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10/25/2011 | 3 MINUTE READ

Teach Your Customers The Hidden Costs of Offshoring

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They might not realize that' low cost' isn't all that it appears to be.

I recently received a document from Phil Cullen, senior consultant with The Corporation for Manufacturing Excellence in San Ramon,  Calif., a member of the National Institute of Standards and Technology (NIST) Manufacturing Extension Partnership (MEP). The subject was near and dear to my heart … and to many others’, I’m sure: offshoring.

In that document, Cullen points out that there are costs associated with offshoring that are typically not fully understood by OEMs. In the long run, he states, by the time the OEM factors in these “hidden” costs it can make the entire offshoring exercise a financial wash, or worse, can end up costing more.

Maybe you work for an OEM that is looking to source mold parts at an overseas “low-price” supplier. Maybe you have already lost their business under these circumstances. So maybe it’s time to show your customer the big picture.

Cullen wrote in some depth about these hidden costs. Let’s go over a few an OEM might face:

Supplier selection: Expect this to consume 2% to 10% of the OEM’s lifetime budget for the project. Skimping on this step can have major cost repercussions (cost ratio of ~100:1). The OEM’s vendor selection process for offshoring is typically more elaborate than that for domestic outsourcing. RFPs are more involved, specialized legal talent is more expensive, and more time is consumed at every step of the process.

Site visits will be necessary. An OEM will likely meet with the best and brightest people their overseas supplier has to offer. However, these are not the people who will be doing the actual work. If the OEM wants the real story, he must go to their location and personally perform due diligence.

Transition: This will take from three months to 1 year, during which time costs will go up. If the OEM has not prepared its executive team for this inevitability, life can get quite uncomfortable. People will have to be trained. This will involve some overseas travel. Processes will have to be documented. Is the OEM’s current documentation good enough to support overseas manufacturing? Probably not.

There will be false promises made and unexpected impediments. The only thing you know for certain about your plan is that it is not exactly what is going to happen. You may get lucky in some areas, but experience shows that more often than not, some things go wrong.

Customer relationship costs: Things will almost certainly go wrong during the business transfer. Some of the OEM’s customers will get the short end of the stick, and retaining them will incur more expense. The rule of thumb for customer retention costs is that acquiring a new customer costs 10 times as much as keeping an existing one. OEMs can expect that something will happen during transition that will cost them a few customers.

Maintenance: Maintaining the offshore asset will involve significant recurring costs. Make sure the OEM really understands what those costs are and how they affect the bottom line.

Capture: Once the OEM has transferred its processes to the offshore vendor, what guarantee does the OEM have that later renegotiation with the vendor will not scavenge whatever cost savings are left, if any? Losing control of its core product capabilities puts an OEM a step closer to being the captive U.S. marketing agent of an overseas producer. Every partnership has a hierarchy.

Global supply-chain risk: As events in Japan this past March have shown, “unanticipated event” costs can be quite large. While natural disasters can strike anywhere, there are political and currency risks associated with overseas production that are simply not an issue in domestic manufacturing.

Next time your OEM customer threatens to pull a job from you for the sake of a “low price” offered by an overseas competitor, make them aware of all this. Check out manexconsulting.com for more information.