Womack: Do ‘lean math’ to calculate true cost of offshoring

Tags: lean manufacturing

Before offshoring work to low-wage countries, senior managers should use "lean math" to calculate the true total cost of relocating, according to management expert James P. Womack, Ph.D., founder and chairman of the Lean Enterprise Institute (LEI).

Companies usually compare piece-price costs for a product or service with corresponding costs in a low-wage country, then add in the cost of slow freight, usually boat, when deciding whether or not to outsource, explained Womack. "This is mass production math and it is no longer realistic," he said.

Womack recommended that senior managers perform a more accurate analysis of total costs, which he called "lean math" because it is based on contemporary lean management thinking. A lean math cost analysis includes:

Costs of additional inventory of goods shipped over long distances from the low-wage location to customers. Costs of additional safety stocks to ensure uninterrupted supply over long distances from the low-wage country. Costs of expensive expedited shipments from the low-wage supplier. Costs of lost sales caused by stock-outs due to longer lead times caused by longer distances. Cost of warranty claims if the new supplier has a long learning curve. Costs of engineer visits to help the new supplier get the product or service right. Costs of senior executive visits to establish or correct relationships with new suppliers. Overhead costs allocated to operations remaining in the high-wage location, which usually don't disappear when products or services are outsourced.

"This is becoming quite a list," said Womack, "and note that these additional costs are hardly ever visible to senior managers or purchasing executives who relocate production or services to a low-wage country based simply on piece-price plus slow freight. The reason is that these additional costs are paid by different functions in the company because they are allocated on a budget basis not a product-line basis."

Womack noted the list also should include currency and country risks, plus the danger that the new supplier will become unstable or a competitor.

"Because these risks are hard to calculate precisely, senior managers tend to assume they are zero when, in reality, they can be substantial," Womack said.

A lean-math analysis of total costs is no guarantee that companies will not have to relocate. For example, companies selling mature products in high-growth, low-wage markets like China or India will almost certainly need to locate most or all of their production there for these markets, Womack said. In addition, lowest total costs for supplying mature products to high-cost markets like North America, Europe and Japan are likely to be in nearby low-wage countries within the region of sale (for instance, Mexico for the United States, Poland for Germany, and China for Japan).

However, for customized or new products and services within the U.S., Europe or Japan, total costs are likely to be lower within these markets because proximity to design centers, logistics networks and customers offset high labor costs.

"The point is that offshoring is not the first line of defense for producers in high-wage countries," said Womack. "Rather, senior managers must get truly serious about using lean principles and tools to improve the design, quality, cost and delivery of the product or service in question, then implement lean management to sustain the gains."

About James Womack:

Management expert James P. Womack, Ph.D., is the founder and chairman of the Lean Enterprise Institute, a non-profit training, publishing, conference and research organization founded in 1997. He is co-author with Dan Jones most recently of “Lean Solutions” http://www.lean.org/Bookstore/ (Simon & Schuster, 2005), which describes how to apply lean concepts to management and processes outside manufacturing. Their classic business book “The Machine That Changed the World” (Simon & Schuster, 1990), the first book to describe in detail Toyota's revolutionary lean business system, recently was reissued in paperback with a new foreword and afterword.

About the Lean Enterprise Institute:

Based in Cambridge Mass., the Lean Enterprise Institute (LEI) develops workshops, books, conferences, training materials and case studies that help organizations transform themselves into lean enterprises and that teach leaders new behaviors to sustain lean enterprises.

Copyright, Lean Enterprise Institute (LEI), Cambridge, MA, www.lean.org. All rights reserved.

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