Intent on impressing his boss, an up-and-coming American business unit-manager reported they were now saving $8.69 in purchase price on every unit being manufactured in China. While the boss was enthusiastic about the savings, he couldn’t help wondering, with all the problems they had encountered in starting-up their production in China, would they ever turn a profit?
Unfortunately, both the business unit-manager and his boss had underestimated the cost and complexity of taking manufacturing overseas. They’d also failed to realize that, although labor and materials costs are lower in China, profits would not be automatic.
Whilst this scenario was occurring in the United States, leading Japanese companies were outsourcing complex products to China, getting quality results, and making money.
How is this possible?
The Japanese outsourcing process
While Western companies favor outsourcing product manufacturing as early in the life-cycle as possible (including the engineering prototype stage), the ultra-cautious Japanese follow a profoundly different approach. Not the least of which is developing, testing, and refining manufacturing processes internally, long before considering outsourcing.
“Engineering and manufacturing are a continuum. If engineering expertise or bandwidth is not available then there aren’t sufficient resources…”
A practice whereby the Japanese first build a substantial quantity of devices in-house so the design, manufacturing processes, and end product can be tweaked and perfected internally. Then, when satisfied with first pass yields, predictability, stability of the design, and overall product quality, the Japanese move the entire process – generally including the tooling, fixtures and test equipment – to China for volume production.
Hence, the unique Japanese practice of outsourcing processes as opposed to functions.
The difference between “China” and “Canada”
Despite the fact that the names “China” and “Canada” begin and end with the same letters, there’s a huge difference between outsourcing manufacturing to the two locations.
Sending a team of technical and manufacturing personnel to China for weeks or months to find and solve problems can cost an order-of-magnitude more than sending them to Vancouver or Toronto. Yet most Western companies continue to structure their outsourcing programs as if they were working in Canada.
This Western approach is a subtle but significant variation from that of the Japanese and one that regularly results in cost over-runs, production delays, and missed opportunities.
Western companies tend to focus their outsourcing strategies around minimizing purchase price, while paying less attention to total-cost-of-ownership (TCO). An amount that, according to data collected in Technology Forecasters’ 2005 Global Pricing Workshop, regularly exceeds 5% of purchase price and in more than a few cases can range as high as 10-12% of purchase price.
This Western focus on purchase price rather than TCO represents a practice that is wholly divergent from the approach taken by the Japanese. Their primary focus is centered on problem – and therefore cost – avoidance.
This philosophical difference is further exemplified by the practice of many large Western OEMs who require that engineering and early low-volume runs be priced at “full volume production” rates. At best, a scheme capable of shaving a fraction of a percentage point off the overall cost of an outsourcing project. At worst, a dangerous message to the supplier that price – not service, or quality, or performance – will be the driving objective of the relationship.
Navigating the outsourcing landscape
There are also fundamental differences between the way Western and Japanese companies view and interact with the outsourcing landscape. Increasingly, Western companies have transformed themselves, or large portions of their organizations, into marketing businesses. Applying their long-established brand names to products they neither design nor build but procure directly from ODMs, a practice seldom embraced by the more conservative Japanese.
“The history of Western industry is littered with monetary losses produced by companies ‘off-shoring’ product design and manufacturing.…”
The exact rationale for using ODMs varies from company to company but generally is rooted in one or more of the following:
- The OEM lacks engineering expertise or bandwidth to develop a product in-house.
- The projected purchase price from an ODM is lower than from an EMS.
- The OEM wishes to avoid having to carry excess or obsolete materials on the company’s balance sheet.
- An ODM product is used to fill a nonategic hole on the OEM’s line-card.
- The OEM’s primary focus is time-to-market and ODM solutions are higher velocity.
These five items compose a reasonable listing of real issues that can be successfully addressed by the ODM methodology. In fact, numerous examples of the successful implementation of the approach can be found without difficulty in the industrial press.
However, re-considering the list from the Japanese — versus a Western — perspective helps to explain the divergence of style between the approaches, especially on the front-end of the manufacturing process:
- Engineering and manufacturing are a continuum. If engineering expertise or bandwidth is not available then there aren’t sufficient resources to support the manufacturing process.
- Purchase price is only one element of total-cost-of-ownership. Adding a supplier adds costs and increases risk.
- The problems of excess and obsolete material are avoided by the use of Lean Manufacturing (and other techniques), not by shifting responsibility to another party.
- Nonategic products are not part of Japanese companies’ product offerings.
- While velocity is important, time-sensitive market windows are usually too small an opportunity to be of strategic importance to long-term goals.
Supply solutions and the supplier interface
Whereas Western companies often look for the lowest-cost supplier for each new opportunity, Japanese companies place a much greater emphasis on finding suppliers they can work with over the long-haul. Consequently, Japanese companies spend more time in the initial stages of the relationship – an investment that makes the suppliers feel the relationship is less transient and more committed. Moreover, the Japanese (generally) allow the suppliers to profit from the relationship, while most Western companies remain stubbornly focused on securing the lowest possible price, at any cost.
Western companies also work hard to ensure that every “i” is dotted and each “t” is crossed in agreements designed to wring the last drop-of-blood out of their outsourcing suppliers. Contracts running 55-65 pages of impossible to read legalize (even when English is your native language) constructed to address every conceivable adverse event. Whereas standard Japanese agreements are no more than 10-12 pages and read more like “you will do this,” and “we will do this.”
Additionally, Japanese companies pay Chinese manufacturers faster than their Western counterparts, who often require Chinese suppliers to manufacture, ship, and consign goods to distribution centers outside of China, but withhold payment until the products are sold to the end consumer – a practice placing a heavy burden on the Chinese manufacturers’ cash- flow.
All of which has led to a number of rifts in Sino-Western business relationships. Contrasted by the less contentious style of Japanese, whose clear and simple approach, focused on high quality manufacturing, profit for both parties, and the establishment of a productive long-term relationship, having been broadly embraced by the Chinese.
Conclusion
There is nothing in the Western playbook that automatically precludes successfully outsourcing product design and manufacturing to the Chinese. However, the history of Western industry is littered with monetary losses produced by companies “off-shoring” product design and manufacturing to partners in China and elsewhere, without first having proven the worthiness of the products and processes used to build them.
Historically, Japanese companies have made sure that every product they manufacture overseas has been successfully manufactured at home first. And they have done so using sound, time-proven, and productive processes that yield dependable, high-quality end products. Plus, the Japanese make sure these processes are transportable to (and well supported in) whatever lower-cost geography they wish to utilize.
A concept and approach worthy of serious consideration.
Editor’s Note:
Jeff Berger has been working with Technology Forecasters since 1999. Jeff has also worked with Texas Instruments, Compaq Computer, AT&T, and IBM. He is a freelance technology writer, who began his career as a newspaper-radio-TV reporter in Rhode Island. He can be reached for questions or comments at info@techforecasters.com. (Thanks go also to Ed Nance, a long-term resident ofHong Kong who often contributes insight and perspective to Technology Forecasters on Chinese issues; Ed contributed significantly to the development of this article.)