Right shoring: A flexible strategy for tough times
Although far-shore operations can often equate to cost-savings, a better plan is right-shoring, or combining on-shore, near-shore, and far-shore operations into a single, flexible, low-cost, and service-centric approach to supply chain and logisitcs management. Here is a menu of right-shoring options and opportunities.
By Amit Gupta & Ganesan Ramachandran, Accenture -- Logistics Management, 4/1/2009
Controlling manufacturing and distribution costs is doubly important in a down economy. However, if a company's cost-reduction efforts are too aggressive, the result could be alienated or disenfranchised customers—customers that may not return when the economy rebounds. This is potentially the case for companies that over-committed themselves to off-shoring—relocating production (and, concurrently, some warehousing) operations to far-shore, "low-cost" countries.
Are we implying that far-shoring is no longer a viable strategy? Not at all. The point is that worldwide economic problems and changes have drastically altered the cost dynamics associated with manufacturing and distribution network strategies. So much so, in fact, that companies may no longer assume that far-shore operations are less expensive in the long term. After all, companies that are over-invested in far-shore operations are the ones most at risk as crude oil prices fluctuate wildly, labor costs rise in developing countries, and the value of the U.S. dollar shifts unpredictably.
Too much reliance on far-shore operations also makes it more difficult to meet surges in consumer demand. Quality of service—which is always linked to cost of service—could suffer, which is the last thing you need when the economic chips are down. Perhaps more than ever, companies need a low-risk supply chain strategy that balances supply speed and cost effectiveness. Think of this strategy as "right-shoring" or the formulation of flexible, customer-centric strategies that base a product's manufacturing and distribution locations on total landed cost.
Over the next few pages we're going to cover today's most significant influencers of total landed cost as well as a variety of right-shoring approaches that can be considered, evaluated, and blended to ensure flexible, low-cost operations that also meet customer needs.
The True Costs of Far-Shore Operations
Looking back, the genesis of off-shoring sourcing, production, and distribution was a dramatic labor cost differential between U.S. workforces and workforces in countries such as China and India. However, after a decade, it's becoming evident that the potential for cost advantage derived solely from far-shore operations is waning.
Consider that even though labor costs in China are far lower than those in the United States, productivity levels in China are also lower. As a result, savings are not nearly so substantial when the two countries' "labor cost per unit output" is compared. China's double-digit salary increases are also reducing the gap in labor costs.
Still, labor costs are hardly the only factor. As shown in Figure 1, logistics and transportation costs, exchange rates, fluctuating customer demands, and the cost of quality can quickly erode the advantages of a near-sighted, far-shore operating strategy.
Transportation Costs
Crude oil prices have fluctuated wildly over the last year. Transportation costs, therefore, have been equally unknowable. Factor in higher costs of warehousing and inventory holding, in-transit insurance/security, duties, customs clearance and documentation, and your potential logistics costs are significantly higher and a great deal less predictable than just a few years ago.
When transportation cost is a significant portion of a product's total landed cost (such as with a low-cost, heavyweight product), the impact is even higher. Tesla Motors—producer of a zero-emissions, electric-powered sports car—recognized this fact and recently moved assembly of battery packs from Thailand to San Carlos, Calif., near its headquarters. Thailand's low labor costs no longer offset the high costs of shipping 1,000-pound battery packs across the Pacific.
Fluctuating Customer Demand
One of the biggest challenges faced by today's companies is responding quickly to fluctuating customer demand. Demanding consumers are nothing new; but advancements made in recent years have shortened most product lifecycles. This is true for technology-intensive products such as mobile phones, computers, cars, and electronic gadgets, as well as apparel, sports equipment and fashion accessories—some of the products most commonly produced off-shore.
Stiff competition is part of the same daunting equation: When manufacturing takes place 10,000 miles from the consumer, the time needed to counter competitive moves increases significantly, potentially resulting in lost market share and customer trust. Steps to counter this (e.g. by increasing inventory) only heighten total landed cost.
With a typical transit lead time of 30 days from an Asian country to the U.S., a shipload of containers could even become partially obsolete, as needed changes to packaging, promotion, or even the product itself arise before a shipment arrives. To supplement the surges in demand for a particular item, air freighting becomes more of a necessity, which can further raise costs.
Cost of Quality
Historically, the U.S. labor force has produced the highest number of innovations, quality products, and products that meet the needs of the largest consumer base in the world. In fact, Toyota leadership had stated that an educated and ethical U.S. workforce was one of the main reasons the company set up a manufacturing base in the state of Mississippi.
While the quality of products coming out of low-cost countries cannot be termed poor, many products rank low in differentiation and innovation. And although off-shore manufacturers work hard to ensure consistent quality, slipups still happen. Recent difficulties faced by pet food companies, toy companies, and software companies point to the potentially fatal cost of low quality. A major issue with product quality can have horrendous consequences.
A Menu of Right-Shoring Options and Opportunities
There is now an unprecedentedly high need to balance supply speed (service quality) against cost-effectiveness. In this multi-polar world—characterized by more risk, more exacting customer demands, and more economic hardships—what can companies do to "keep their balance?"
As noted earlier, one direction is right-shoring; or acknowledging that far-shore operations remain an essential part of your company's global strategy, but that far-shore decisions must be aligned (and potentially combined) with other options to form a single right-shoring strategy. Those other options include:
Operational hedging: This involves managing risks with adjustments to manufacturing, sourcing, and selling locations—creating flexibility in the supply chain and market-facing activities. For existing and new products, such flexibility can help mitigate the impact that large and long-term changes in dollar rates have on revenues and profits.
With existing products, manufacturing facilities can be located near the customer and in low-cost countries, with total landed cost calculations used to decide the percentage of total demand addressed at each manufacturing location. New products pose a different challenge. With the quality of innovation a strong point in the U.S., launching new and better products at a fast pace should be an ongoing focus for U.S. operations.
Early in a new product's life cycle, it is difficult to estimate demand, so the inherent service disadvantages associated with off-shore manufacturing make this a risky proposition. A more practical approach may be to manufacture certain new products locally at first and then shift production to low-cost countries as demand stabilizes.
Near-shoring: Across North America, near-shoring has become more popular since the signing of NAFTA and CAFTA. With wages in most Central American member countries at one-third the level of U.S. wages, sourcing from CAFTA countries could offer a particularly significant cost and proximity advantage.
Split-shoring: Keeping manufacturing processes that are not too labor intensive on-shore is another strategy to consider. For example, the final assembly of foreign-made mobile phone batteries, circuits, cameras, and outer casings could be completed closer to the customer, thereby shortening the time needed to respond to market changes and simplifying customization to meet changing consumer demands.
Peak-load manufacturing: Manufacturing operations could be divided so that some of a company's products and components are manufactured domestically, with others produced overseas. For example, local manufacturing capabilities might be used to accommodate surges in demand while off-shore venues are deployed for longer or more stable production runs.
Figure 2 describes how these various strategies might be assessed to create a single approach that weighs total landed cost differential against demand variability and stock-out costs.
Right Shoring is Key to High Performance
A right-shoring strategy—one that cost-effectively meets consumer demands for the right price and the right quality—must be supported with sound information for decision making. This highlights the need for econometric models that can help a company continually evaluate the impact of changing scenarios, such as changes in crude oil prices, shifts in the value of the U.S. dollar, or the influx of European and Asian competitors onto U.S. soil.
All of these scenarios are more or less inevitable. It is the degree of change that is nearly impossible to predict; and this is why right-shoring—the ability to understand and adjust manufacturing and distribution options—is so valuable. In today's economy, companies must be able to rapidly reshape their business approaches as macro-economic factors change.
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