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Maximizing benefits of Off Shoring*

When a European or North American manufacturer thinks about off shoring a factory or function, it often looks first at China and India. This is because both of these countries offer an attractive combination of

  • low costs
  • well developed capabilities
  • business friendly regulatory environments
  • large domestic markets

However, for people considering offshoring, it is dangerous to take a narrow geographical view. This is mainly because every country has a different mix of strengths and weaknesses.

For example, a country may have very low labor costs but a high degree of political instability and a small domestic market. Another might have engineering talents, but quickly rising labor rates.

Hence, to obtain the maximum benefit from offshoring, the foreign operations should be spread over a broader and well balanced mix of regions and countries.

Vestring et al(2005)’s research into industrial offshoring confirms the wisdom of a portfolio approach. Accordingly, in creating their offshoring portfolios, cost leaders take into account a wide range of decision criteria. For example, current labor rates, related costs like facility construction and utilities, education and skill levels of local workers, their business experience, maturity and stability of the nation’s infrastructure. Also, these cost leaders consider both short term and long term benefits which affect all relevant criteria.

However, maintaining production facilities in higher cost countries makes sense when labor is a minor cost component or when transportation costs are high. For example, call centers and textile industry.

Thereby, deciding whether to shift costs requires making focused decisions for each product line, while looking deeply into issues like relative labor costs, logistics costs, customer requirements and time to market.

For example, Emerson Electric Co a U.S. based conglomerate embarked on a strategy to methodically and progressively shift sourcing, manufacturing and engineering from its traditional bases in Western Europe and U.S. to a variety of low cost countries around the world in Asia, Latin America and Eastern Europe.

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It set up production operation in Mexico, for its low costs and proximity of the operation to U.S. Also, production capacity was established throughout in Asia to tap both into low costs and ensure a high degree of responsiveness to rapidly growing Asian markets. For example, Emerson hedged its risks by accessing skilled labor pools in Phillipines, India and China. By 2002, low cost countries accounted for 44% of Emerson’s total manufacturing labor cost. This has led to improvement in the company’s operating profit margin.

Emerson is thus known to have benefited from being earlier and bolder in its pursuit of cost migration.

This has led to the understanding that offshoring is not limited to routine production and assembly jobs. This is why cost leaders examine specific functions like finance, ICT, marketing on a case by case basis.

For example, Boeing Co. has a center that designs and does technical work in Russia. P & G gets its taxes done in Costa Rica, which has a strong cadre of workers with accounting skills. General Electric Co, has an R&D center in India with a staff of about 500 with about a third of them being locales with doctorates.

Considering portfolio diversity, it should be highly disciplined, balancing the risk advantages of consolidation. For example, Emerson concentrates its activities in 4 major production centers.

Achieving such a balanced portfolio requires a centralized approach to planning, with headquarters overseeing and coordinating a company wide offshoring program. This is mainly because leaving offshoring decisions upto individual business units has its own drawbacks.

  • It provides no mechanism to temper risk by distributing functions across a range of countries
  • It prevents companies from reaping savings across business units
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Thereby, cost-migration leaders take a number of practical steps to ensure that their portfolios are constructed successfully.

  • Establish and constantly update a detailed and robust database of current costs and other key criteria across low cost countries
  • Carefully set priorities for both functions and countries
  • For each activity, a short list of target countries are evaluated on the basis of long term competitiveness, current costs and capabilities
  • Upfront investment in building its infrastructure and capabilities

Thus, benefits of off shoring can be maximized.

Stay tuned with Zeeable for more of such updates!!

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