In the late 1990s Electronic Hardware Corporation (EHC) of Farmingdale, NY had reached a vital crossroads in its history. The manufacturer of injection-molded plastic knobs, dials, and pointers to the builders of consumer and commercial electronic devices was awash in spiraling costs. Its competitive ability was under fire.
No matter what it did, internally EHC couldn’t make a profit. “We were treading water at best,” says Steven Sgammato, President of EHC. “We ran the gamut of incorporating new efficiencies and nothing worked. It all came down to labor and overhead since there’s minimal automation in our processes.”
As manufacturers struggle trying to deal with offshore competitors, many have chosen outsourcing to third world nations as their only answer to survival. EHC executives felt that developing direct relationships with assembly plants in China might be an effective way to lower manufacturing costs without the risky capital investment of building, then maintaining a plant. In the end, not only would this decision turn a $750,000 annual loss into a $1.2 million profit in three years, it would also reveal an entirely new and lucrative revenue stream.
“Competitive pressures and fast-paced technology changes are driving manufacturers across all sectors toward outsourcing and cost reductions,” according to Joe Barkai, Program Director for product lifecycle strategies at IDC. “This is forcing original equipment manufacturers (OEMs) to rethink traditional methodologies and look overseas to reduce costs, especially in redundant areas.”
Leveraging Chinese Outsourcing Experience
Under speculative circumstances, EHC began its China outsourcing “adventure.” “We began with the ‘low hanging fruit’,” says Sgammato, “larger quantities, less sophistication, fewer steps, legacy products that would transition well to China.”
The success enabled the company to quickly return to profitability and inspired it to establish a spin-off shelter group as the EHC/China connection matured. This shelter firm, International Smart Sourcing Inc. (ISSI), leverages these lessons learned into a commercial offering that helps OEMs establish and maintain Chinese manufacturing presences. Initially ISSI helped other injection-molding manufacturers. But soon it began assisting metal and electronics OEMs.
The past several years ISSI has helped over 50 small and mid-sized American and European OEMs outsource to existing manufacturers in China. ISSI oversees the projects and keeps close tabs on its Chinese vendors to ensure the work is done right and all intellectual property is kept proprietary.
One of them is The Allen Field Company Inc. (AFC), also of Farmingdale, NY. Outsourcing to China helped this manufacturer of molded plastic garment hangers and other custom-designed fittings for the packaging, woodworking, and textile industries change business models from operating a full manufacturing facility in the US to outsourcing all of it to China while keeping its executive and sales and marketing offices in the US. “It gives us a competitive edge in price and frees up internal resources,” says Robert Ahearn, Vice President of Sales and Marketing at AFC.
“But our ability to help others now is the icing on the cake,” says David Hale, Chairman and President of ISSI. “The EHC venture was the guinea pig. We did it strictly for own self-interests. It was after we went over and opened our China office that we realized what we were learning and how the relationships we were developing had distinct value to other OEMs.”
What Stays? What Goes Offshore?
“A surprising new trend is that small and medium-sized companies of all types are aggressively using offshoring as a growth strategy (91percent) compared to Forbes 2000 companies (65 percent),” says Professor Arie Y. Lewin, Director of Duke University’s Center for International Business, Education and Research (CIBER).
“But there is a tendency to base outsourcing decisions solely on current performance rather than potential improvements offered by internal or external solutions,” says Stephen J. Doig, Associate Principal of McKinsey’s operations strategy and effectiveness practices. “Even after years of belt tightening and incremental gains in efficiency, most manufacturers can still achieve 20-30 percent gains in direct labor productivity.”
But when outsourcing to China, Hale feels the real challenge to EHC, in the beginning, was developing a common technical language because “there is a difference between the way terms are expressed here and there. Not that many Chinese assembly workers are versed in English technical terms. And in some cases, no common words exist.”
EHC’s Sgammato says the first task in developing a common operational language was to analyze which of his products he could outsource overseas.
The first task, according to the EHC president, is to develop a tiered knowledge level of operations along with a detailed analysis on the logical way to transfer this manufacturing knowledge to the Chinese worker. “It’s what he or she can do that’s more important than what can actually be outsourced,” says Sgammato. “Deciding what to send overseas without taking into account how well the worker can perform the job is sometimes a commonly-made mistake.”
This is why Sgammato says his firm will likely never completely offshore its entire manufacturing operation to China, just strategic parts of it. “In 2002, our percentage was 70 percent here/30 percent China. Now it’s reversed, but 30/70 is probably as great a disparity as we’ll see.”
The reason for that is continued development of new products that, in their early years, it must be produce in the USIt’s the legacy products that have a high percentage of task redundancies and repetition. So around the third year of a product’s life, EHC begins to consider shifting its assembly to China because “by then, the process is refined enough and the Chinese workers can perform the assembly efficiently enough to make it profitable,” according to Sgammato.
Extending the Supply Chain in a “Just-in-Time” World
Manufacturers are faced with major challenges such as geographically diverse supply chains, reduced margins, tightening business regulations, and ever-increasing customer expectations. But they’re also discovering that the extended supply chain represented by having their products manufactured in China is not detrimental if they use the right approach.
Part of managing that supply chain effectively, according to Hale, is ISSI’s Web-based monitoring system that logs all communications for each specific purchase order and stores it so that the entire history of that product lot is available any time. “We learned to write simplistically within their common language. He also counsels his clients that a manufacturer who outsources to China not only has to better manage its supply chain, but also customers’ expectations. “When you manufacture here, you have the ability to fulfill in a week or two. But with China your product is on a Pacific Ocean container ship for a month.”
He says the customer has to accept that the lead-time has jumped from two weeks to six and they in turn have to make adjustments in how they manage their supply chains. “But it’s us, the American manufacturing supplier, who must help them understand and adjust.”
AFC’s Ahearn said that was the case when his firm shipped all its manufacturing to China. “But that’s the responsibility of sales and marketing. Still, before we began manufacturing in China exclusively, we bulked up on inventory to get us through. It only took a couple of cycles for it to settle down.” Ahearn says that no matter what sort of supply chain change a company makes, “there are bound to be some bumps in the road. The trick is to make them your bumps, not your customers’.”
He adds that AFC’s China manufacturing outsourcing has increased annual revenues by over 15 percent and the reduced costs keep his prices within his customers’ budget. “We’ve been able to focus more on sales, marketing, and new product development which has opened up a lot of new opportunities. And ISSI’s China assistance was instrumental in pointing us in the right direction.”
Sgammato notes that now his company and other ISSI OEM clients don’t have the burden of managing all the day-to-day manufacturing. “What outsourcing to China does for us (EHC), and the firms ISSI helps, is give manufacturers the ability to focus on sales, marketing, new product development and growth.”
Lessons from the Outsourcing Journal:
- Successful offshore manufacturing outsourcing is based on the capabilities of a country’s workers, and then on the products that are best sent offshore, not the other way around.
- When outsourcing manufacturing to China, a common communication channel must exist that can be used and understood in all areas: engineering, production, operations, and supply chain.
- OEMs that send redundant production duties overseas can expand their customer base because they are free to focus more on business, product R&D, and sales and marketing.