Moving production overseas may look good, but watch out
June 10, 2006
It's irresistible for labor-intensive businesses to be attracted to locations where workers cost less than a tenth of what they get paid here.
Add to that greatly reduced regulatory burdens compared with the United States, and a developing country can appear to many manufacturers as alluring. There's a risk, however, that they'll regret the decision.
Business publications are loaded with articles detailing the lousy experiences of firms whose overseas flings proved less satisfying than promised. While a 90 percent labor-cost differential can cover many problems, the savings are not infinite. Many companies that outsource manufacturing overseas discover numerous hidden costs. Here are some of them.
Language, cultural differencesThere are costs associated with translation, both verbal and written, and endless opportunity for mistakes leading to customer returns and other costly penalties. Cultural differences also create misunderstandings. A nod of the head in our society means, "Yes, I agree." In some other cultures, a nod means, "I understand what you're saying, but you are a dope for thinking that way."
Americans grow up valuing initiative and creative solutions to problems. In China and many other parts of the world, deference to elders and authority prevents most workers from challenging a senseless status quo.
Quality control/productivityThird World factories are rapidly modernizing; yet, it's still difficult to produce quality goods far from home. Keep in mind that in all things, you tend to get the quality you are willing to pay for, and dirt-cheap overseas labor is largely unskilled and frequently illiterate. Moreover, many foreign workers were raised under socialist regimes where the work ethic was shaped by a mindset of "Ask not what you can do for your country, but what your country can do for you." Productivity usually is much less than it is in North America.
Travel and transportationPlane fares costing thousands of dollars add up quickly, and so does management time spent on airplanes and recovering from jet lag. Many outsourcing companies severely underestimate the amount of travel required in selecting and supervising overseas partners. Shipping costs are even more burdensome. When an order needs to be filled in a hurry, ocean shipping sometimes must give way to ultra-expensive air transport.
Lead times and backlogs"Just-in-time" delivery is a dreamy concept when dealing with plants half a world away. Keep in mind, too, the growing problem of delays and backups at docks and transportation hubs worldwide, due to globalization.
Capital expendituresStart-up costs often include building factories from scratch or at least substantial renovation and retooling. U.S. patrons sometimes must provide for sewers, roads and other infrastructure as well as factory bricks and mortar. The payback in labor savings may take years, but there's no guarantee you'll want to stick with the vendor that long.
Selection/supervisionSome studies have estimated that costs associated with selecting an overseas vendor amount to as much as 2 percent of the contract's value. Thus, for every $1 million worth of work being outsourced, it would cost $20,000 worth of travel, paperwork, legal fees, etc., to set it up. Although this is a one-time expense, ongoing supervision also gets more expensive halfway around the globe.
Layoff costsLaying off longtime employees back home not only is emotionally wrenching, but expensive due to severance and retention bonuses, unemployment compensation and other payouts governed by law, labor agreements or just plain compassion. Whatever goodwill is worth in a vacated community, kiss all of it goodbye.
PiracyOverseas outsourcing increases the risk to intellectual property. Knock-offs are a burgeoning problem in most hard-goods industries, and doing business in their back yard makes it that much easier for the counterfeiters - who may emanate from your overseas partner's dirt-cheap payroll.
In addition to quantifiable expenses, overseas outsourcing leads to a host of intangible business hassles. You lose supply chain flexibility, inventory turns ratchet down and obsolescence up, customer service usually suffers, employee morale declines here at home, and so on.
When you look at this list of things that can and do go wrong, it makes you wonder why so many companies respond to the siren's call of overseas manufacturing. Of course, they have access to numbers that I don't, which may tell them whether it's paying off or not.
One can only conclude they must be raking in profits like never before.
Surely, that describes your company. Doesn't it?