low-wage country based simply on piece-part price plus slow freight.

However, lean math requires adding three more costs to be complete:

* Currency risks, which can strike quite suddenly when the currency of either the supplying or receiving country shifts.

* Country risks, which can also emerge very suddenly when the shipping country encounters political instabilities or when there is a political reaction in the receiving country as trade deficits and unemployment emerge as political issues.

* Connectivity costs of many sorts in managing product hand-offs and information flows in highly complex supply chains across long distances in countries with different business practices.

Granted, these latter costs are harder to estimate but are sometimes very large. The only thing a manager can know for sure is that they are very low if products are sourced close to the customer rather than across the globe.

If you do the “Lean Math”, will it always mean that you should relocate? Absolutely not, for example, if you are planning to sell within high-growth, low-wage markets like China or India you will almost certainly need to locate most or all of your production for those markets within those markets. This is simply because “Lean Math” works in the opposite direction as well. Transport, inventory and connectivity costs and country and currency risks are much lower if you produce within the market of sale.

Fixing the real problem

In our experience, a hard look at the true cost situation will suggest that outsourcing is not the first line of defense for producers in higher-wage countries or, for that matter, insourcing back from lower-wage countries.

Rather, the task is to get serious about a lean transformation throughout the entire value stream for the product(s) in question. By optimizing the value stream through transformation you work to understand the potential value that can be released through greater flexibility with less inventory shorter lead-times. Rather than forecasting future demand via assumption, the company will be able to wait to place an order and actually observe early demand before forecasting how much product they’ll actually need. Being able to observe the actual demand allows the company to constantly refine their forecast and minimize waste.

If after doing “Lean Math” and applying the full complement of lean methods, you find that you do need to relocate, our experience is that moving ALL of the steps in the value stream for a product to an adjacent location is likely to provide the lowest total cost. Low-wage countries within the region of sale include Mexico for the U.S., Poland for Germany, and, yes, China for Japan.

All the “Lean Math” in the world will not solve all the cost problems! Fixing the value stream by eliminating waste, dramatically reducing the remaining cost added and focusing the business on the value added will go a lot further in the short as well as in the long run.

We welcome your own thoughts and experiences with this question, which we think will or already has emerged as the largest single issue many managers are wrestling with in higher-wage countries. If you've got some better (leaner!) math please let us know and we will pass it along.

e we will be including the table and graph, I would like for your to summarize the process high level and reference the details in the table. For example, you have to start with the basic equation and then add or subtract…..

Blogs Parent Separator Mike's Blog
Operational Excellence

(“The Professional Provoker”) is the Founder and President of Empowered Performance, LLC a worldwide management education and consulting firm. Michael has extensive international experience working with companies of varied sizes and industries helping them implement strategies to attain World-Class levels of performance. Michael has developed expertise in “Enterprise Excellence”, Enterprise Resource Planning and Supply Chain Management (ERP/SCM), Lean (Toyota Production System), Team Building and Problem Solving, Six Sigma and Reengineering Business Processes. He is considered an expert in helping companies develop and implement Strategic Business Units and fast response customer service production units.

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