The Outsourcing Paradox

William Newman is the author of the forthcoming title “Understanding SAP BusinessObjects Enterprise Performance Management (EPM)” due to be released by SAP Press ( in June, 2010.  This article appears as an abstract from that book focusing on supply chain effectiveness methods and approaches.  Visit our strategy page at our websit to learn more on this and other supply chain effectiveness and EPM approaches.

One of the major trends in the past decade has been the strong movement towards outsourcing the make and delivery phases of the SCOR® model to third world and developing countries, including BRIC (Brazil, Russia, India, and China) nations.  The driving advantage in these arrangements is principally cost, with a movement of 40% or more in price point reduction for goods and 50% or more for services depending upon supply chain network design.  Many nations have benefited from the increased demand for labor and materiel, contributing to the globalization of the world’s marketplace.

In the post-crisis economy, a move towards re-evaluation of these basic cost-driven principles has created the “total cost model” for goods and services.  This has created a need to review several areas of supply chain effectiveness in organizations today.  For example, a tooling manufacturer in the United States may find that they are competing at a 40% cost disadvantage versus a tooling manufacturer in China, however for delivery of the tool in Mexico the US-based supplier may have a three-week deliver cycle time advantage.  The OEM manufacturer must also weigh the complexities of the tooling design (can both suppliers provide the same content?) and the quality of downstream parts made from the tooling (can both suppliers provide the same reliability?).  Increasingly these decisions are not simply based on price point considerations.

If one considers a broader more complex and global operating model, the nuances of the supply chain become very clear.  Resources including capital investment originating from the headquarters of the global manufacturer based in Germany are distributed to its operations in China, Mexico, Brazil, and the United States.  While most product intellectual property originates in Germany, the product designs are modified per region and for particular marketplace orientations.  Additionally materiel flow and final product assembly are produced and transported for the given marketplace.  A deeper investigation of these principles sheds a clearer picture on the three elements of supply chain effectiveness: intellectual property, materiel flow, and final product distribution.

Consideration for Intellectual Property Source Flow

Intellectual property (IP) can flow quickly given the networking capabilities afforded by 20th century technology and global 24/7 collaborative teams.  Based upon the direction of the IP source flow, restrictions around technology may exist, creating the need to consider how the flow occurs and the filter of IP used as information passes from one location to the next inside of the enterprise.

One supply chain protocol used in the defense and energy sectors in the United States is the International Traffic in Arms Regulations (ITAR).  The provisions of ITAR preclude particular passing of controlled information based on the location of the individual accessing the information, the credentials (including citizenship) of the individual accessing the information, and the program access the individual may or may not have in order to access the information.  For example, our multinational organization passes information used to develop advanced turbine technology from the design center in Germany to its US affiliate.  Based on ITAR protocol, if that information is also part of a defense program as restricted information, it may be possible that a citizen of the United States with access to the program may not be able to access that information if they are based, for example, in Shanghai.  In this case the IP flow should be routed directly to Shanghai and re-purposed without divulging any sensitive defense related elements not already identified as permissible between the governments of Germany and China.  This releases the ITAR location restriction so the individual in Shanghai may see the relevant information in a useful albeit slightly sanitized form.

Other scenarios may exist for the control of IP in a global enterprise.  Management should be well advised to consider these scenarios in advance of enacting supply chain procedures that assume the information will be used in the same manner in different markets.

Consideration for Material Make Flow

The material make flow is one of the most important components to the manufacturing process.  Whereas most service industries are driven by ideation and IP content delivery, manufacturing enterprises have long-focused as we have seen in reducing waste in materiel and equipment used in the make phase of the SCOR® model.

Making a decision where to source materiel in the post-crisis economy has become more complex.  In the 1950s the idea of integrated supplier cities and villages reduced transit costs and lengthy issue resolution cycles.  This concept perpetuated as a long-held view in many industries through the 1990s and even into the 21st century.

The advent of outsourcing though created new economic scenarios where the vast reduction in labor wages and the absence of costly environmental standards in developing nations created a cost advantage to outsource the delivery of raw materiel.  Into the 1990s and early 2000s this evolved into component sourcing and eventual complete outsourcing of operations, such as electronic contract manufacturers (ECMs) in the semiconductor and high tech industries in the Southeast Pacific region and toy and textile manufacturers in China.

In today’s world some of the conventional wisdom of the 1950s has returned, wherein management considers not only the source of the materiel but also the region to which the end product will be destined.  This has created a regional-based operating model, similar to one clothing manufacturer example.  In this case the fabrics are developed in various regional centers and then shipped to target assembly destinations which first serve regional customer demand and then provide additional capacity for other markets based on the costs of labor, transit, and distribution.

In the case of the multinational manufacturer, final assembly of products is made for North America in the US and Mexico, for South America in Brazil, for Europe in several nations principally Germany (location of global headquarters) and in India and China via full operating brand subsidiaries in those markets.  Materiel flow is handled largely inside those operating regions, with the understanding that inventory, stock and materiel can be “traded” if needed to address peaks in regional customer demand.

Consideration for Product Delivery Flow

Similar to materiel flow for the make stage of the SCOR® model, final product transit in the delivery flow has evolved into complex global logistic models.  Final product assemblies made in key regional markets generally serve those markets based on familiarity with guidelines, standards and customer expectations.  This became painfully clear to American automakers in the 1980s who pondered the fact that sales of American vehicles in Japan were unpredictable and trendy at best due to the absence of right-hand drive vehicles to sell into that market.

In the post-crisis marketplace, however the return to local production communities serving regional customer markets has had a major impact on distribution and transit models.  For small price-point, high-margin products it continues to make good business sense to build these components and final products in developing nations where there exists an advantage to do so, and then incur the heavy transit costs to ship these products to other regional markets.  For complex, make-to-order products this can become increasingly costly.  Particularly as financial lines of credit continued to be difficult at the end of the economic crisis, some manufacturers have re-evaluated their insistence on offshoring models to address local customer demand.  In the case of make-to-order products such as equipment and tooling, the 40% reduction in make price point evaporates during the delivery stages.  Likewise, in the information technology service industry, reduction in price point to produce software could be eroded through the need to conduct costly software quality reviews when troubles occur.

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