DC Velocity - IdeaBook 2014

D ecades ago, when many companies began outsourcing production overseas, they had several reasons for adopting that strategy. One of their most important objectives was to establish a presence in China, Brazil, India, and other high-growth countries with the potential to generate huge demand for goods and services. Another major driver of outsourcing was the availability of low-wage Chinese workers who could produce goods so cheaply that their output essentially flooded the global marketplace. Companies that outsourced production internationally were looking at incremental revenues, significant cost reductions, and huge profits. It seemed like a winning, can’t-miss strategy.

In retrospect, though, many of those outsourc-
ing decisions were based on a flimsy foundation,
driven by a cursory spreadsheet analysis that
focused on labor and other visible profit-and-loss
elements of costs. Some organizations, moreover,
blindly followed the outsourcing paths taken by
other companies. Several executives even man-
dated that “X levels of outsourcing be achieved by
Y date” without any analysis at all. Along the way,
companies became confused about the difference
between price and total landed cost, and they
failed to consider all of the cost factors associated
with outsourcing.

Those overlooked factors—what I call the “ hidden costs of outsourcing” (described later in this article)—typically add up to somewhere between 14 percent and 60 percent of purchase price. In some isolated situations I have seen, the hidden costs represented in excess of two or even three times the purchase price. For now, at least, incremental revenues from international sales are covering those costs, and profitability is not immediately at risk. In my estimation, however, more than half of the outsourcing arrangements today need significant improvement if they are to maintain profitability and achieve long-term feasibility. Why? Because 80 percent of total costs are in the supply chain, and the contractor arrangements in force today include millions of dollars in hidden opportunities to reduce cost, improve quality and delivery performance, increase velocity and throughput, and enhance the customer experience through closer relationships.

Now is an especially appropriate time for companies to take a fresh look at their current policies and be sure they understand the true costs of outsourcing. That’s because many of the assumptions behind their initial outsourcing decisions have changed: