Outsourcing: Your Job and Theirs

September 1, 2006
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Guest columnist George Elliott discusses the true costs associated with outsourcing

Not long ago, I stood in front of a group of manufacturing executives and made the following statement: "If your organization does not have 'first-time' 1.33 Cpk production, you have no right to outsource." The group was silent, and I continued, "Outsourcing is more a matter of values than profitability. At the end of the day, an organization that moves a large percentage of their production or service volume to an international LCC (low cost country) is, in fact, abandoning the past legacy of the organization as well as its future."

The Outsourcing Option

Let's start with the premise that when an organization professes "our employees are our greatest asset," it is not just idle rhetoric but rather a basic belief. Thus, as entrusted managers and leaders, it is our obligation to strike a balance of value and financial return among all constituents, including consumers, employees, suppliers, the community, retirees, stockholders, investors and even our country's future lifestyle. It is what might be called a "Balanced Value System," much like a "Leadership Balanced Score Card" that provides feedback for both internal business processes and external outcomes to facilitate continuous improvement in strategic performance and results.

I have never seen a balanced score card that maintains that protecting jobs and growing current domestic employment is a priority. Nor have I seen a balanced score card that supports the concept of a full commitment to legacy costs. For organizations on the brink, such issues may well be low priorities in the battle for survival. But to the many organizations where growth, profitability, executive bonus and stock option appreciation account for the bulk of their news coverage, there is no balance without such measured priorities.

The primary objective of international outsourcing is simply to lower costs. In many cases, outsourcing can create a net 15 to 20% product cost reduction. This cost reduction is substantial and real. Although there is always an ever-changing cost dynamic from country to country, the bottom line is that production labor costs in China, Vietnam, Thailand and India can run as low as $1.50 to $4 an hour, against a U.S. average of between $23 and $25. On the staff side of the equation, professional salaries in these same countries run from one-quarter to one-half of current U.S. salaries.

Focus on Quality

So that is the challenge. How does an organization maintain an acceptable profit level while still maintaining a competitive position against such third-party costs? The answer, it seems to me, is obvious. It is to establish a truly lean, minimum 1.33 Cpk operating culture as part of the overall business strategy. It is the only answer that responds positively to a truly balanced value score card. Closing factories and outsourcing work is the easy way out, as is downsizing and down-paying. The tough job is aggressively addressing internal quality and cost.

The merits of a Six Sigma or even the lesser 1.33 Cpk "first time" quality imperative against the cost savings of outsourcing may not be obvious to those who have entered the workforce in a time when outsourcing is the accepted cost savings strategy. However, poor quality and inadequate quality control carry costs as well. Often as much as 20 to 40% of an organization's costs are tied to the costs that result from a lack of quality, including prevention, appraisal and internal activity costs. More importantly, though, it is the overall value proposition as perceived by the customer that really counts. In fact, in most cases, simply establishing a 1.33 Cpk "first time" quality can reduce total product cost by more than 15%.

Where does the quality cost reduction come from? It starts with the direct cost of defective work, followed closely by the lack of rework and warranty costs, but these are only three of the most obvious sources. In all cases, a 1.33 Cpk "first time" production quality will produce significant productivity and capacity increases.

Far-Reaching Opportunities

Once consistent and sustained quality levels are achieved in production, it immediately becomes obvious that enhanced quality can produce the same effect throughout any process, from order entry to shipping. Lean staffs are driven by profound knowledge, careful tracking of any process or production variation, and a full commitment to implement and support a passion for variation reduction.

One of the most encouraging aspects about addressing the incremental changes needed to reduce costs at home is the fact that a company is, so to speak, "family." We know how things work, and with brutal honesty we can almost immediately identify and go after the highest return opportunities. It's not that we do not see the issues and problems, it's just that there is so much to do that we seldom find time to stop and focus on excellence.

The truth is that to raise quality and reduce costs-at home-management must establish and sustain a value system that is based on the premise that leadership is an honor and a privilege. After all, managers and executives who are entrusted with the jobs and future of an organization must, first and foremost, understand that it is because of the past that they have the opportunity to lead.

To achieve excellence, a leader must lead the charge to an "extreme lean" 1.33 Cpk organization. He or she must stop work on any process that is not adding sustained value and encourage his team to challenge these activities every minute of every day. It is only with such a "balanced value system" that excellence can be achieved.

Certainly there are risks involved with dedicating ourselves to quality and leading the organization to performance excellence, but we owe it to ourselves and to the employees we call "our most valuable assets." Of course, not all people are fully equipped to undertake such a performance ethos. It therefore becomes the responsibility of today's leadership to step up to the plate of intellectual and value integrity to ensure that all workers have the knowledge, time and resources required to excel. In the end, the cost-effectiveness of this approach will be self evident. And while it might not be easy, we have proven that, as a country, we can do anything we put out minds to.

Taking Risks

As tough as this resolve might seem, gambling on one's own leadership, as well as your employees' knowledge, capabilities, and desire to learn and excel-presents far less risk than the long list of possible vulnerabilities one assumes with international outsourcing. As a reminder, some of the costliest potential risks associated with outsourcing include:
  • Currency vulnerability
  • Supply chain disruption
  • Infrastructure issues
  • Changing labor and material costs
  • Leadership shortages
  • Extended communication links
  • Language and cultural differences
  • Freight and insurance costs
  • Documentation and entry fees
  • Effect on company loyalty

In the end, outsourcing is about cost and values, leadership and integrity. It is time that we all pause in our quest to maximize profitability at all costs and instead reexamine our priorities. The base question that needs to be correctly answered before outsourcing is, "Are we living up to our responsibility to ensure that our organizations and country live and work by a 'balanced value system?'"

SIDEBAR: What is Cpk?

Cpk (Process Capability Index) is an index (a simple number) that measures how close a process is running to its specification limits, relative to the natural variability of the process. The standard of excellence is 1.33.

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