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Is Outsourcing Losing Its Appeal?

Vertical integration? Manufacturing in-house? The last few weeks I've been reading things that make me think I'm living in the 1980s.

For more than 20 years now, the conventional wisdom has been that companies should focus on design and marketing and outsource the rest. This gave rise to a whole new electronics manufacturing industry. Indeed you could even say it was the birth of the modern supply chain, in which different pieces of the product are made by different companies, then put together by a contract manufacturer, and finally marketed and sold under a specific company's brand, such as Dell or Hewlett-Packard. These OEMs don't make their own parts, and they certainly don't do their own manufacturing.

Now along comes {complink 2294|Google} with its Nexus Q wireless home media player, which is being built right in Silicon Valley, presumably by American workers. Google isn't giving up much information about the factory, including its exact location, but the company apparently gave The New York Times a tour. In a recent article, the newspaper reported that the product was being assembled “in a large factory 15 minutes from Google headquarters” and that it saw “hundreds of workers” at the plant. The article also noted that Google was using a contract manufacturer.

It would really be a surprise if Google started hiring assembly workers. Although, come to think of it, the company manufactured its own servers for years. And last year there was speculation that Google was considering making its driver-less cars in the United States.

Could this be a trend? The NYT article noted that {complink 8019|General Electric Co.} and Caterpillar have recently brought some manufacturing back to the United States, and speculated that this just might be the beginning of resurgence in building products at home. In fact, the Boston Consulting Group reported last spring that a third of American companies with revenues of $1 billion or more were either planning or considering moving manufacturing back to the United States.

Then there's Lenovo. It's not moving more manufacturing to the States, but it is doing more of its own manufacturing. An article in last week's Wall Street Journal explains how the company is bucking the trend of using contract manufacturers. Lenovo sees competitive advantage in owning its own factory and using its own employees. It currently owns eight factories around the world and plans to build three more.

“Selling PCs is like selling fresh fruit,” Lenovo CEO Yang Yuanqing told the WSJ. “The speed of innovation is very fast, so you must know how to keep up with the pace, control inventory, to match supply with demand and handle very fast turnover.”

For example, Lenovo was able to adjust quickly last year when the Thailand floods caused a hard drive shortage. Certain types of hard drives were in short supply, while others were not, so it just shifted manufacturing to products for which it could get drives, enabling the company to increase market share, according to Gerry Smith, Lenovo's supply chain senior vice president.

Bringing more manufacturing in-house is part of a strategic plan set in 2009, according to Smith, when the company “came to the conclusion that even though all our other competitors are going in the other direction… we can move faster if we're more vertically integrated.”

The future will tell whether the pendulum is indeed swinging back to in-house manufacturing. Meanwhile, it's worth watching Google, Lenovo, and any other companies going retro. It could have major implications for the worldwide supply chain.

60 comments on “Is Outsourcing Losing Its Appeal?

  1. Ariella
    July 27, 2012

    If it does become a trend, it would be a really good thing for the American economy.

  2. Himanshugupta
    July 27, 2012

    I do not understand the reason for the reversal of this trend. Is the inceasing cost in Asia or political pressure or simplified supply chain or Made in USA marketing tag or any other reason behind? What will happen to the significant investment that companies have made in offshore companies/contractors?

  3. itguyphil
    July 27, 2012

    I think this is only the case in specific industries. Overall, the geo-arbitrage model will stick around. It has helped many in the US to scale their businesses by leaps & bounds and actually hire MORE people than if certain jobs were fulfilled on shore.

  4. bolaji ojo
    July 27, 2012

    I would be interested also in finding out the type of products that are being produced in the US versus in the Far East. I believe low-volume products and high-end equipment that are really expensive can still be manufactured cost effectively at Western locations but high-volume consumer electronics devices will stay probably in China and at other low-labor cost countries.

  5. bolaji ojo
    July 27, 2012

    Himanshugupta, Just to take one tread of your question, I think the investments you referred to is quite relative. Companies have indeed made huge investments in China but often these are mainly in engineering, marketing and sales and not in plants. The manufacturing investment has been heavily on the part of contractors.

  6. Tam Harbert
    July 27, 2012

    My own speculation is that Google wants to keep manufacturing in the U.S. initially because it needs to be able to make quick design tweaks and also because it may be working with Hollywood movie and TV folks on the content side. If/when the product starts selling in high volumes, it will probably contract it out overseas.

  7. Eldredge
    July 27, 2012

    I suspect it is a combination of all of the factor you mentioned. Regaridng the overseas investmment, I suspect that can be sold to an interested party – but the fact is, that investment, like any, has an element of risk associated with it.

  8. Anna Young
    July 28, 2012

    @Himanshugupta, you have raised an important question.  I read in a report published by Boston Consultancy Group that American manufacturers will only be saving 10 percent when they outsource to China in three years. Why? The report suggested that there has been a shift in the cost of production in South East Asia, due to increase in transportation costs, wage equilibrium etc. Ok! We understand this, every good things does have an end they say. But like you said what will happen to all the investments made by companies in these countries? I'm sure it can't go to waste. I don't think all the production segments in these countries will return to shore, it's not economically viable. I think some parts might return In-House whilst the rest will remain offshore. What's your thought? Do you think the trend is politically inclined?

  9. Cryptoman
    July 28, 2012

    This trend is obviously positive for the US economy and the workforce. I am not sure why this is happening though. My guess is because of the global economical slow down, the sales volumes are probably not as high as they used to be. Therefore, the cheap manufacturing costs abroad is not as attractive as they were due to the reduced volumes. Leading companies may therefore prefer to manufacture locally rather trying to save a few pennies by manufacturing abroad these days. By manufacturing at home, these companies will obviously gain a lot of brownie points and will be able to use this as valuable PR material as an added benefit. I think the PR value of this is more valuable than the slim cost savings to be gained by manufacturing abroad at least for now.

  10. syedzunair
    July 28, 2012

    pocharle, I think so too. The reverse trend may only be applicable to specific industries. Will it be feasible to shutdown operations in the other countries and bring back the production to the US? What would be the kind of costs that will be associated with this transfer? 

  11. Himanshugupta
    July 28, 2012

    @Bolaji, i agree that companies might not have invested direct capital in Asia but setting up a business somewhere is a huge undertaking. I think if any company decide to leave Asia then it will be win-win for local companies as they will both get experience workforce and a sizable local business. The only benefit of outsourcing was cost but i think it is becoming more geo-political now.

  12. Himanshugupta
    July 28, 2012

    @Anna, i will be interested to read BCG's report as i do not believe that the saving will only be 10% for outsourced jobs. I think wages here are still very low as compared to Europe and USA. The whole outsourcing demon has surfaced after recession when the employment started to climb and the local politicians could not agree on policies to increase jobs so the easy target now is the low paying jobs that are outsourced to Asia. 

  13. Himanshugupta
    July 28, 2012

    Tam, i kind of agree with you that Google is keeping its manufacturing of Nexus close to innovation hub as it is easy to tinker with designs and development this way. But mass manufacturing will be contracted out and some of it will go to Asia.

  14. itguyphil
    July 28, 2012

    Too much. Then there's the associated costs with shutting down operations in the other countries. Those cannot be calculated accurately since, as we know, things outside of our borders DO affect us in one way or another. Most people do not account for that.

  15. Taimoor Zubar
    July 28, 2012

    “..it may be working with Hollywood movie and TV folks on the content side”

    @Tam: I think Google can still do that even if it outsources the manufacturing to China or Taiwan. Of course Google will still be the OEM so it will have control on the design and content of the product. Almost all the cable companies are working with TV and film producers but I don't think any of them is producing the hardware themselves. There has to be some other reason behind why Google opted for this strategy.

  16. Taimoor Zubar
    July 28, 2012

    “The only benefit of outsourcing was cost but i think it is becoming more geo-political now.”

    @Himanshugupta: I don't see how cost can play a role in Google's decision towards starting manufacturing in the US. The only reason that makes sense is that Google does indeed wants US to regain the strength in manufacturing. Google may be having to produce at a higher cost in the beginning but they may have assumed that the cost would fall as more and more companies look to manufacture in the US.

  17. elctrnx_lyf
    July 28, 2012

    Manufacturing outsourcing is completely unavoidable if your investment in owning the manufacturing is not recoverable with in five years. But when it comes huge volume quantities like consumer electronics, PCs and telecommunication equipment it does make sense to own the manufacturing and if possible most of the suppy chain.

  18. _hm
    July 28, 2012

    Better sense prevails. Outsourcing was questionable from begining. Now is very good news of homecoming. Thanks for good news.

  19. ITempire
    July 29, 2012

    @ _hm

    For US, it certainly is a good news. Outsourcing usually has been to US's and Europe's disadvantage as their labour cost and material cost have been beaten by suppliers from the far east specially.

  20. ITempire
    July 29, 2012

    Its surprising to know the reverse trend being made a consideration and also its nice that companies have started realizing that they will lose the manufacturing learning curve if manufacturing remains away from them for a long while and when the situation will necessitate bringing manufacturing back home, the company's own resources wont be ready for it.

  21. itguyphil
    July 29, 2012

    I am also pretty sure that since they are such a huge market force and US-based corporation, the US government is giving them a nice tax break by keeping operations, etc on shore.

  22. Himanshugupta
    July 29, 2012

    TaimoorZ, i agree that cost does not play role in Google's decision to keep manufacturing now in USA as Nexus is still in designing and pre-production phase. But i think once Google would want to expand then they will have to look beyond. 

  23. Daniel
    July 30, 2012

    Tam, now it seems that outsourcing are not that much attractive because of various reasons. The major reason is manpower offerings from China/India is not that much attractive, when compare with the older days. The other reason is due to various economic reasons, job opportunities are come down and companies are forced for cost cutting. Moreover some other threats from Government side against outsourcing also made companies for rethinking about outsource programs.

  24. Daniel
    July 30, 2012

    -hm, stopping outsourcing and creating more internal jobs are appreciable, but it has negative effects too. Companies prefer outsourcing is because of low man power cost, so when these jobs are creating domestically then the product selling prices may shoot up. It also forces the companies to ship all raw materials to the local facility and finished products to other countries, which is again an extra burden.

  25. FLYINGSCOT
    July 30, 2012

    Most of the time it depends upon what makes money.  If it is cheaper locally then do it.  If local is faster and faster gets customers, then do it.

  26. Barbara Jorgensen
    July 30, 2012

    I'm glad to hear that companies are pulling back on outsourcing: not because it might bring manufacturing back onshore, but because the process has run amok. I do think that outsourcing manufacturing only still makes sense, but for EMS compnaies the margins are too low. Thus, they started doing design, etc., leading to the ODM…at any rate, I think the economies of scale in outsourcing are shrinking and there are compelling arguments for a certain level of vertical integration within manufacturing.  

  27. Ashu001
    July 30, 2012

    Barbara,

    I agree wholeheartedly.

    In the race to save costs,too many ineffecencies have crept into the Supply Chain Process.

    Bringing back selective manufacturing back in-house gives companies the chance to have much greater control over the whole process.

    Also,most users are ignoring the aspect played by Cheap Energy prices here in the US.Thanks to the Shale Gas boom,Electricity prices(a major cost for all manufacturers) has declined dramatically.

    This gives them many more reasons to bring manufacturing back to the US[Alongwith the fact that Wage Disparity between China and the US is not what it was 20 years back].

    Regards

    Ashish.

  28. Ashu001
    July 30, 2012

    Flying Scot,

    Quite right. Its all about the money,Honey!!

     

  29. Ashu001
    July 30, 2012

    Jacob,

    I disagree.

    For arguments sake,Lets say all the products manufactured in China are now going to be manufactured in the US.

    So what?

    Most of the elements that go into electronics manufacuturing(copper,lead,Tin,etc) are anyways imported into China from Africa,Canada and Australia.Even the Energy Used here(Crude Oil,Natural gas,Uranium,etc) is also imported from America,Africa,Middle East,Russia,etc.

    This will just change the flow of the raw materials.

    In contrast,imagine how much manufacturers who are producing in America for American markets will save-Because of lower Distribution,Energy and IP costs(through this move).

    I think its best if we leave onto Individual companies and let them decide what is best for them.

    Regards

    Ashish.

  30. Ashu001
    July 30, 2012

    Himanshu,

    I don't think so.

    If Google re-builds the entire Supply chain in-house(which is what they are hoping to achieve here);there will be no reason to move elsewhere.

    On the other hand,it will give them enormous brand leverage over competitors especially in Asia and Africa;where –Made in America brand name has much higher value /comsumer perception than Made in China Brand Name .

    Regards

    Ashish.

  31. Ashu001
    July 30, 2012

    Charle,

    Its not the Federal govt (which provides incentives/Tax breaks for moving production back onshore) as much as State Governments who are eager to generate Jobs in America today.

    These States go out of their way to lure manufacturers to invest and set up production here.

    In addition,the fact that they get much cheaper electricity and competitively priced man-power also adds to the equation.

    Regards

    Ashish.

  32. Ashu001
    July 30, 2012

    Waqas,

    Quite right.

    In a way,what Google is doing is ;Hedging its bets.

    If things go totally hay-wire in China(scenes of Violence have increased considerably in their major manufacturing centres primarily because Workers are no longer prepared to work on extremely low wages);Google has a backup option which is definitely more secure and not just that;has all the resources needed very closeby(Including Cheap Electricity).

    These are all extremely powerful incentives to build a manufacturing base in the US today.

    Workers are more ready and willing(thanks to massive unemployment here in US) and competitive salaries than in china today.

    Its another undeniable fact.

    Regards

    Ashish.

    P.S Just look at these crazy scenes to get an idea how bad things can get in China

    http://www.bbc.co.uk/news/world-asia-china-18623085

  33. Houngbo_Hospice
    July 30, 2012

    @tech4people,

    If Google re-builds the entire Supply chain in-house(which is what they are hoping to achieve here);there will be no reason to move elsewhere.

    That will be an impressive feat for Google if it can really help “bring jobs back home”. Made in America poducts will always sell well provided they are affordable. 

  34. Ashu001
    July 30, 2012

    Houngbo,

    That's true.

    But you also underestimate the Power of The Made in America Brand Name.

    Today everyone in Asia and Africa equates Chinese products with Cheap,Disposable and poor quality products(rightly or wrongly).In contrast,Consumers there are very,very eager to Buy and Hold American products and Services.

    Its a massive prestige issue which I am sure Google can and will leverage here.

    Regards

    Ashish.

  35. Houngbo_Hospice
    July 30, 2012

    @FLYINGSCOT,

    Most of the time it depends upon what makes money.

    That is right, the reverse movement will only make sense if the companies can still make money when they manufactures their products at home. It successfuly happened in the past and it can also be possible today.

  36. bolaji ojo
    July 30, 2012

    Ashish, You are right that in many parts of the world, Chinese products can often be associated with poor quality but it used to be that Japanese products were once seen in the same way. The Chinese will learn. It will take time but some of them will try to burnish that image. If they succeed they'll face the challenge that came with becoming quality manufacturers just as the Japanese found out: it raises your cost.

  37. Ashu001
    July 31, 2012

    Bolaji,

    You make the right points here.

    But the more important question is this-Are they(the Chinese) ready for this transistion?

    Please Note-China is today much-much poorer than Japan was when they made this transistion(to Higher valued Goods);if they can't make it effectively;it will have disastrous consequences for the Chinese economy as they see themselves get priced out at the Lower end and squeezed out at the Upper end(because of poor quality products).

    That perception of Chinese products in most of Asia and Africa is well merited(IMHO).And the Chinese will have to work very hard and show some original thought-process to change that.

    Trouble is Innovation usually comes in A Free Economy;not in a Command and Control style of setup(which China is today).

    Let's Wait and Watch!

    Regards

    Ashish.

  38. itguyphil
    July 31, 2012

    I could be wrong but I thought that was one of the major sticking points made during the last election. Does that mean that the federal incentivizes the state governments?

  39. ahdand
    July 31, 2012

    Yes indeed becasue many have opted for the in-house development prohest which is good.

  40. kilamna
    July 31, 2012

    The Japanese have this behavior worked out to a science; as perhaps the Germans do too. Make change in management and organization every few years if you need it or not. In the case of the US businesses the true, and perhaps cynical, view would be 'whatever maximizes management bonuses'. Short-term P&L etc. I wonder if anyone really ever did a thorough analysis of the total cost of offshoring? The cost of effects of miscommunication, resulting from cultural, language, and time differences. Labor is a very small portion of most electronics manufacturing. What I have found is that it is the support structure and turnaround may well be a more significant factor.  We find that the smaller suppliers are more flexible and responsive.  Somewhat like the story of DOS vs MS-DOS and how Gates essentially created a business out of another person not being responsive.  THAT may well be the reason why China has become a powerhouse > and only when the US infrastructure and supply chain develops the willingness to be flexible will re-shoring become a true trend, rather than just a 'greenwashing-like' fad.  A factor that the US govt should take up with the WTO: China Govt support and funding of industry … so it is really private enterprise competing against the Chinese govt's financial power. A power we helped 'create' by the shortsighted (but very selfish-mercenary) thinking of US leadership.

  41. itguyphil
    July 31, 2012

    nimantha.d,

    Not sure I follow your comment? Can you clarify?

  42. bolaji ojo
    July 31, 2012

    Outsourcing didn't happen overnight. In some ways it first crept up on the industry until it became a “must-do-too.” Perhaps nearshoring will follow the same trend.

  43. Daniel
    August 1, 2012

    Barbara, you are right and it depends up on case to case. If the OEM Company in China is importing everything from outside and finally exporting all the finished products is not that much economical. So it’s always better to set up the manufacturing facility, where minimum importing is less.

  44. Daniel
    August 1, 2012

    Nimantha, in-house design, development and production are good, but most of the companies have not that much resource. Moreover such requirements are only for a certain time frame. That's the one reason for outsourcing and they have t pay only for the work done.

  45. atkipp
    August 1, 2012

    I recently visited one of our customers who was doing some of their manufacuturing in-house, but decided it was more beneficial, financially, to farm that particular part of the job out.  Because they are only paying for each job they need done outside, they are saving themselves by not having to pay additional employees to sit around when there is no work to be done.  It makes complete sense and I completely understand the logic.

  46. Barbara Jorgensen
    August 2, 2012

    atkipp: I agree 100 percent. If a cost analysis is done and the savings make sense, I think outsourcing is still a great option. In fact for a certain class of produts, it is still the BEST option. But I do think in many cases, a cost analysis was ignored in favor of “everbody else is doing it” or more importantly “our competitors are doing it.”

  47. atkipp
    August 2, 2012

    Barbara; You're absolutely right.  I would hope that type of decision would be based on a cost analysis, a whole lot smarter than  “everyone else is doing it”.  The companies who makes those decisions using the correct information are the one's who will thrive.  Outsourcing makes sense, when it makes sense, but it won't always.  I  

     

  48. Daniel
    August 3, 2012

    Atkipp, you are right. If the company has enough resource and manpower then everything goes well. If they don't have enough skilled manpower, resources then it's always better to outsource the works. Again it depends from case to case.

  49. syedzunair
    August 7, 2012

    @pocharle:

    I think that the costs of shutting down operations elsewhere and bringing them back to the US would be much more if than the cost of production elsewhere. But then it would help the company and not the US economy. Probably, manufacturers are thinking about all the jobs that will be created once the production comes back to the US. And don't forget that if they manufacture in US they will have control over the quality at all times. 

  50. syedzunair
    August 7, 2012

    Outsourcing makes sense, when it makes sense, but it won't always

    Exactly, it depends on the kind of products you manufacture and the industry you are competing in. Most firms actually decide to outsource after they have a firm basis, i.e. cost analysis and future feasibility. The ones' that just get into motion as a reaction to a competitor are the ones I believe for whom it doesn't make sense. 

    For a manufacturer the production is the key phenomenon to control. And a decision such as this one has a deep impact on it. 

  51. ahdand
    August 8, 2012

    Well Jacob just because yo do not have any resources to make your systems work as you would like to ,outsourcing is not the key. I feel you should hire employees who has he skill and then do it in-house. That way you can expand your business plus has a gurantee that the data will be in safe hands.

  52. atkipp
    August 8, 2012

    Nimantha.d: The particular customer I had, initially, been referring to only outsourced to someone they had completely trusted, because they had used them in the past for overflow. It was, also, kept in the US (even local), which is, of course, the only way it should be done.  If there is a particular piece of a job that isn't done frequently enough to justify keeping someone in-house on a full-time basis, I don't begrugde these companies for using an outside company. If the numbers say it doesn't make sense, then it doesn't make sense. If they do a particular job on a regular basis, then it would make sense to have someone in-house to do it for them.   All manufacturers are looking to do the best job for their customers, but they also need to do what's best for them, financially, otherwise they won't stay in business, hence, no more customers.  

  53. Daniel
    August 9, 2012

    Nimantha, if my requirement is for a short while, then why should I have to take the pain? Recruiting an employee is a lengthy process. I have to advertise for the post, call them for interview, after appointing I have to fix a salary along with other benefits and perks, allocating resources for work,…. etc. if am outsourcing the same job, I have to pay only for the work done. That’s the main reason behind outsourcing.

  54. ahdand
    August 10, 2012

    Well atkipp yes it depends on how the business process is going to run and for how long. If its a short term project then outsourcing is ok.

  55. ahdand
    August 10, 2012

    Jacob true you have a point but you still have the risk of loosing data and also keep in mind that if the 3rd party company knows that this is a short term project they might try to get it indirectly. That is a risk which has to be handled with care.

  56. ahdand
    August 12, 2012

    Well I think its not loosing as such but things are becoming a bit more commercialized where the original outsourcing has been changed dramatically. That may be the reason where you get lots of support services charging hugh amounts which makes companies to feel that outsourcing is not that worthy as it was sometime back.

  57. Daniel
    August 13, 2012

    Nimantha, I agree about the risk part. But the same risk can be from inside the company also. In every company there are a certain percentage of employees which will do all sort of such things like stealing datas, technology, design etc. So there is no guarantee that we can safe guard our technology or datas, but obliviously in house works are much safer when compare with outsourced works.

  58. Jim4007
    August 14, 2012

    Companies outsource for several reasons, First they do not want to invest in assets that they cannot keep efficiently employed, Second they don't have the core competency to do the work at their cost target. Third, they need additional capacity.

    Companies off shore as a form of labor arbitrage or to save logistics costs and get closer to their customers, or to deal with currency abd balance of trade issues,

    Since the world is a dynamic place and these factors are always changing, we can exect that offshoring and outsourcng will ebb and flow in response to the changng factors and the expense and difficulty involved in moving  manufacturing locations.

     

  59. ahdand
    August 16, 2012

    Yes there are people who misuse company properties but that can be handled easily rather than handling 3rd party data violations. That would be a cost for the company.

  60. itguyphil
    August 22, 2012

    True but if in bringing operations back on shore, they company ends up losing moeny, thus having to layoff employees. This will cause another ripple effect on out economy.

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