Extending the risks and rewards

Any chain is only as strong as its weakest link. While the cost rewards of outsourcing manufacturing to the Far East can be huge, so too are the risks. When a supply chain is extended geographically, its crucial for any manufacturer to be aware of the potential logistical pitfalls so they can be addressed at the outset.

That's why it pays to understand the hurdles that other business have faced, and how these have been overcome. Exel is one company which has had significant expertise in this area, working as it does on behalf of many manufacturers of all sizes and sectors.

Steve Hunter, technical director for Exel s Industrial sector, says the factors driving the route to the East are lower labour costs and lower materials costs. However, he adds, some manufacturers are excited about the whole idea of it being a large market to sell their products to. "Take China, for instance: even if it's still in its infancy, it's still a huge market."

But of course, the risks of moving production to China, for example, are significant. As Hunter explains: "A key risk is leadtime. Many manufacturers have adopted the concept of the demand chain rather than the supply chain - instead of pushing product through the supply chain to increase production efficiency, the real challenge lies in responding to demand. So lengthening the leadtime from six hours to maybe six weeks, in terms of transit time, obviously makes a huge impact. Putting product on a boat in China to get to Europe will cost you more than if you make it locally. That's pure common sense."

An important consideration is the unreliability of the infrastructure: Hunter says that transporting goods in China can be up to 50% more expensive than in the West. "There are less kilometres of paved highway in China than there are in the UK. So when you transport goods within China, it's always a horrendous journey. While the economies are there to move goods by road - the labour is cheaper, the vehicle itself is slightly cheaper, and so on - any savings will be eroded as it takes a lot longer to travel anywhere."

There are, however, many incentives to move production to China, including a five-year corporate tax holiday. But the cultural differences should not be underestimated. "If you've no presence in that geographical area, then a lot of businesses may run into difficulties while laws are written in black and white, the way you do business in practice can be quite different. That s a real challenge. Most Western cultures do adhere to rules and regulations, so it's quite tough to go and operate in an alien environment," Hunter points out.

There are, he says, four key risk areas, and he cites anecdotal examples to illustrate these:

* Unreliable supply: an electronic music player manufacturer sourced components from the Far East, but problems with one particular batch halted production, so damaging sales and subsequent profit figures.

* Inventory policy not linked to demand: a leading network and systems firm found that, despite having sophisticated supply chain software, it ended up with more than $2 billion in excess inventory due to inflated demand forecasts.

* Poor working practices: a clothing retailer suffered disastrous PR and was forced to end supply deals with 136 plants in developing countries due to use of unsafe machinery and violations of child labour laws. "You must ensure an ethical approach is upheld when you change the origin of production," advises Hunter.

* Initial one-off costs to relocate production: a white goods manufacturer found that the cost of moving production to low-cost countries hit its operating income by 34% last year, and it experienced charges of 151m.

"What all these demonstrate is that if you get it wrong, you can get it wrong very badly," says Hunter.

Inventory optimisation is the key conundrum. Figures from McKinsey show that customers in all sectors across Asia suffer shortages of the right product 40% more often than world best practice - despite inventory levels which are often 30% higher than the world benchmark. "Having extended the supply chain, there's a multiplication factor in terms of inventory problems," he points out. "To try and cover more, you have to increase inventory if you can't manage the information properly."

With offshoring, total costs should come down but the actual proportion of what is product cost and what is logistics cost changes quite significantly.

"The approach we take is to say that one of your opportunities lies in buying the freight cheaper," he says. "But to be able to do that you need scale. Exel doesn't own any boats or any aircraft, we purchase capacity from the major carriers, therefore we have huge buying power for a whole range of customers to tap into."

Information is vital in this: the supply chain has to be managed as an entire entity. "Sometimes it may be beneficial to send a small portion of your shipment as air freight so it gets to market and enables you to maintain customer satisfaction," he says. "The economics of that are, of course, that it's more expensive, but if you look at the whole cost-to-serve model, then you actually end up with higher profitability."

To do this, however, the right information must be at hand. "The route we've gone down, because we work with so many partners regularly the same carriers, the same customs elements, etc - is to track goods on a milestone basis. So if demand changes, we have an immediate picture of where product is and when it's due to arrive. We can make informed decisions on whether we need to change or enhance the delivery pattern. It is practical and it is happening."

Hunter advocates a sea change in attitude: "Traditionally, when manufacturing has been sourced locally, businesses have been run as manufacturing concerns - rightly so, as that's where the biggest proportion of the costs lie. But if you move offshore, particularly to the Far East, the balance of expertise needed is more towards the supply chain aspects. If an organisation doesn't address that balance, then they are not focusing on what is becoming a much larger part of the cost element.

"Whether you're moving production there, or just sourcing components there, accurate information is vital. With a locally sourced component, you've usually built up a track record on the service level provided. So when you order, you have a very good idea of a shipment's arrival time and its accuracy. In the first instance of moving, you lose that history so you need to monitor that very closely and be able to react to any changes. But even then, once you do build up some history, our experience shows the supplier will probably be less reliable. That s when you are in the danger period of increasing your stock levels to counter that risk. Poor reliability will often negate any financial benefit if you don't plan around the likely problems."

Exel's expertise is scaleable - whether as a logistics partner or, as is increasingly the case, as a final assembler of 'vanilla' goods. What it offers is the capability for a company to pay for that service on an as-used basis, rather than having extensive fixed overheads.

"More and more, we're not only acting as a logistics supplier, we're becoming a real supply chain partner, helping with all aspects including subassembly and light manufacturing. For many of our customers, we're an integral part of their business as the supply chain proportion of cost - and risk - becomes ever larger."

SPONSOR PROFILE

Exel

Solstice House

251 Midsummer Boulevard

Milton Keynes MK9 1EQ

T: 01908 244214

E: steve.hunter@exel.com

W: www.exel.com