Outsourcing production may be fashionable, but not everyone is cashing in on the trend

On the surface, outsourcing production operations is the ultimate no-brainer. It can save on manufacturing labor and capital equipment costs, and allow more time spent on innovative product designs that lead to new revenue streams. But outsourcing arrangements don't always work out as expected. Stephen Hochman, a director with Boston-based AMR Research, says the desire to lower costs is the No.

By Hope Neal, Contributing Editor August 1, 2007

On the surface, outsourcing production operations is the ultimate no-brainer. It can save on manufacturing labor and capital equipment costs, and allow more time spent on innovative product designs that lead to new revenue streams. But outsourcing arrangements don’t always work out as expected.

Stephen Hochman, a director with Boston-based AMR Research , says the desire to lower costs is the No. 1 reason cited by companies that are outsourcing production. Yet a recent AMR study of 80 manufacturers found 56 percent of companies that are outsourcing production operations have experienced cost increases. Hochman attributes this to simple factors such as the need to stockpile inventory as a hedge against late deliveries of parts or finished goods coming from distant locations. Outsourcing also can make it more difficult to change production plans.

There are ways to keep outsourcing from becoming a costly endeavor: Foremost is to avoid focusing solely on potential up-front cost savings, and instead look at outsourcing as part of an overall business strategy.

Historically, companies have viewed contract manufacturing or outsourcing as a bit of an afterthought."
—Per Hong, principal, A.T. Kearney

Per Hong, a principal with Chicago-based A.T. Kearney , says a lot of manufacturers make the mistake of turning to contract manufacturers only after finding themselves with orders for more goods than they have the capacity to produce on their own.

“The idea is we’re going to load up as much volume as we can, and if we can’t produce something in-house, we’ll see if there’s somebody outside who can help,” says Hong. “That creates a dynamic in which a contract manufacturer is seen as a second-tier supplier to the in-house manufacturing operation.”

Companies that have the most success with outsourcing see contract manufacturers as business partners rather than suppliers. That’s the mind-set at Teradyne , a North Reading, Mass.-based manufacturer of automatic testing equipment that turned to outsourcing as a way of coping with volatile product demand.

“We’d make money hand over fist in good times, and lose money in bad times,” says Jim Wood, supply chain information systems director. “We wanted to get on an even keel.”

A strategic partnership

Outsourcing allowed Teradyne to shift its fixed-cost worries to its contract manufacturers, which, because they serve customers in several industries, are better equipped to absorb the overhead and depreciation associated with maintaining facilities and equipment.

Looking at outsourcing as a business strategy—rather than a short-term fix—prompted Teradyne to pare its list of contract manufacturers. Today it has a single outsourcing partner.

Teradyne’s experience can serve as a lesson to other manufacturers seeking to master the art of outsourcing production.

“The very first thing that broke down when we outsourced was visibility into demand and supply for some key components,” Wood says. Teradyne recaptured that visibility by deploying RapidResponse software from Kinaxis.

Kinaxis RapidResponse software allows a manufacturer to merge its own planning data with data from contract manufacturers, and then run simulations to determine the best way to respond to situations that could disrupt the flow of customer orders.

RapidResponse allows merging data from the contract manufacturer with Teradyne’s own data. Teradyne then runs simulations to determine the best way to respond to situations that could disrupt the flow of customer orders.

Wood says consolidating data in RapidResponse allowed Teradyne to “see demand and supply across all factories.” And the ability to run scenarios in response to problems enabled more intelligent use of production capacity. In essence, Wood says, “It was like having two new factories.”

John Sicard, an executive VP with Kinaxis, says RapidResponse makes better use of existing production capacity because it’s not a traditional closed-loop planning system. He classifies it as a “response-management tool.”

Closed-loop systems work well for long-term planning, Sicard argues, while response management comes in when the plan doesn’t work as expected. “When you’re faced with having to course correct—and I use that word on purpose—it’s not a question of starting with a bad plan,” he says. “It means something unexpected has occurred and you’re forced to course correct as a business. It invariably requires some human judgment or compromise, and that’s where traditional planning software generally fails. It doesn’t understand how to compromise.”

Control the brand

RapidResponse allows outsourcing partners to review a number of comprises together, and ultimately create a situation in which the primary manufacturer—not the outsourcing partner—decides how to respond to potential problems. That’s possible because the Web-based system allows multiple partners to view the same sets of data—including the recommended actions generated by the solution’s simulation engine—from different locations.

“If I introduce changes in demand at Teradyne, I need that information to flow through to my contract manufacturers so they understand the impact on them,” Sicard explains. “I can’t just throw the simulation over the wall. I need to have control.”

This control is important because the primary manufacturer—in this case Teradyne—owns the brand associated with the product, even if it’s built by an outsourcing partner. “Brand owners realize they still own customer satisfaction, and they still own brand loyalty,” says Sicard. “They also know their customers have their competitors on speed dial. So if they can’t get their gear in the field, or if they can’t get their goods on the shelf, the customer will reach for something else.”

AMR’s Hochman points out that while response-management tools are helping companies manage outsourced relationships, closed-loop planning systems still play a significant role.

“Closed-loop systems typically [move] toward a single answer to planning problems,” Hochman says. “That can save a lot of time, and maybe increase the profitability of whatever planning decisions that you make.” But advocates of response-management—or scenario-based—solutions argue that it’s becoming more difficult to run a manufacturing operation without the ability to deviate from pre-determined plans.

Some companies support outsourcing management needs by using closed-loop and response-management tools side by side. And one supply chain software vendor, i2 Technologies , claims to have blended these capabilities into a single application it calls Global Capacity Management.

Harish Iyer, i2’s director of industry solutions, describes Global Capacity Management as a “holistic closed-loop planning system” that addresses all the steps needed for planning. “We help create plans for using all of your outsourced production capacity,” Iyer says. “We also help with execution of those plans, providing visibility across the global outsourcing network, and monitoring its performance.”

If a user determines that a plan is not being executed properly, they can conduct analysis—including running “what-if?” scenarios—to determine what corrective actions to take. “There are multiple implications to a supplier not delivering to plan, and you need to evaluate all those options and decide the best course of corrective action,” says Iyer.

Response management systems—with their ability to offer options for coping with unexpected issues—complement closed-loop systems that many manufacturers use for long-term planning.

While human collaboration is considered critical to successful production outsourcing, many companies’ attempts at collaboration are limited. Hochman says approximately 65 percent of companies still rely on email, fax, and phone as collaboration tools. Even so, vendors continue to offer increasingly powerful collaboration capabilities.

i2, for example, refers to Global Capacity Management as a collaboration framework. The solution allows trading partners to link their enterprise systems, enabling automatic data feeds between organizations. Partners also have the option of requiring workers from each organization to have an actual conversation before any action is taken.

Iyer explains how the automatic data feeds work. “When a customer places an order, the information on the capacity and parts needed to fill that order is sent to the supplier’s internal planning systems, which create plans for executing on the order. And whatever plans the supplier’s systems create can flow back to the customer’s systems.”

Sicard claims functionality in the latest release of RapidResponse takes this process a step further by identifying the right person in the supply chain who can assist with a problem. “When something unexpected happens, the first thing people want to know is how it impacts the business,” he says. “The second question—which they can now answer with RapidResponse 9—is ‘Who can help me?’. ”

A collaboration platform

Another vendor focusing on collaboration is E2open , which describes its offerings as complementary to the planning and response management tools offered by i2 and Kinaxis.

While those vendors’ products help companies make decisions, Lorenzo Martinelli, a company VP, says E2open helps create the collaboration environment that enables the flow of data from external sources to fuel those decisions.

Hochman describes the E2open any-to-any hub model as ideal for situations in which companies have many supply chain partners.

“If you have two or three partners you’re collaborating with, and you’ve all agreed on a single method of communicating, then [point-to-point connectivity] can be very effective,” Hochman says. “Conversely, as a partner network becomes larger and more complex, you’re more likely to come across different data formats and communication protocols, and different processes for sharing data. That’s when companies struggle with point-to-point solutions.”

E2open focuses on enabling supply chain partners—each with their own unique systems and protocols—to connect as easily as possible through a single private network.

“The only way to do it effectively is to provide as many options as possible so the other party can come onboard with the minimum amount of cost and change to their systems. We allow companies to pick and choose how they wish to connect and collaborate with partners,” says Martinelli.

Even though simplified collaboration is vital to E2open’s customers, Martinelli says using the right technology is only half the battle. “We think a lot about what the best-in-class processes in certain industries are because they work if there’s a win-win for both parties. Otherwise people will find a reason not to participate in the process. And at that point, it doesn’t matter what the software does … it’s never going to provide value.”

Author Information
Hope Neal can be reached at hope@ontargetcomm.com