The search for lower operating costs caused a stampede of companies to rush to outsource manufacturing beginning in the mid-1990s. Those same cost pressures continue to drive the outsourcing trend today among both true believers and those who feel forced to the decision by competitors.

The outsourcing model basically is one in which companies focus on the "core competencies" of product design and marketing, while sending manufacturing to countries with low-cost labor. It clearly has worked well in a number of industries, but outsourcing veterans have learned that success involves a lot more than merely having someone do over there what used to be done here at home. Moreover, anticipated savings easily can fail to materialize due to unmanaged risk and unanticipated or overlooked costs in the supply chain.

"In a lengthy supply chain, complexities can produce costs that are implicit and not taken into consideration during the initial outsourcing analysis," says Richard Ligus, president of Rockford Consulting Group, Rockford, Ill., which specializes in helping companies develop and implement manufacturing and supply chain strategies. Most outsourcing analyses look at total landed costs, "but leave out the implicit costs such as exchange rate variances, cash tied up in floating inventory on the high seas, expediting efforts, engineering changes, travel, and loss of a customer order because of late deliveries or deliveries of wrong or defective products." Ligus estimates these hidden costs can add as much as 40 percent to a product's total cost. "Hidden costs are deceptive but need to be included in the total cost analysis of offshoring," he says.

Some costs may be recognized up front, but companies fail to account for the inevitable creep upward of these costs over time. Beth Enslow, senior vice president of the supply chain risk management practice at Marsh, New York, notes that food prices in China have risen 23 percent since February, while studies show wages going up between 5 percent to 10 percent a year and raw material costs rising 7 percent a year. Fuel costs also are a huge issue and as China becomes more concerned about the environment, costs there will rise, she says. "Companies are fooling themselves if they think their China-based costs will remain the same."

Companies also fall short when it comes to estimating costs of maintaining solutions, says Gary Lynch, global leader of the Marsh supply risk management practice. "Most companies are not aware or have not taken the time to understand the maintenance of particular solutions, whether it's a security solution, complying with a regulation or some other mitigation, and that cost can be five to 10 times greater than the initial investment," he says. "We just don't see organizations focusing on those issues." Enterprises also lose sight of aggregated costs across different departments or business units, he says. "For example, say there is a new local regulation or a new security requirement that impacts movement through customs. A company may have someone in supply chain dealing with part of that, but there may also be a global security department that is dealing with it or a separate international group. All are managing different parts of the requirement and all are adding costs, but these costs are probably not being aggregated and rolled up into the product cost."

Because these are soft costs, they are easy to overlook, Lynch says. "It is really only the capital investments that have clear visibility that get the attention of those that are evaluating the total cost of doing business in a particular location," he says. "Soft costs typically are just embedded into the cost of operations, so they really are hidden."

And some costs are simply impossible to calculate. "If a brand is damaged due to a defective product, how do you put a price on that?" asks John Sicard, executive vice president of development and service operations at Kinaxis, a supply chain solutions provider based in Ottawa, Canada. Loss of flexibility is another side effect of manufacturing outsourcing that can't be measured. "There is no question that you lose supply chain flexibility when you outsource," he says. "If your customer calls and asks for something different, it takes you longer to give them an answer and you typically are answering them with less information-you don't necessarily understand all the cost implications of a decision because much of the data you need isn't in your building."

These problems are exacerbated by two other trends at play in the world, Sicard says. One is that product lifecycles are shrinking, especially in technology; the other is the loss of brand loyalty as consumers change their buying habits. "Combined with the loss of flexibility, these trends result in higher costs to maintain customer satisfaction when you outsource," he says. "Even though you are not making a product anymore, you are still responsible for keeping the customer happy."

Response Management

Having the flexibility to respond quickly even in complex, outsourced supply chains -a solution area known as response management-is the basis of the Kinaxis RapidResponse product, which is used by many contract manufacturers as well as by their OEM or ODM customers.

Kinaxis defines response management as "solving problems you can't plan your way out of," says Sicard. "We believe response management is emerging as a category unto itself partially because of those trends mentioned earlier-global and pervasive outsourcing coupled with less loyal consumers and shrinking product lifecycles. Together these present an acute problem for companies that are no longer in control of their manufacturing facilities." RapidResponse solves this problem by "creating the equivalent of a glass factory, so brand owners can see right through the contract manufacturer's facility as if it were their own factory," he says. The Glass Pipeline solution provides visibility to the contract manufacturer's production plans and inventory positions. In addition, it enables users to simulate the impact of placing a new order or changing an order so they can determine whether it is feasible and what constraints are impacting operations. "With the multi-tier visibility enabled by Glass Pipeline, the brand owner can use the system to explore alternative scenarios that could enable them to fill the customer's order," Sicard says. "For instance, would making an existing order a lower priority enable the new order to be taken? If the brand owner could arrange for the contract manufacturer to receive more material, would that help? Could the contract manufacturer fulfill a slightly lower quantity or meet a slightly later date?"

Of course, contract manufacturers have to be open to this, he says. "This is a competitive industry and contract manufacturers recognize that they can't say, 'I'm sorry, but I am drawing my window shades.' If they do that, the brand owners will take their business elsewhere."

This kind of real-time visibility "is the antidote for everything," says Kevin Harrington, vice president-global business operations, Global Supply Chain Management, at Cisco Systems, which has extensive manufacturing outsourcing arrangements with contract manufacturers around the world. To help give it visibility into the operations of its partners, Cisco developed a solution called Autotest. "The integrity of the manufacturing process and the quality of products being manufactured was not something Cisco was willing to compromise, so we spent a lot of human effort, technological effort and intellectual property to create Autotest," Harrington says. "Autotest scales across our product families and allows us to have a window into the manufacturing process at each of our major contract manufacturing partners. It allows us to specify tolerances, collect statistics and real-time feedback about production status and quality, and automates a whole series of alerts. It allows us to understand what is happening while it is happening, so that if an intervention is required we can do that in a realistic way. In fact, if need be, we can stop a line halfway around the world from our offices in San Jose."

Autotest is an ongoing investment that is constantly being worked on and enhanced, he says. "We believe Autotest is a great differentiator and competitive advantage for us in terms of our outsourcing strategy because it assures quality on the front end."

E2open's Multi-tier Visibility Solution also was developed for use in a manufacturing outsourcing environments. Toronto-based Celestica, an $8bn electronics manufacturing services provider, uses E2open as the backbone for end-to-end supply chain visibility and collaboration with suppliers, says John Boucher, executive vice president for supply chain solutions. The E2open technology also enables the company to look at data in new ways "I can measure supplier performance based on the supplier's flexibility attributes, which I couldn't before," he says. This helps Celestica "execute the business the way in which we want to, and award suppliers based on their performance." It also supports Celestica's total cost ownership process by enabling decisions "based on real, accurate and timely data from the entire end-to-end supply chain," says Boucher.

In addition to visibility, these types of solutions provide collaboration platforms that enable contract manufacturers and their customers to quickly confer on and resolve problems. "Succeeding today is less a function of planning and more a function of responding to plan variation," says Sicard. "Responding to plan variation requires that teams work together to make a collaborative judgment and these teams need to be able to quickly form and disband, perhaps several times a day, for different unexpected events that occur." Kinaxis RapidResponse identifies the right people that need to be involved on these teams and enables them to collaborate in a virtual meeting space, he says. "Our unique technology merges a human being's job responsibility with the supply chain data itself to figure out who needs to get together to resolve an issue," Sicard says. "Human nature makes it difficult for strangers to immediately be able to collaborate on something, but if you are able to look around at members of a team and you know why they are there, it is a lot easier for them to get down to business."

Cisco is attacking this issue with an advanced technology called Telepresence that it acquired when it bought Webex. Harrington is executive sponsor of Cisco's global supply chain Telepresence rollout. Telepresence enables very realistic face-to-face meetings between people that need to collaborate on an issue, he explains. "In a highly disbursed business and operating environment, there is nothing like bringing constituencies and stakeholders who are far away right to you, and with this technology we can do that. We can take cameras right out onto the manufacturing floor while having a meeting with our contract manufacturer in a Telepresence environment. So we can be in San Jose and looking at something right on the line half way around the world with crystal clarity-and nobody had to get on a plane."

That in itself is a competitive advantage for a relationship, Harrington says, "but the thing I am really looking forward to is layering applications on top of that infrastructure, once it is present. A whole gamut of Web 2.0 technologies can be used to enable behavioral and business process changes. So the real call to action for our organization in the next year is to set up an environment for using this technology across every element and every function of the supply chain."

This will benefit not only Cisco but also its partners "as together we invent a new way of doing business that keeps us out of airplanes, keeps us in our time zones, keeps us fresh and productive and allows us in a highly dispersed way to convene on a problem with laser focus," he says. There will be direct savings as a result, but more important will be changes in the relationship, says Harrington. "It will show up in our ability to make faster and better decisions, it will show up in productivity which will impact margins, it will show up in faster time to market and it will show up in better product quality."

All About Relationships

Experts agree that true strategic relationships are at the heart of all successful outsourcing initiatives. Companies need to understand that they are not merely divesting production investments, but rather trading one kind of investment with another, says Aberdeen's Benchmark Report on Manufacturing Outsourcing. "Instead of owning and optimizing assets, they must turn their attention to owning and optimizing relationships. Enterprises that fail to grasp this will find that their outsourced manufacturing strategy is fundamentally not very different than a supplier strategy nor is it any more valuable," the report says.

Being "strategic in name only," is a failing of many outsourcing arrangements, says David Rutchik, a Washington, D.C.-based partner at Pace Harmon, an advisory firm specializing in contract manufacturing and other types of business outsourcing. These arrangements often "turn into nothing more than out-tasking, where a third-party performs the activities that the customer would have provided for itself, under similar basic conditions," he says. One problem is that the contract manufacturing industry remains largely focused on cost-plus or rate-of-return models, which result in negligible strategic benefit, he says. "When well executed using a true strategic sourcing model, outsourcing should deliver customers with value-driven results that they would likely never be able to produce on their own. Strategic outsourcing involves the outsourcing vendor utilizing its scale, purchasing power, and lower wage locations to reduce its own costs as well as the vendor capitalizing on its ability to perform functions in a more efficient and effective manner by deploying technology, methodology, and leverage across multiple customers."

Eric Larkin, chief technology officer and co-founder of Arena Solutions, Foster City, Calif., agrees that companies need to be prepared to make a significant investment up front in order to develop a strategic relationship. "Fundamentally, manufacturers should approach contract manufacturing and outsourcing with an economic expectation that in some ways is similar to the way they approach the problem of tooling for a product," he says. "You are aiming to achieve a reduction in the variable cost of each unit of product and typically you may spend $100,000 or $1m, depending on the complexity of the product or part, to purchase the tooling. With contract manufacturing, the same scope and scale of investment has to take place up front in order to end up with a successful relationship."

Arena provides on-demand product lifecycle management (PLM) software. As part of its PLM suite, Arena offers a costing model that can help companies better understand the economics of outsourcing. "Working with a tool like Arena PLM, companies can selectively share views of the product design with contract manufacturers, who can then provide them a costed bill of materials with a rollup to the total cost," he says. "They can then review that against their own internal sourcing methods to make sure they are seeing a reduction in the end unit or variable costs that are in line with what they expect."

This is an area where PLM "is a very valuable tool because it enables companies to establish a shared truth about the product with the contract manufacturer up front that is clear and unambiguous," Larkin says. "In outsourcing manufacturing you are asking a remote party to do something very complex," he continues. "PLM removes any ambiguity around what the contract manufacturer is supposed to be doing or building today. This is important because ambiguity leads to mistakes or errors that can end up being very expensive and chew up the cost reductions that you were expecting."

Larkin says an Arena survey shows that contract manufacturers like it when a customer uses a PLM tool for just this reason - "it removes the ambiguity around the relationship and makes the process of resolving the real dollar questions that have to be resolved substantially easier. Ambiguity is expensive and tools and business practices that reduce the level of ambiguity in a relationship end up yielding very substantial benefits in terms of being able to achieve the outcome expected," he says.

Risk Management

Another of the advantages of Arena's solution is that it ensures the communication of accurate product data and requirements to the contract manufacturer and keeps an auditable record of all instructions and changes, Larkin says. "You not only have to make sure the right information is used on the shop floor, but there also had better be something clear in the product record that says, for example, that the paint that gets used on this product has to be non-toxic and lead free. If you can't show that you effectively communicated that requirement to the manufacturer, you have a very serious liability problem."

Potential product defects are just one of the risks that companies need to consider when outsourcing manufacturing. "Companies may want to only focus on design and marketing and they may be really good at those, but they need to remember that they can't outsource risk," says James B. Rice, deputy director of the Center for Transportation and Logistics at MIT, Cambridge, Mass. "It is incumbent on every company to be thoughtful about how they manage risk and be aware of the risk they are exposed to throughout the supply chain, because companies are most vulnerable at their weakest point."

In the supply chain organization at Cisco, Harrington says, "I have a director who is leading supply chain risk management. That individual is working with crisis response, crisis management, business continuity planning, and business continuity management -- all of those types of things." While working from a central location, this manager also interfaces directly with various functional leaders at Cisco, Harrington says. "We initiated the concept of a risk index that basically measures resiliency and that allows us to see where different products and product families fall on that risk index. With that knowledge, we can create very custom and specific mitigation strategies based on the attributes and profiles of the products and product families."

JDA Software, Scottsdale, Ariz., also has a contingency planning tool to help companies develop a risk management strategy. "This is a very robust and flexible modeling tool," says David Johnston, senior vice president of manufacturing. "It can model various supply interruption scenarios for any particular category of products involving all the sources for that product and capacity constraints at these sources." From this "users can get pretty granular and fact-based cost data to see what the impact would be on profit or on service level, and see what the potential revenue reduction would be, given capacity limitations at alternate suppliers, he says. "This really helps the CEO or CFO make strategic decisions on how to flex their supply chain to protect themselves against some of the risks inherent in going offshore."

RESOURCE LINKS:

Rockford Consulting Group, www.rockfordconsulting.com
Kinaxis, www.kinaxis.com
Marsh, www.global.marsh.com
Cisco Systems, www.cisco.com
E2open, www.e2open.com
Pace Harmon, www.paceharmon.com
Arena Solutions, www.arenasolutions.com
JDA Software, www.jda.com