Deciding whether to automate or outsource your manufacturing operation depends on how well you understand your process and your customers.

Automate or outsource? That has been the manufacturer's dilemma since the industrial revolution. To respond to price competition, you can find a location where wages are lower than you currently pay and move your production there. Alternatively, you can improve productivity by automating part or all of your process. Both options can reward you with lower costs and improved profits. However, if you ignore the risks, either choice can be a very costly mistake that damages your organization's profitability and/or your shareholders' value.

Of course, with 147 countries in the World Trade Organization, and nearly all of them able to pay their workers a tiny fraction of what an American company can, choosing to do nothing can be even more perilous. If you cannot find ways to keep your prices competitive, someone will find a way to undercut your price and steal your customers. As recently evidenced by the steel industry, you can't rely on the government to protect you. The same treaties the U.S. government signed that force others to accept our exports have also forced us to import theirs.

Before answering the "automate or outsource" question for your company, it can be helpful to look at the experiences of others who have already been down these paths. The stories are true, but the names have been changed to protect the privacy of companies and individuals.

Randy's "Easy" Choice

Outsourcing can seem to be the easy answer. Chinese companies are aggressively soliciting work and offering rapid turnaround times, no tooling costs, and prices for parts and labor that are a fraction of what a western company can offer. With these advantages, outsourcing can appear to be a very attractive option. This was the route that Randy decided to take.

Randy's company makes small ceramic parts. He has a customer who purchases an assembly where one of Randy's ceramic parts is fastened to a metal component. Randy does not make metal parts, so "when we initially looked at this decision, it was an easy one." Randy said. "We needed to find a partner to produce this part for us, and our Chinese vendor was able to add the assembly of the parts essentially for free. The numbers looked great on paper, so we moved forward cautiously."

Randy gave his Chinese supplier a small volume of test production. Their deliveries were on schedule and the quality was good. Randy's customer was happy with the results of the sample products, so Randy began shipping containers of his product to China. A few weeks later, he received the Chinese assemblies and forwarded them to his customer.

"Everything was going extremely well. The shipments were on time, our customer was happy with our quality, and we were making a good profit. Everyone was happy," Randy said, "...until we got our first change order."

Randy's customer needed a change in the design of his ceramic part for the next month's shipment. While the die changes were inexpensive, all the current work in process needed to be scrapped. "We had a quarter of a million dollars worth of work in process tied up in shipping containers." Randy said. "Our customer had another supplier who did not keep a large inventory and would absorb any charges, so we were forced to do the same. With that one change order, our Chinese source went from being an enormous profit to a terrible loss."

Randy wrote off the losses from the work in process, and did what he could to reduce the amount of inventory in shipping. However, it didn't work. "After a few more months, we found that our customer needed a change every six weeks. We absorbed one more write-off for work in process before we canceled our agreement with the Chinese supplier and found a domestic one."

Randy found that even with the higher cost of the domestic supplier, what his customer really wanted was a supplier with the ability to react to its changing needs quickly.

"To produce their product and deliver it the way our customer wanted, we couldn't afford to have so much production tied up in shipping," Randy said.

Edward's Automated Solution

Edward's company makes a product that has an inconsistent demand. Some months demand is low, while for other months the demand can be very heavy. The demand is related to an external factor that is nearly impossible to forecast.

"We made a decision several years ago that we needed to produce our product domestically," Edward explained. "Because of the particulars of our market, our ability to get orders is related to the speed at which we can deliver our products. We knew our competition could deliver product from scratch in less time than it would take us to ship and import finished product from Asia."

To remain competitive, Edward needed to update his production system in a way that would allow him to profitably produce his product domestically. He developed a specification and then placed orders with several suppliers to build his system. Edward's system automatically carried parts from the forming operation through the firing, finishing, quality control and packaging operations. If all worked as planned, the parts would pass through the system without ever being touched by human hands.

"Some of the system's machines worked well from the initial start-up," he said. "Other machines never did. For example, during firing, our parts stuck to the setter plates, forcing us to bypass an entire series of unloading machines. We had to add two operators around the clock to compensate for this. It took us years to optimize our process so we could use the automated system that we purchased."

Edward found that the complexity of the machine did not matter. Several processes required multiple steps, complex robotic manipulation and precise timing. These appeared to be the most risky parts of the system but were actually implemented without much difficulty. Most of these processes had been automated before and were well understood. The machines that performed most poorly were ones that replaced what were thought to be simple, manual operations. These processes often had sub-steps that the operators were performing but the engineers did not have documented.

"We found that if we understood a process well, we could communicate that process to our suppliers very effectively. On the other hand, if we didn't have a good grasp of the process, we ended up with an automatic system that did not work well," Edward said.

The machines he purchased would have yielded more value had he invested the time to better understand his process.

Bill Finds that Less is More

As Randy's and Edward's experiences show, proceeding with an automation or outsourcing project without analyzing your customers and your process can be perilous. Key questions to ask include: What are you doing well right now? What are you doing poorly? What shouldn't you be doing at all? Why do your customers buy their products from you? What else could you do for them that would save them money? What are you doing now that you don't have to do? A thorough understanding of all these factors can make the difference between a successful project and a failure.

Bill asked himself these questions and found that he could benefit from both automating and outsourcing. He runs a small company that makes what many consider to be a low value-added commodity product. The competition in his industry is fierce, from both domestic and overseas competitors. During a tour of his factory, he picked up a part from a storage bin. "We took our manufacturing know-how, and developed this product for a large industrial company. This product took what used to be a 10-step process and reduced it to two steps. With the customer's old process, about 20% of their assemblies needed to be reworked. Our new process has reduced rework to a fraction of a percent," he said.

The advantages of Bill's new product allowed him to capture 100% of the customer's business. Bill had formed a tight partnership with his customer to develop the product and knew that the customer could afford to retool to use his part if it cost $2.30 per piece.

"I had only one problem," Bill said. "My theoretical cost was $2.65 to make each part, and I took the first orders at their break-even cost to get them to green light the project."

The customer scheduled a ramp-up to transition from buying less than 1000 parts per month to thousands of parts per week.

"I knew I couldn't afford to do this for long, so I went to China," Bill said. There, he found a supplier that could make a key subassembly for a fraction of his in-house cost. It brought his per-piece cost down to $1.85. However, the process of securing the deal gave him pause.

"I began to question my whole business," he said. "If these people can produce this part for so little money, how can I stay in business if they choose to compete with me head to head?"

Instead of outsourcing that part, Bill developed a completely automated process to make it himself more efficiently. One machine constantly turns out the parts with part-time attention from one operator.

"When we developed this product, it competed with a three-piece assembly our customer used to buy from Taiwan," Bill explained. "The Taiwan company had 90% of our customer's business, and I had 10%. We were matching their price, and making a nice profit on these parts. One day, the Taiwanese got greedy and decided to sell this product to our customer's competition. The very next day, the customer asked me if I could handle a larger order volume."

Since then Bill has received 100% of his customer's orders for this particular item. The Taiwanese company has not received any order from that customer since then.

Will Bill continue to look at outsourcing? Yes, when it makes economic sense for an item that is outside his core competency. But what allows him to grow in the marketplace is being close to his customers and keeping close tabs on his process.

"By constantly working alongside my customers, I know what they need today," he said. "If we're making their product in-house, we can react almost instantaneously and change to meet their needs. If we're relying on a vendor on the other side of the world, it's going to take us more time to adapt to the customer's demands, and I will probably lose that customer."

Remaining Vigilant

Remaining competitive in the global marketplace requires constant vigilance. If you are selling a commodity, there is always another company who will find a way to sell it for less. If you are outsourcing key parts of your production, your customer might change its specifications and render your work in process obsolete-or worse, your supplier might turn into your competitor. It's easier than ever to move information, money and goods between nearly any two points on the globe. If you can meet their specifications, few companies care if their products are coming from Maryland or Maharashtra.

As you make your strategic plans, take these people's experiences into consideration. When Randy decided to outsource, he did not realize that it would cost him his newfound profits to respond to his customer's changing needs. Edward found that the quality of the automation he purchased improved with his understanding of the underlying process. Bill used a mix of outsourcing and automation successfully by making his decisions with a thorough understanding of his customer's needs and the constraints of his process.

Before you decide to automate or outsource, look first at your customers and your process. Do you understand what your customer is really buying? Will your decision make you less competitive in their eyes? Do you really understand your process? Is what you're planning to do going to make an improvement? Can you rely on a vendor to give you a solution for a problem that you don't understand?

Don't rule out any options until you consider the whole picture. Sometimes, what seems like the easy solution is not necessarily the best choice.

About the Author

For the past 10 years, Chris Pilko has been helping companies improve their business through process improvements, automated systems and strategic planning. He can be reached at mailto:PilkoTech@yahoo.com .