© Rossmore Group
The attractions of a supply source that could reduce unit costs by 80% are obvious. Not so obvious are the implications for the agility of the supply chain and the ability to maintain customer service performance. Detailed, objective planning is essential if the unit cost savings are to translate into increased margins for the business.
This Paper outlines an approach that will enable you to assess the opportunities in a rational way and come up with a strategy that delivers results. It also provides a questionnaire that you can use to assess your state of readiness.
Transferring manufacturing operations to low cost regions around the World is being considered by many businesses, due largely to the relentless pressures on margins and demands for increasing shareholder value. However, the decisions taken in principle do not necessarily deliver improvement in practice. Anticipated margins are eroded and customer service suffers, leading to loss of market share.
In considering transferring manufacturing to low cost regions, most assessments look at benefits (from the reduction in unit cost) and business transferability (from a technical perspective) but tend to overlook the issues created by an extended supply chain. The characteristics of a supply chain incorporating low cost supply sources can drive dramatic and unforeseen effects on business performance.
This paper looks at the attractions of low cost sourcing and the relationships between service level, lead time and inventory within the supply chain. It then suggests ways of making the opportunities for low cost manufacturing deliver benefit for your business.
Managing the Supply Chain for Low Cost Sourcing
There is no doubt that the potential savings in unit costs that can be achieved by sourcing components and products from low cost regions should be enough to make the CEO laugh all the way to the bank.
Labour costs that are around 20% of European levels are just the taster. A recent purchasing mission to China that we were involved in sought comparative prices on raw materials, parts and packaging for a specific product range. Savings of up to 90% against US costs were quoted (see figure 1).
It is easy to see how the link between 90% saving in cost and a huge improvement in profit is made, but there are three key issues to note:
Firstly, the range of savings is up to 90%, with some being only 10%. The effort involved in finding the higher level of savings may be beyond the resources of some companies. Secondly, competitiveness varies over time - can you be confident that the current savings will be at the same level in a few years time, or will you be looking at yet another move when this one has just settled down?
Thirdly, it takes no account of the other elements that make up the cost to the company, the Total Acquisition Cost (TAC). TAC recognises the additional costs involved over and above the purchase price, including procurement costs, verification costs and inventory costs. It has a strong relationship with the Service Level Model (see figure 2) which shows the cause and effect between service level, lead time and inventory.
The direct effect of trying to maintain service levels with the increased lead times that come with a geographically spread supply chain is to increase inventory. Try and fix inventory levels in this environment and the service level goes down. This is just another nail in the coffin of long lead times, which are a huge cause of waste in business.
Imagine a world-class industrial products company looking at sourcing components from the Peoples Republic of China for assembly in the UK. Let us assume the cost savings achievable are 50%. Currently the company is achieving upper decile performance for its sector, with over 99% delivery performance, less than 0.25% scrap rate and it works with 20 stockturns, equivalent to 10 day's stock. Their customers value them for their quality, agility and dependability. What impact will the following facts have on their performance?
The company has no facilities in China, nor does it have any experience of purchasing from the region
Development and monitoring of production and process capability to achieve required standards will take 3 years
It takes about 5 weeks to ship from China to the UK and up to 3 weeks to clear customs. This can vary by at least 1 week in summer and 4 weeks in winter.
Lead times for urgent parts from China are much greater than for own manufacture in the UK
Very simply, it would mean a major investment in developing the capability, a continuing additional cost in running a local buying office, and probably an eight times increase in stock levels. There is also a very real risk of reduced customer service levels.
The overall supply chain, from suppliers (and their suppliers), through the company operation, and to customers (and their customers) will be quite different, with extended lead times, stretched communications, higher stocks and higher risks of supply problems.
Will the CEO still be laughing all the way to the bank? Well, he could be if the whole process of designing and managing the supply chain is conducted in an objective and rational way. And that starts with understanding the operations strategy of the business.
The Operations Strategy should be developed from the market and business requirements and defines how the operations of the business are to be structured, the core activities that must be...