U.S. manufacturers need to look deeper on costs really are for the sourcing strategies they are considering. To understand the possibilities. But that means the first thing we must do is prepare to let go of many past assumptions, which generally is not a complete picture.
Are labor and materials costs lower in China? Yes. Is this the full story? No -- there is much more to consider on the path to profitability. What do the alternatives look like?
It comes down to cost and control.
When you source from China, you will see lower cost per unit, but the other costs will dramatically increase. What other costs? These other costs don't appear on the purchase order, which leads to false understandings. We need to understand total landed cost.
Let's look at one case study on a Colorado company.
Sourcing in the U.S.
For years, this company sourced 316L SS forged parts from a domestic distributor using a U.S.-based supply. Average lead time to delivery was two weeks for things not held in stock at the distributor. The company held a small amount of safety stock in the high runners they used frequently, a bit more safety stock on the slower-moving items, and there were always a few items ordered as required for very infrequent demands.
The quality of these purchased items was routinely high, with superior packaging and well protected to make sure the product stayed in good condition. The company enjoyed good inventory turnover in the double digits because they enjoyed a low average inventory with a very fast lead time from the supply chain. These attributes enabled excellent internal performance, with on-time delivery averaging 98 percent to Customer Request Date consistently. Customers were very happy.
Then came a management decree from corporate HQ to have all the divisions source 316L SS collectively using a contract with a supplier in China. Several things happened in this decision.
Sourcing in China
Costs per unit dropped on the PO as planned, but lead time increased from two weeks to 8-12 weeks and often longer. That required gigantic increases in safety stock to protect the manufacturing schedule and to meet customer demand. The lead time of ocean freight is long, 48 days on the water plus customs plus the port transfer time and then trucking to the company. The cost of delivery dramatically increased. But again, these costs don't show up on the PO.
The quality degraded in several ways, all requiring more safety stock to protect against variation. Product often did not meet specification which normally would require return to the supplier.
But if you have a customer order waiting, you cannot afford to return the defective product and wait for another replacement that carries no guarantee it will be any better. The quality control is just not always there.
Add the big additional expense of purchasing more products to replace defective materials, for dealing the rework, and expediting, which then leads to air freight since waiting for ocean freight is no longer an option.
This is a lose-lose situation with a really long lead time, and tons of added cost. And no part of this additional cost is showing up on the PO. The total landed cost is adding up quickly.
The company had no choice but to increase safety stocks on all the items to protect themselves from the ongoing waste and supply disruptions. Average inventory tripled for this commodity simply because of the lack of reliability, quality and availability.
In the end, of the list of items that were moved to China sourcing, less than half of them were actually less expensive when comparing total landed cost to the cost of sourcing in the U.S. Add to this the fact that with all this disruption, the operations scheduling, the factory production and order management people were all spending more cycles to deal with the delays, to communicate to customers why their orders were late, as the on-time delivery rate fell to 76 percent. Working overtime became necessary. Spending on air freight delivery to the end customer became routine. All of these are big cost increases not on the PO.
Cost went up, customer service went down, but the unit price was still lower. The corporate HQ's edict to source in China was not a good plan here and had to be argued for the original approach now supported with real data on total landed cost.
The reason many firms give up on reshoring is that they are not prepared to make the necessary investment in process and people to drive out the waste which stands in the way of reduced cost for local sourcing. They often don't understand this concept as it takes a shift in culture to reduce waste and a commitment to change that enables the cultural shift.
There is a reminder of the U.S.-based firm that found a way to automate the production of chopsticks, thereby reducing the production cost allowing the seller to price lower than sourcing from Asia. Maybe not everyone can leverage technology, but most companies have significant waste in their processes.
When a company commits to Leaning out the process to remove the low- or no-value waste that is always present, they will be pleasantly surprised to find reduced cost with a more reliable process and higher quality. Isn't that the goal?
At the end of the day, getting internal costs down by eliminating waste allows us to be more flexible, with a shorter lead time, lower average inventory, and a similar capacity. And it's not just manufacturing waste either.
Another case study: A company committed to removing waste across the manufacturing and order management processes. The benefits were:
Lead time to fill a customer order reduced from 12 weeks to four hours.
Inventory turnover increased from 1.1 to 28
Quality increased on first-pass yield to greater than 95 percent
On-time delivery improved from 55 percent to 98 percent
Rework reduced from 30 percent to less than 1 percent
Scrap costs fell from 35 percent to 1 percent
Revenue grew by a factor of 10 while size of the warehouse actually reduced.
This is what Lean thinking will do for you. No, not everyone enjoys these kinds of gains. What if you realized half of these improvements? Would you be more profitable and more competitive?
Learn to see the waste and remove it.