The Offshoring Hangover

It all seemed like such a good idea at the time. Particularly in the late '90s and early '00s, outsourcing to low-cost countries (LCCs) held the promise of lower manufacturing and assembly costs and seemed to present a sure-fire way to improve corporate profits. Establishing a supply base in a country such as China also offered an opportunity to establish credibility with the host-country government and tap into the country's explosive economic growth. The outsourcing party was on. Achieving immediate cost savings looked downright easy.

But that was all before high-profile supply-chain failures, skyrocketing oil and prices, rising inflation and upward pressures on factory wages in many low-cost countries in 2007 and 2008 began to change the economics of offshoring. And it was before companies realized that the local infrastructure and skills base might not yet have been ready for the spike in work. Or that their customers would notice a difference in the level of service or quality associated with their offerings.

Now many firms are rethinking their LCC outsourcing programs. Many of the expected economic benefits associated with migrating a supply chain to LCCs have not materialized. In fact, for many firms the ROI associated with offshoring has not been positive. Nearly half of the firms surveyed recently by Grant Thornton LLP indicated that their offshoring activities have either no impact or a negative impact on their ROI. Lower product quality and delivery delays make the top of the list.

As a result, an increasing number of firms (again, nearly half of those surveyed) are planning to reign in their global supply chains a bit and bring operations closer to home. Numerous examples of this phenomenon can be found.

Grant Thornton makes two key recommendations in assessing the data from its recent offshoring study:

1. Look closely at the financial health of your supply base.
2. Monitor the evolving marketplace and respond as quickly as possible to changing opportunities.

We would add another recommendation: leverage the full breadth and talent of your own organization and network of partners around the world to:

• Identify the right suppliers for your firm;
• Assess suppliers' capabilities to serve as reliable partners;
  
• Understand hidden supplier risks and costs (e.g., intellectual-property theft and corruption); and
• Detect as early as possible signs that your offshore suppliers may be at risk.

The internal supplier-knowledge network in most multi-national firms is simply waiting to be tapped. Offshoring need not be a zero sum game. Being fully-informed about your supply base and continually refreshing your supplier market intelligence can help you monitor the opportunities and risks related to maintaining an offshore supply chain.

(Photo credit: centralsq on Flickr)

At the Top of the Slide

Think you have a good read on what's happening on the ground with your offshore supply base? Most procurement executives probably think they do. Sure, they have their teams of supplier-quality engineers checking in a continual basis with their suppliers. They keep up with all the economic news coming out of China and other export-oriented Asian nations. And from those perspectives, things probably look good: their suppliers continue to meet production schedules and quality targets; and China seems poised for some sort of rebound given all the stimulus money the government is injecting into the economy. Supplier viability appears good.

But supply-chain executives should bear all this news with caution. Your staff in China are likely focused only on your own products. Supplier-quality engineers are not inclined to be tuned in to how suppliers are faring with their other customers. And despite signs that China's public spending may help sway its current economic downturn, other economic data out of China point to tough times ahead. How do you expect your suppliers to react in the face of a downward spiral? How will you react?

The unemployment rate in China is on the rise. And nowhere is this being felt more acutely than in the eastern provinces that helped fuel so much of the country's recent growth. Government figures place the unemployment rate at 4.2%, but according to The New York Times, this number "excludes more than 100 million workers who have migrated from rural areas or between cities to find jobs, often in the export sector, and are now feeling the brunt of dismissals, pay cuts and sharply shortened work hours." These are the workers who have been making your parts and assemblies at such low cost over the last several years.

So, what should you be prepared for in the coming months? One thing is a continuing wave of factory closures (or, at a minimum, some form of supply-chain disruption). Factory managers that lose (or simply fear losing) one or two key customers may decide to shut down their operations and walk away entirely (or shift to making higher-margin products).

From its network of sources in China, SupplyScope is getting word of suppliers actually turning away business--despite the current economic climate--for fear of not getting paid by those potential customers. These suppliers are accepting that it would cost them less to refuse an order than to accept one and never receive payment for their services.

With rising unemployment you can expect an uptick in crime in areas hard-hit by the recession. While the Chinese government does not publish crime statistics (for fear of facing embarrassment for its inability to contain crime), local news sources indicate that crime in Chinese factory towns is on the rise (that Guangdong Province officials recently mandated the installation of a vast network of security cameras should be a good indicator). Consider the risks that crime can pose to your suppliers' workers, to your suppliers' operations and their ability to get your goods from their loading docks to nearby ports.

And there is a human side to all of this that relates to corporate social responsibility. If you don't have a good sense for which of your suppliers is required to (or unwilling to) comply with recently-imposed labor laws in China that protect worker rights (i.e., privately-owned factories are not affected by the laws), you better begin to understand your risks in this area. This doesn't only apply to your China-based suppliers. Tough economic times are going to lead to some harsh decisions by factory managers in all countries. Taking the necessary steps to understand your suppliers' business conditions and plans for responding to the current economic crisis will make you better prepared to manage your supply-chain risks.