Offshoring a Manufacturing Process
Offshoring a process means moving the process execution to a service provider on a different continent as a typical outsourcing. Offshoring has been synonymous with far-shoring, as this relocation involves a large distance. Many companies pursued offshoring as a cost reduction measure, and it has been extended from simple business process outsourcing to production as well. Over the year, many manufacturing processes have been transferred to an offshore location to take advantage of lower labor costs. In this document, we describe how to make offshoring successful.
Key Consideration for Moving Manufacturing Abroad
Outsourcing a manufacturing process is different from selecting a supplier for parts in a different country. In pure outsourcing, the company provides the materials and parts to the supplier and the supplier will perform the manufacturing processes with the material supplied by the customer and sends the finished product to the customer. In recent years, in an approach to reduce parts tourism, companies have outsourced both the manufacturing and the purchasing of parts based on supply contracts with them.
There are three reasons for moving manufacturing abroad: Lower costs, higher flexibility, and availability of workers.
Since other countries have different labor costs, moving to a different country changes the required wages for the workers. In many Asian countries, the wages are much lower than in the US. This pushes many managers to shift labor-intensive production to a far-shore location to take advantage of the labor cost difference. If the savings in labor cost is higher than the transport cost from the far-shore operation site to the customers, there is a simple business logic for offshoring.
If your company has high demand peaks, moving the production offshore will allow a different production approach. In many other countries, migrant worker can be hired with very short notice. Instead of building inventory ahead of time with a regular fixed workforce, increasing the manufacturing work force in a time of high demand rapidly allows to produce the right volume. When demand decreases, production will be decreased, and migrant workers will only be employed in lower volumes. Foxconn, the outsource partner for Apple iPhone production, increases the workforce to build the extra high demand, when a new phone generation is launched into the market, and reduces the workforce after the initial sales peak. While they maintain enough production lines to produce the peak demand, lower volumes production is run on less production lines with the lower number of workers.
The availability of workers is another reason to move away from the current production location. If production cannot be increased, as the market for new hires is empty, moving to other locations with a high surplus of employees makes a lot of sense. Looking at the labor pool and finding enough qualified hires is an important evaluation for moving production offshore. Industrial work experience and dexterity are other key criteria for evaluating the labor market in offshore countries.
The higher the standardization of work, the easier the transfer of production processes to a different location.
Select the Right Country and Partner
Offshoring manufacturing requires the selection of appropriate countries and then the selection of the right manufacturing service company. Unless the company is forced to move production because of limited labor availability, the systematic approach is to identify suitable countries as future locations for the manufacturing first. The country defines the wage level and the transport distance, which are key parameters in the return-on-investment calculation. At the same time, the country also defines work rules and customs regulations.
The key question is how much labor is in the product and how much labor cost saving is needed to pay for transport. As an abbreviation, the amount of labor that fits into a sea container can be calculated and then an inquiry made, what are the costs for transporting sea containers from the selected country to your home base. When the transport cost is lower than the labor cost saving, the company is included in your country short list.
Once you have a short list of countries, you can identify suitable manufacturing service providers. Unless you have a lot of experience with offshoring work, it is wise to work with an experienced manufacturing service company. The international chamber of commerce or industry directories will indicate, which companies offer the kind of manufacturing services, you are looking for. Collect the key companies.
The next step is the RFI/RFP process to narrow down the possible candidates. Ensure that you follow up with references provided rigorously. It is important, that the manufacturing transfer works seamlessly, you cannot afford any problems, especially product problems. Review the selection of the final partners with the management team before you engage in final negotiations.
When you have the management team aligned on the partners, start the final negotiations and select the partner for the outsourcing. Now you agree quality, process and logistics with the agreements that document your requirements. The more your expectations are documented beforehand, the easier the transfer will happen.
Change the Manufacturing Process to Fit the New Partner
Production processes have always been in the focus of optimization. Saving manufacturing time translates into cost savings. In a high wage country, you can achieve a lot of cost reduction by mechanizing or automating production. Many companies have invested a lot in assembly automation, such as automated screw driving tools or assembly robots.
In a low-cost country, this automation approach is not right anymore. The return on investment for automated equipment is based on labor savings. With lower labor costs, these savings are lower, and typically, the return on investment disappears. Expensive automation is not applicable in these countries.
The production processes, therefore, need to be optimized for manual operations:
Take out automation steps with machines, where there is likely no local support for complex equipment support.
Make the processes failsafe by using fixtures for critical process steps.
Ensure that highly complex assembly operations can be broken down in easier separate steps.
Create cells for subassemblies and final assemblies.
Balance flow in the cells.
Create extra testing steps for better quality assurance.
Many industrial engineers require to realign their thinking with this new reality and implement a new focus on manual operation. They need to think about, how to use the least amount of manual labor without automation to ensure the highest product quality.
Manage Commercial and Customs Issues
The key commercial issues during negotiations are the price and the payment terms. But soon after the transfer, unforeseen issues happen and all of a sudden, new negotiations happen, either because the original scope was not well defined, key activities are missing or there is a disagreement on non-conformances of process execution. Other issues may be higher inventory requirements at the outsource partner or higher scrap rates. For expensive materials, the question who gets the profit from recycled materials, may arise.
The move of the production processes to an offshore location has many commercial traps. One key issue is the achievement of yearly cost savings and their distribution. Some companies demand a 2% cost saving per year plus half of the additional cost savings, that the company initiated. On the other hand, what happens, if the expected volumes will not be achieved. What are the costs for lower volumes and how are the cost reductions achievable by the supplier. Remember, it should remain a win-win situation for both parties.
Especially the move to an offshore location has many custom issues. First, you need to understand import taxes for the material. Some countries, especially China, require you to pay import taxes, that cannot be offset to any exports. At the same time, you need to check the import customs of the finished products. Usually, the harmonized system (HS) code is needed. While an exporting company has this information for the final product, getting the HS codes for the material is more complicated, especially, if they are produced inhouse. With the HS codes, you can identify customs rates and understand the impact of customs on the costs.
If your company wants to relocate an existing production line, the question on ownership and the way to export the equipment to the other country arises. Do you sell the production line to the service company or do you retain ownership? If you retain the ownership, how do you deal with maintenance costs or line improvements?
For new products, the production equipment can be separated. Standard equipment can be supplied by the supplier. You should retain ownership on tools and fixtures that are product specific to ensure flexibility to move to a different supplier easily.
Prepare for the Big Move
If your company has decided to offshore the production, set-up a team for the project. As a minimum ensure that each team member has a passport and can apply for visa for the destination country.
Then, there is a set of production movement steps:
Collect all documentation regarding the production.
Try to find information from the production ramp-up, from production process design.
Ask the production to develop a training manual.
Document the production with pictures and videos
Create detailed production instructions.
Create an inventory list of all equipment, all fixtures and all tools required
Create a list of all materials, the transport containers, and the storage level.
Create a training plan for employees from the new supplier
Create a ramp-up plan to build transition buffer
Order materials to build the transition buffer
Create a plan for the key people in the production that you want to keep and plan, how to train them for the new jobs
Although some of your suppliers will plan the own material flow, having a documentation of the existing flow is a good backup for future reference.
Plan the transfer with key steps. Define decision criteria for key milestones. How much inventory needs to be prepared to transfer critical equipment. When do you stop the transfer? With good preparation, you may never need to stop the transfer. As a last step, create a list of all possible risks and develop risk mitigation strategies.
When the planning and preparation is completed, the implementation can start.
Implement Offshore Manufacturing
The first step of the outsourcing process company specific production is the training of the first people from the new place. It is important to have these workers work at the factory in the old project and learn how to do the basic production steps. Once the first set of future workers is trained, the transfer can start, whenever the required transition buffer is built.
Sometimes, there are several similar production lines to move. In this case, the transfer is easy, as one of the production lines can be moved to the new location, set-up and production can be ramped up quickly. During the first week of production, having an industrial engineer and a quality engineer on site will help solve problems quickly. At the same time, in the old location manufacturing is still ongoing. In an iterative fashion, more production lines can be moved step by step.
If there are not multiple lines, the production line needs to be taken down, packaged well and sent to the new location. Ensure, that equipment is packaged very well, as the quality of roads may be much worse than you are accustomed to.
If there are different product variants to be moved, move one variant first and slowly ramp up the next variants. During the transition, the new supplier needs to prove, that the quality is perfect. Products need to pass all end-of-line tests, so operating the end of line tester at the beginning is an important task. After the end-of-line test, run a separate product audit on site to ensure, everything is okay.
Then a production trial run (“run@rate”) is required so the supplier demonstrates that the company is ready to run at full speed. During the trial run, the production needs to run at the final volume. As a preparation, all required materials need to be on site and quality checked, so that the production is not inhibited by missing material.
Once the first products have been produced and a first article inspection has been passed, the supplier can officially be released as serial manufacturer. After this release, any change in the production process requires approval from your company.
Improve Communication
One of the recipes for success is good communication. It pays to spend a lot of time communicating between the partners. Once a regular exchange meeting is implemented via a web conference, many questions can be answered quickly or assigned for follow-up.
The more communication takes place, the more trust will develop. Instead of trying wrong approaches, many times, these plans can be discussed in the regular exchange meeting. This meeting takes place every two weeks and follows a standard agenda. After a review of the action items, actual production status for existing orders is exchanged, and open issues are discussed. If the open issues cannot be resolved in the meeting, they are converted to action items with responsibility assigned to one participant for follow-up. Then new orders and projects are discussed. At the same time, the supplier discussed capacity availability for the next months, including special availability around holidays. During the discussions, new action items are added to the list of open issues.
The standard format of the meeting helps to focus on the key business issues. The discussion ensures, that both partners have all necessary information and problems can be discussed when they arise, and joint solutions can be developed. This leads to better understanding and higher trust. The key is to create an open work atmosphere, where issues can be brought to the table for find solutions not to finger point.
Adapt to the Changes from Offshoring
After offshoring the manufacturing, many things need to change. From setting up new MRP parameters to ensure availability of the product to the new reality, that it may take much longer to get a prototype or small change to the product.
So, the company must adopt to many changes. The key process to update is solving quality issues. If an issue appears at the offshore partner, there is a need for fast reaction. The reaction needs to be aligned with possibly different time zones and ensure constant communication. As there are more product in the pipeline – transport from remote location to you - and more inventory, quality issues need to be solved quickly to avoid costly rework. At the same time, due to the transport distance, you may need to accelerate some deliveries to have enough stock to support your customers with the right products.
The engineering change order process also needs to be updated to involve the external manufacturing partner. Due to the long transport times, the changes cannot be implemented as well and inventory of finished products and parts – both at your site as well as the offshoring partner site – need to be included.
For a long-term relationship, the new product ramp-up and the old product ramp-down process need to be included as well in the process updates. For prototyping, it may be useful to create a small prototype shop at the development center, but for ramp-up, it is important to ramp-up the new product at the offshoring partner site.
Conclusion
Offshoring your manufacturing process can be a complex but highly beneficial decision for your business. By considering key factors such as labor costs, availability of workers, and standardization in work, you can find the right country and partner for your needs. With careful planning and execution, offshoring can help you reduce costs, improve flexibility, and increase productivity. However, it's important to remember that this decision should be made with care and consideration of all factors involved, so you can make the most informed and effective choice for your business.