DC Velocity - IdeaBook 2014

cally to customers in the Midwest and on the West Coast. Additional analysis revealed similar results for a few other product lines. The company found that if it moved production of several product lines back to the United States, those products could be manufactured at a lower total cost and be shipped directly to customers with a net 30 days invoice. That’s exactly what the manufacturer did, and all problems were solved: product availability, quality and reliability, order fulfillment, customer satisfaction, incremental revenues, and cash flow all improved. No currency issues, either.

10 Cost of unplanned and unforeseen risks. Organizations that outsource production tend to overvalue the labor savings they expect to gain from outsourcing and undervalue all the other potential costs and risks. These include such underhanded practices as intellectual property theft, and product and component piracy and theft that may be acceptable or are rarely (if ever) prosecuted in some countries where outsourcing is common. In fact, the risk of unauthorized copying of products increases when outsourced manufacturing is involved. One of our clients, for instance, discovered that a supplier was selling the client’s parts and components to a family member, who then reproduced the branded product and was selling it for US $600 less than the originals. This kind of product piracy can generate additional hidden costs, such as warranties and repairs that the legitimate company may end up paying for.

In addition to “man-made” risk, unpredictable situations like tsunamis, earthquakes, and other natural disasters add irreversible costs to the outsourcing process. It’s imperative, therefore, that responses or contingency plans for dealing with all of the possible risks and potential consequences be integrated into any outsourcing strategy. This will allow you to mitigate the costs of those consequences and recover more quickly.

UNCOVER HIDDEN COSTS

It is no secret that most decisions to outsource
production were fueled by the expectation of
huge labor savings. But the largest cost driver in
many products today is materials, not labor—so
chasing labor savings is yesterday’s game. Still,
some executives are reluctant to revisit their past
decisions. This is unwise, because complacency,
postponement, or procrastination about improv-
ing outsourcing costs are not winning strategies
for future success.
In fact, there is a lot of “gold” to be found
in the outsourcing practices of most organiza-
tions, but it’s not easy to uncover these hidden
costs. Because outsourced production involves
a complex network of transactional processes, it
obscures a significant array of costs. Complicating
matters is the fact that outsourcing involves a lot
of unpredictability, professional judgments versus
hard data, a high degree of informal activities
underlying a formal process, and fuzzy cause-and-
effect situations. For the uninitiated, or for those
who are too hasty, it is easy to double-count or
totally miss these elements of costs, thus quick-
ly compromising both the reconciliation of the
numbers and the credibility of the analysis. Given
those conditions, the path to reducing outsourc-
ing costs is to redefine and employ a combination
of seasoned experience with the best data-driven
and evidence-based strategies in today’s global
marketplace. Some of the most effective tools
include activity-based cost analysis and using an
organization’s integrated enterprise architecture
and other information technology resources to
trace transaction streams and reconstruct these
hidden costs.

Most companies need to improve how they make their outsourcing decisions, not because they made a mistake but because outsourcing is a dynamic process where circumstances change over time. And in fact the situations surrounding the 10 hidden costs described in this article can be game changers, because they may open the basic assumptions underlying outsourcing decisions to question and make a different option more feasible and cost effective. It is more than worthwhile to re-evaluate outsourcing of production now. A serious effort at improving the outsourcing deci-sion-making process can easily add a few more margin points and millions of dollars in new savings opportunities. c