The planning horizon for overseas manufacturing is much longer, which adds uncertainties and risks and hence hidden costs. Planning under these conditions is much more problematic and challenging than for domestic manufacturing. The longer the supply chain, the more the company is at the mercy of its forecast accuracy. A longer supply chain can increase the risk of obsolescence. Mistakes are not as easy to correct in an extended supply chain as with a domestic manufacturer. The domestic supplier may be able to provide additional products in a matter of hours or days, not weeks or months. Thus, great care should be taken in the assessment of total cost of inventory (working capital, damage, obsolescence) and the facilities and costs required to manage it, both at the “average” level and during the peaks and valleys that often accompany cross-ocean supply chains.

Tracking Tribulations

Inventory management with offshore manufacturing is further complicated by having inventory in different places at different times – on the ocean, waiting for an inspection in port, moving on a train or already stored in the warehouse. All inventory must, of course, be tracked, no matter where it is. Technology can help, but only to a degree. Without sophisticated tracking processes, products being shipped from overseas tend to go into a “black hole” until they arrive at a port. It may take several days just to find out whether a container has been loaded onto a ship as scheduled or has been “rolled,” i.e., left behind because the ship left full without it. Uncertainty means risk, and hence costs.

Several transportation management systems are available to track inventory, all of which claim to provide clear line-of-sight to the inventory throughout the supply chain. However, these technologies can be difficult to implement. Moreover, they may be of limited use in inventory management because the various carriers do not abide by a single standard for communication and some carriers are spotty at best in their delivery of status messages that drive the tracking systems. Further, a number of third- and fourth-party logistics companies claim to provide visibility of shipments around the world. But these are also hampered by the lack of common standards, and sometimes they are owned by a carrier that may have difficulty obtaining information from a competitor. Adding to the challenge are the difficulties of communicating in multiple languages and across different cultures, which may lead to misunderstandings and unmet schedules. At best, tracking attempts present a fragmented picture, regardless of how “easy” electronic commerce supposedly has become. Inability to track shipments accurately calls for great flexibility, and often additional costs, in inventory. Don’t forget to include these tracking costs as part of the TDC analysis.

Costs That Change Over Time

Some companies do a thorough job of analyzing the entire cost picture initially but forget to review their calculations regularly. When this happens, they pay much more a year or so later when rapid global change has suddenly made their decision unprofitable. A profitable outsourcing decision never depends on a single number at a single moment in time, but needs to consider a range of possibilities and a range of possible futures. This is the third step in a good decision-making process.

Among the global changes that can dramatically affect manufacturing costs are currency fluctuations, demographic and socioeconomic changes and, of course, the ever-rising cost of fuel. Such changes can quickly double manufacturing and transportation costs and can erase any return on investment (ROI) from an overseas capital investment. Today, it is more critical than ever to evaluate a planned infrastructure capital investment overseas against many different futures to ensure it is robust enough to be profitable under any conditions. Once a decision is made, continued vigilance and flexibility are just as critical.

Let’s say that, to obtain a reasonable ROI, an offshore facility has to operate at reasonably full capacity for five years. What macroeconomic changes might occur in that country, and the world, during those five years that could change the facility’s profitability? India, for example, was the destination of choice for information technology-related outsourcing just a few years ago. Now, that country’s economy has grown, and these services have become much more expensive. More jobs have become available for people who used to depend on work in all-night call centers, and computer manufacturers are paying much more to retain quality personnel so they can maintain service levels for US consumers. Similarly, in China, an emerging middle class is creating a larger demand for consumer goods and skilled workers, resulting in unprecedented job hopping that makes retaining good people exceedingly difficult. Some estimates suggest China's labor-cost advantage will come to an end by 2010.

Whether companies outsource their services or manufacturing operations, they need to remain vigilant to changes in workforce demographics and salary costs. Even over as short an investment horizon as five years, the changes in developing countries can be dramatic.

Along with demographic changes, changing political and regulatory policies can have a significant impact on total delivered costs over the time horizon of an offshoring or outsourcing decision. For a number of years, many companies have taken advantage of a 17% tax rebate on products exported from China. However, based on a protest brought to the WTO for unfair trading practices, this rebate is being phased out, creating a step change increase in the cost of goods that are now sourced from China.

This kind of cost increase could be a disaster if it were not anticipated.

Components of Complex Decisions

Making the right decision under such complex conditions and evaluating it against many possible futures depends on three components: the right tools, the right data and the right methods. Tools must have the ability to:

• Calculate the total delivered cost.
  
• Account for all the elements of the total delivered cost, tangible and intangible.
  
• Allow accurate forecasting over the length – both time and distance – of the supply chain.
  
• Track the total cost so it can be used in decision-making.
  
• Model and compare the entire matrix of sourcing options for all raw materials and components used in the manufacturing process.
  
• Account for the extreme variability that comes with global commerce.

With a short, domestic supply chain, it is easy to take quick, corrective action if variability has been ignored in the beginning. But with a global supply chain, the next shipment may be two months away.

The data that supports decision-making covers all the cost elements: raw material, manufacturing, transportation (ocean, air and land), taxes and duties, warehousing, inventory and distribution. It also includes currency values and forecasts of changes in those values.

A common pitfall is discounting the risks of currency fluctuations, regulatory change and risks associated with transportation. Discounting risks usually results in higher costs.

Even the most capable tool and the best data, however, can lead to poor decisions if the underlying assumptions about a company’s operations are incorrect. Many companies have the best forecasting tools on the market, but their forecasts are not worth the paper they are printed on because they do not follow a disciplined forecasting process. If an accurate forecast was assumed in the TDC analysis, the inventory and expediting costs that were calculated will be significantly lower than the actual costs will be.

Once a decision is made, sensitivity analysis can help ensure it remains profitable. What would have to happen to reverse the decision? Could it happen, and is it credible? For example, if expediting 5% of all orders were to reverse the economics of the decision, is such a 5% expedite rate credible? If so, perhaps domestic manufacturing or a blended strategy would be more cost-effective. It may be efficient, for example, to obtain 90% of the products from a developing country, using an inexpensive method of transportation, while ordering the remaining 10% from a more expensive, but highly responsive domestic supplier to mitigate expediting requirements.

Think Globally

Savvy logistics professionals are analyzing the impact of all manufacturing and distribution components to determine the best sourcing matrix. They achieve a proper balance between domestic and overseas sourcing by correctly assessing supply chain cost and risk. With a short, domestic supply chain, it is usually easy to take corrective action if the unexpected happens. With a global supply chain, variability is not only more likely, but when it bites, it takes a bigger chunk out of profits. The trouble with variability is that it is an uncomfortable concept, difficult to grasp and it is hard to account for in calculations of costs and benefits. A step in the right direction is having good processes and analytical tools for supply chain analysis and forecasting. But don’t count on analytical detail and forecasting to provide the right answer automatically. Take the time to think about how a decision will operate under varying global conditions, now and in a number of possible futures. The most informed decisions will emerge from regularly-scheduled reviews, which include a combination of detailed analysis and a wide-ranging perspective of the global landscape.

Alan Kosansky is President and Ted Schaefer is Director of Logistics and Supply Chain Services with Profit Point, a company that specializes in helping businesses optimize complex processes. www.profitpt.com.

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