In the increasingly competitive global marketplace, manufacturers need to continually strive to reduce costs to keep or increase market share. This is one of the key factors in making the decision of whether to make parts in-house, outsource to domestic suppliers, or outsource offshore.
Even after a company makes the decision to outsource to a supplier, most don’t look beyond the quoted unit price in making the decision about which supplier to select. This is especially true when comparing the quotes for domestic vs. offshore suppliers. Some companies choose to outsource offshore because the price is cheaper than a domestic supplier. They don’t add in the costs for transportation, much less all of the other “hidden costs” of dealing with an offshore supplier.
In order to make the correct decision for outsourcing, a company needs to understand the concept of “total cost of ownership” for outsourcing manufacturing.
What is “Total Cost of Ownership?” It is an estimate of the direct and indirect costs and benefits related to the purchase of any part, subassembly, assembly, or product. The Gartner Group originated the concept of (TCO) analysis several years ago, and there are a number of different methodologies and software tools for calculating the TCO for various industries, products, and services.
Total Cost of Ownership includes much more than the purchase price of the goods paid to the supplier. For the purchase the types of manufactured products we are considering, it should include all of the other costs associated with the purchase of the goods, such as:
· Geographical location
· Transportation alternatives
· Inventory costs and control
· Quality controls
· Reserve capacity
· Technological depth
The search for low cost areas for manufacturing isn’t something new. Fifty years ago, northern and New England companies started moving manufacturing to the southern states. Twenty-five years ago, many West Coast manufacturers started moving high-volume production to Hong Kong, Singapore, and the Philippines. The next lower cost area was Mexico with the advent of the maquiladoras in Mexico.
“Offshoring” refers to relocating one or more processes or functions to a foreign location. For the past 15 years, many manufacturers have sought to reduce costs by outsourcing manufacturing to China. In the last decade, outsourcing offshore has evolved from a little-used practice to a mature industry. Even conservative companies are now willing to experiment with going offshore to gain a competitive edge. The concept of globalization has become part of the fabric of today’s business.
Many times, the decision to outsource offshore is based on faulty assumptions that can have unpleasant consequences. In some cases, the basis for the decision is well intentioned, such as to win new business by being close to a customer.