Executive Briefings

What's the Real 'China Price'?

With its cheap labor and open-arms policy toward industrial development, China is nearly impossible to resist as a source of manufacturing. But maybe U.S. producers ought to think twice. What business wants to extend its supply chain by thousands of miles, to a country with its own regulatory and infrastructure challenges, only to end up paying more for production?

That scenario was offered up by Jim Miller, executive vice president of industrial, multimedia and automotive with Sanmina-SCI Corp. (www.sanmina-sci.com/), at a recent meeting of the Council of Supply Chain Management's San Francisco Roundtable (www.cscmpsfrt.wildapricot.org/). Sanmina is one of the world's five biggest contract manufacturers of consumer electronics and other high-tech products, so it ought to know a thing or two about the right place to locate a plant. In fact, the company has 10 factories in China. "It's very important to us," said Miller, "but it's not the only answer."

There are plenty of examples to challenge the conventional wisdom about Asia as an ideal source for offshore manufacturing. Take Miller's personal experience while vice president of product operations with Cisco Systems Inc.(www.cisco.com). Cisco had a product with a U.S. customer base and a supply chain based on the West Coast. How much could it save by moving assembly of that item to Da Nang, Vietnam? Maybe $25m? Think again. When all costs were factored in, Cisco would have increased its supply-chain expense by 15 percent.

Or listen to a recent study by McKinsey (www.mckinsey.com) about the potential benefits of producing a mid-range server in Asia. Say the company was looking at $100 of savings from lower labor rates, back in 2003. With all supply-chain costs included, that amount would be shaved to just $64 - still an appealing proposition. Now fast-forward to 2008. The $100 in labor savings is now only $45, and the bottom-line number is - wait for it - a loss of $16. Extra costs include freight, higher inventory carrying expense, product returns and other less tangible risks, such as the failure to satisfy customer demand. That "total landed cost" thing can really be a bear.

"Historically, offshoring was about chasing low-cost labor," said Miller. "We were all enthralled with the 'China Price.'" Of course, that degree of ardor was based on fairly simple supply-chain modeling, under the assumption that life is non-stochastic - in other words, predictable. Anyone who's heard of chaos theory will have a good laugh over that one.

Having jumped on the China bandwagon, a manufacturer finds its risk factors soaring. Suddenly, it's a lot more difficult to cover up for glitches in the supply chain. Safety stock levels begin to rise, canceling out the savings that were realized through just-in-time supply strategies. High-priced airfreight becomes a frequent fall-back position. And managers "spend countless hours in business-contingency exercises that are about as valuable as the binders they sit in," said Miller.

No supply chain exists in a vacuum. Consider the many market drivers that can impact total sourcing costs: the state of the economy, the volatility of fuel and commodity prices, shrinking product lifecycles, political and regulatory changes, environmental considerations, counterfeiting and intellectual property theft. Now think about the importance of reliability as a factor in customer retention. As Miller put it, "Our brand is a reflection on our extended supply chain." Now ask yourself: Do you really want to dump everything in a Chinese factory just because the wages there are lower?

Echoing the comments of Tesla Motors' Evelyn Chiang (see my previous post), Miller stressed what ought to be obvious: that supply chain and corporate strategies are inextricably linked. Factors to keep in mind include the use of mass customization and postponement practices, the weighing of centralized versus regional production and inventory schemes, the unique lifecycle of each product, the availability of talent for both direct and indirect labor, system-wide capacity constraints and overall marketing strategy.

Many companies are eager to begin making a product in Asia on Day One of its lifecycle. Miller suggested that they take time to stabilize the item with local manufacturing, then move to a lower-cost region as volumes ramp up. When they do venture overseas, they should take a good look at the target country's infrastructure. He cited the case of a Silicon Valley maker of disk drives, whose vice president of supply chain shifted global manufacturing from Thailand to Shanghai. The company spent a year and a half getting ready for the move, only to discover that Shanghai didn't have enough heavy-lift capacity. So it was back to Thailand, with all that time and money wasted.

Despite his cynicism about much contingency planning, Miller recommends a good risk-management program. Things to keep in mind include the protection of intellectual property (a "cornerstone" of success in the high-tech world), disease pandemics, natural disasters, global climate change, new security requirements, labor unrest and other "stuff" that happens. Ironically, for all their efforts in this regard, even the most far-seeing companies are rarely ready for what actually occurs. "My guess," said Miller, "is that the thing that will bite us is not on this list."

Are you ready to pay the "China Price"? Fine, but keep Jim Miller's words in mind: "Offshoring is not simple - and quite frankly, it's not always the right answer."

*     *     *

That paper examining Boeing's supply chain for the 787 Dreamliner, from UCLA's Anderson School of Management, is now available in full (www.supplychain-forum.com). I posted about it last August (http://www.supplychainbrain.com/content/headline-news/single-article/article/building-boeings-dreamliner-why-all-the-delays-1/). Authors Christopher S. Tang and Joshua D. Zimmerman take a close look at why the innovative aircraft has encountered a rash of production delays. They offer a number of tips for manufacturers who don't want to repeat Boeing's mistakes. Highly recommended reading.

- Robert J. Bowman, SupplyChainBrain

Comment on This Article

With its cheap labor and open-arms policy toward industrial development, China is nearly impossible to resist as a source of manufacturing. But maybe U.S. producers ought to think twice. What business wants to extend its supply chain by thousands of miles, to a country with its own regulatory and infrastructure challenges, only to end up paying more for production?

That scenario was offered up by Jim Miller, executive vice president of industrial, multimedia and automotive with Sanmina-SCI Corp. (www.sanmina-sci.com/), at a recent meeting of the Council of Supply Chain Management's San Francisco Roundtable (www.cscmpsfrt.wildapricot.org/). Sanmina is one of the world's five biggest contract manufacturers of consumer electronics and other high-tech products, so it ought to know a thing or two about the right place to locate a plant. In fact, the company has 10 factories in China. "It's very important to us," said Miller, "but it's not the only answer."

There are plenty of examples to challenge the conventional wisdom about Asia as an ideal source for offshore manufacturing. Take Miller's personal experience while vice president of product operations with Cisco Systems Inc.(www.cisco.com). Cisco had a product with a U.S. customer base and a supply chain based on the West Coast. How much could it save by moving assembly of that item to Da Nang, Vietnam? Maybe $25m? Think again. When all costs were factored in, Cisco would have increased its supply-chain expense by 15 percent.

Or listen to a recent study by McKinsey (www.mckinsey.com) about the potential benefits of producing a mid-range server in Asia. Say the company was looking at $100 of savings from lower labor rates, back in 2003. With all supply-chain costs included, that amount would be shaved to just $64 - still an appealing proposition. Now fast-forward to 2008. The $100 in labor savings is now only $45, and the bottom-line number is - wait for it - a loss of $16. Extra costs include freight, higher inventory carrying expense, product returns and other less tangible risks, such as the failure to satisfy customer demand. That "total landed cost" thing can really be a bear.

"Historically, offshoring was about chasing low-cost labor," said Miller. "We were all enthralled with the 'China Price.'" Of course, that degree of ardor was based on fairly simple supply-chain modeling, under the assumption that life is non-stochastic - in other words, predictable. Anyone who's heard of chaos theory will have a good laugh over that one.

Having jumped on the China bandwagon, a manufacturer finds its risk factors soaring. Suddenly, it's a lot more difficult to cover up for glitches in the supply chain. Safety stock levels begin to rise, canceling out the savings that were realized through just-in-time supply strategies. High-priced airfreight becomes a frequent fall-back position. And managers "spend countless hours in business-contingency exercises that are about as valuable as the binders they sit in," said Miller.

No supply chain exists in a vacuum. Consider the many market drivers that can impact total sourcing costs: the state of the economy, the volatility of fuel and commodity prices, shrinking product lifecycles, political and regulatory changes, environmental considerations, counterfeiting and intellectual property theft. Now think about the importance of reliability as a factor in customer retention. As Miller put it, "Our brand is a reflection on our extended supply chain." Now ask yourself: Do you really want to dump everything in a Chinese factory just because the wages there are lower?

Echoing the comments of Tesla Motors' Evelyn Chiang (see my previous post), Miller stressed what ought to be obvious: that supply chain and corporate strategies are inextricably linked. Factors to keep in mind include the use of mass customization and postponement practices, the weighing of centralized versus regional production and inventory schemes, the unique lifecycle of each product, the availability of talent for both direct and indirect labor, system-wide capacity constraints and overall marketing strategy.

Many companies are eager to begin making a product in Asia on Day One of its lifecycle. Miller suggested that they take time to stabilize the item with local manufacturing, then move to a lower-cost region as volumes ramp up. When they do venture overseas, they should take a good look at the target country's infrastructure. He cited the case of a Silicon Valley maker of disk drives, whose vice president of supply chain shifted global manufacturing from Thailand to Shanghai. The company spent a year and a half getting ready for the move, only to discover that Shanghai didn't have enough heavy-lift capacity. So it was back to Thailand, with all that time and money wasted.

Despite his cynicism about much contingency planning, Miller recommends a good risk-management program. Things to keep in mind include the protection of intellectual property (a "cornerstone" of success in the high-tech world), disease pandemics, natural disasters, global climate change, new security requirements, labor unrest and other "stuff" that happens. Ironically, for all their efforts in this regard, even the most far-seeing companies are rarely ready for what actually occurs. "My guess," said Miller, "is that the thing that will bite us is not on this list."

Are you ready to pay the "China Price"? Fine, but keep Jim Miller's words in mind: "Offshoring is not simple - and quite frankly, it's not always the right answer."

*     *     *

That paper examining Boeing's supply chain for the 787 Dreamliner, from UCLA's Anderson School of Management, is now available in full (www.supplychain-forum.com). I posted about it last August (http://www.supplychainbrain.com/content/headline-news/single-article/article/building-boeings-dreamliner-why-all-the-delays-1/). Authors Christopher S. Tang and Joshua D. Zimmerman take a close look at why the innovative aircraft has encountered a rash of production delays. They offer a number of tips for manufacturers who don't want to repeat Boeing's mistakes. Highly recommended reading.

- Robert J. Bowman, SupplyChainBrain

Comment on This Article