CHAPTER 7

Day-to-Day Issues

Having a good broad-based background in global supply chains is helpful to the supply-chain manager, but there are also day-to-day issues with which the manager must deal constantly. Some of these issues can be found in the differences between domestic and global supply chains. A good starting point is the list of seven wastes in lean systems found in chapter 4. All are important issues in both domestic and global supply chains, but there are significant differences among them. Beyond the so-called wastes are additional issues such as outsourcing versus insourcing, the role of costs, and issues that may have completely different dimensions in the global arena.

The Seven Wastes

Rather than go back over all seven of the wastes, here we shall look at the most important issues relating to the wastes that arise in the management of global supply chains.

Transportation

The first difference between domestic and global supply chains is distance or transportation. As noted earlier, it takes 21 days to export a container from China. When this is added to the transit time over the Pacific, it takes on average 45 days to receive a container from China.¹ There are valid reasons for trying to reduce transportation time, many of which are negated in global commerce. One problem is the risk of not getting what you ordered—either the wrong product or the wrong level of quality. If this happened domestically, you could call your supplier and get a reshipment within days; globally it may take months. Another downside of global supply chains, as pointed out earlier, is the cost of carrying the pipeline inventory. A third is the risk of loss. A fourth is the risk of design changes while the shipment is en route. As Pete Engardio points out in BusinessWeek,

Excess Production

Excess production is another potential waste. Excess production can be, among other things, the result of poor scheduling, poor forecasting, or inappropriate lot sizes. All these are likely to occur in global supply chains. Forecasting is difficult because of long lead times required to place orders from abroad. The inaccurate forecast might have an impact on scheduling, or the manager might simply have lost control of the scheduling process. Inappropriate lot sizes may result from the need to fill a container or other shipping unit from abroad. All these can be managed well domestically but are difficult to control in a global supply chain.

Quality

Another waste is producing goods that do not meet quality standards. Producing abroad does not intrinsically mean poor quality, but it does mean less control over quality at the source. Unless one has quality personnel on site, it is the vendor who will have total control over quality. Volkswagen is noted for having its own quality people on site at vendors’ overseas facilities. Smaller firms do not have this option and have to rely on the promises of their contractors. Quality control is often reduced to inspecting the finished product only after it has been received, a practice that has been discredited since the beginnings of the total quality management (TQM) movement in the 1980s. It is important for the supply-chain manager not to apply blanket judgments to countries or areas. Several supply-chain managers have told the author that they prefer production in China to Mexico, despite the difference in distance, because the quality is better. This, of course, can vary widely from firm to firm.

Maintaining Schedules

Maintaining schedules is perhaps the most difficult aspect of being in a global supply chain. Lean management teaches us that shortening the throughput time leads to multiple benefits, including the following:

• More flexible responses to customers
• Faster responses to engineering changes
• Increased capacity
• Reduced cash cycle time
• Faster response to quality problems
• More accurate forecasting
• Better on-time completion and delivery times

Being part of a global supply chain can negate all these benefits. Many of the points have been touched on previously, but it is helpful to bring them together in the context of production scheduling. The ideal production schedule will result in exactly what the customer wants, when he wants it, where he wants it, and at the price and level of quality he wants. Outsourcing and being part of a global supply chain is generally believed to result in lower costs and thus the price the customer wants.

The Ohio Art case used earlier is a perfect example of many of the benefits of short throughput times being negated in global supply chains. Ohio Art had to deliver the Etch A Sketch toy to their customers—Walmart, Target, and Toys “R” Us—at a price that would allow the customers to sell it for under $10. Production in China appeared to Ohio Art to be the only solution. Production had to be scheduled in the spring for fall delivery (for the December holiday season).

Because of transportation time, there was no opportunity to make changes to the production plan. If the toy somehow became a fad (e.g., it was featured in the most popular Dilbert cartoon of all time),³ there would be no opportunity to increase production at the last minute. Conversely, if it were somehow labeled a health threat, there would be little time to cancel the order. Quality and engineering response times would be lengthened, and the cash cycle time would be longer. Another example is Sauder Furniture. They had a customer response time goal of 4 days, yet their supply line to their overseas vendors was 3 months.⁴

Excess Inventory

As pointed out earlier, these problems are mitigated by carrying more inventory. It is a case of the classic “water and rocks” analogy in reverse. The analogy was introduced in the early 1980s by Robert Hall during the APICS (American Production and Inventory Management Society) Zero Inventories Crusade.⁵ The water was inventory and the rocks were problems, particularly scheduling problems or poor scheduling practices. The problems and practices could be corrected by gradually lowering the level of the water (inventory) and exposing the rocks (problems and practices) one at a time. Each would be fixed and the water would be lowered again. Now, in the era of global supply chains, the problems have been reintroduced, so inventory levels are increased to hide them.

To Outsource or Not?

The ultimate question is, “Should a firm outsource abroad?” There are many arguments in favor of the practice. Producing abroad allows one to be closer to overseas markets and thus more easily tailor products and services to the local customers. Producing in other countries moves one behind tariff and quota barriers. Likewise, much transaction risk in foreign exchange can be avoided by dealing in fewer currencies. A firm can increase capacity without investing in facilities or equipment. BMW, for example, in 2003 outsourced the design and production of their X3 compact sport-utility vehicle to Magna Steyr, an Austrian firm. Magna had already produced cars for Mercedes-Benz, Audi, Volkswagen, Jeep, and Chrysler. By outsourcing, BMW was able to get the new model to market more quickly without a large investment in capital and labor.⁶ The key is “right-sourcing”—outsourcing the right products and processes to the right place with the right partner that will return maximum value for the enterprise.⁷

Local Talents

Outsourcing abroad allows one to take advantage of local talents. The Germans pride themselves on engineering and the Indians pride themselves on their IT skills. There are large labor pools of U.S.-educated, English-speaking engineers, computer scientists, and even lawyers in the Philippines and India (typically earning lower salaries than their American counterparts). The author knew of an unemployed IT engineer in the United States who asked a friend of his (who was a supervisor in an IT firm) if there were any jobs available. She replied that everyone who worked for her was in India. The suggestion that the American move to India to find a job was not met favorably. He became a dance instructor instead. This type of outsourcing arrangement is made possible, of course, by the rapid advances in communications technology. It is now possible for a manager to observe and check on the work of subordinates around the globe. Some firms exploit this capability by passing work around the globe so that work is being done 24/7. Peter Frykman, the founder of Driptech Inc., commented that “thanks to the revolution in communications technology he is able to hand off work in the evening to his co-workers in Asia, and pick it back up in the morning. ‘If you get the rhythm right, you can really be working around the clock as an organization,’ he says.”⁸

Economies of Scale

Becoming a global firm allows a company to achieve economies of scale. Controlling all operations worldwide can eliminate the overhead associated with having a headquarters in each country or area of the world. If the firm gets too large, this can lead to span-of-control problems. Span-of-control problems are exacerbated in the global economy by the issues raised earlier—culture, time, language, distance, and so on.

Insourcing

Some companies that have done significant amounts of outsourcing are beginning to reverse the process (so-called insourcing or onshoring). Apple has begun to move its design process in-house to protect its intellectual property: “[Apple] executives have expressed concern that some information shared with outside vendors could find its way into chips sold to Apple competitors,” and “[Steve Jobs] wanted to develop chips internally and didn’t want knowledge about the technology to leave Apple.”⁹ Sharp’s newest LCD factory in Sakai, Japan, has a campus containing all their major vendors—no shipping, no loss of intellectual property.¹⁰

Spanish clothing chain Zara, which has stores in Europe and the United States, keeps ahead of its rivals by maintaining “an iron grip on every link in its supply chain.” Instead of producing fashion products in Asia, where costs are lower, its production facilities are in Spain, Portugal, and North Africa. The result is higher costs but faster response to changing demand (2 weeks instead of up to 6 months), faster deliveries (24–48 hours), and better forecasting and production scheduling (which eliminates year-end sales of excess stock).¹¹

United States apparel firms are learning the same lessons. The Los Angeles based women’s clothing manufacturer Karen Kane is moving 80% of their production from China to Southern California. Michael Kane said that “declining production quality [and] unreliable shipping times” influenced the company’s decision. Ilse Metchek, president of the California Fashion Association, is quoted as saying, “Fashion changes every 10 weeks. You cannot keep up with that if you are producing ten of thousands of units in China.”¹² Caterpillar and other large manufacturers are moving overseas production to U.S. facilities. The “companies are seeing disadvantages of offshore production, including shipping costs, complicated logistics, and quality issues. Political unrest and theft of intellectual property pose additional risks.” General Electric is moving production of water heaters from China to Kentucky. Block Windows is moving production from China to Florida. “When we [looked] at the costs and complexities of the inventory and lead times, there really wasn’t any savings,” said president Roger Murphy.¹³

Some smaller companies are following the same path. In an article about northwest Ohio, the Toledo Business Journal summed up the problem this way:

These are exactly the same problems mentioned earlier. The problems are not all with Asia. A battery company moved its operations from Mexico back to Ohio:

Sauder Furniture, mentioned earlier, purchased 50% of certain parts needed to assemble its furniture from Asia. They decided that cost was not the only criterion they should use and that long supply chains were causing them difficulties: “In the past, we purchased these parts based solely on price. However, it is important to look at the bottom line cost to the business and not just purchase price.” Sauder decided to shorten its supply chain to a within a maximum 250-mile (400-km) radius of their factory in Ohio and an ideal radius of 150 miles (240 km). It was willing to accept higher costs in exchange for offsetting the other problems associated with long supply chains.¹⁶

The memory-module producer Avant opened a new plant in Texas. According to the CEO, Tim Peddecord,

Decisions Based on Costs

It seems that most firms deciding to move into the global arena are driven by costs. Labor costs in many areas of the world are simply lower than they are in the developed countries. A social argument can be made for outsourcing on this basis. The workers accepting lower wages are actually making more than anyone in their families has ever made. Giving them jobs helps to raise their standard of living and break the cycle of poverty. On the other hand, the purpose of the firm is to provide value for the owners and stockholders by providing customers products and services they want, where they want them, when they want them, and at a price and level of quality they want. While costs are a valid basis for decision making, the shortcomings of the accounting system often make it difficult to make good decisions. In a study in 2005 by Deloitte & Touche, 44% of the companies surveyed said they did not cut costs by outsourcing globally, and more than half said they incurred costs not specified in their contracts with overseas vendors:¹⁸

In other words, the accounting system does not measure explicitly many of the costs that are important in global sourcing (or normal operations management, for that matter).

The cost of carrying inventory, for example, does not appear in the income statement. Its components may appear in different parts of the statement (taxes, warehousing, insurance, etc.), but the critical number of how much it costs to carry inventory is simply not there. The costs of quality (with the exception of warranty costs) are scattered throughout the company’s accounts. The costs of inflexibility and nonresponsiveness are nowhere to be found. The cost of incurring additional risk because of long supply chains, additional handling, poor communications, late deliveries, and so on are difficult to measure but are real. Supply-chain and operations managers often use surrogate measures to compensate for this lack of accounting information. In one company visited by the author, when they received bids from vendors, they would estimate the probability of the risk factors just described and calculate the amount of safety stock necessary to protect against these risks. They then added the cost of this additional safety stock to the potential vendors’ bids before making a decision.

Drivers of Hidden Costs

Phanish Puranam and Kannan Srikanth²⁰ describe three drivers of hidden costs in outsourcing—contracting, transition, and interaction—with some prescriptions (and some additional comments and prescriptions by the author).

Contracting

The first is contracting. If performance metrics for the processes are difficult to define and spell out, then one must take extra measures of due diligence to reassure oneself that the vendors will be able to perform as they promise and as you expect. A supply-chain manager described this process to the author. He had two bids for manufacturing a subassembly—one from China and one from Korea. They were virtually identical on paper except for cost—the Chinese bid was lower. He personally visited both companies and decided to award the contract to the Korean company, even though the Chinese company bid significantly lower. The key is that he made a personal visit to both companies. His decision was based on what he saw: the layouts of the factory floors, the offices of the managers and engineers, the warehousing systems, and the attitudes of the workers. It would be difficult to quantify these factors, but they have the potential to add significantly to bottom-line costs.

Are the skills required of the vendor generic or company specific? If they are not generic, the process may require more time on the part of your quality, engineering, and production people than you anticipated (including extensive [and expensive] travel to and from the vendor’s site). If the skills required are specialized enough, vertical integration may be a better approach. If nothing else, having the function performed in-house (even though the “house” may be in another country) gives better protection for intellectual property.

A quality manager, Michael Rude, related an incident in his company to the author. He worked for a firm with an assembly operation in the United States. The purchasing department decided to outsource fabrication of the parts (a forging operation) to a Chinese company “based on a brochure and a salesman’s presentation.” Twenty percent of the first batch of parts they received from China were defective (and more were on the way). Mr. Rude’s boss dispatched him immediately to China to find the problem. The airplane ticket alone cost the company $8,000 because it was purchased on short notice. When Mr. Rude arrived at the Chinese plant, he found it looked just like the brochure—except for the final step in the process. Workers were visually inspecting the parts and sorting them by “accept” and “reject.” Fifty percent of the parts went in the reject pile. Of the 50% in the “accept” area, 20% were rejects by the U.S. company’s standards. He finished by saying that someone should have visited the vendor before they signed the contract, not after container loads of defective parts started arriving in the United States with more on the way.²¹

Transition

The second area Puranam and Srikanth describe is transition. Are you sure the vendor is prepared to carry out the work? Are the documents describing your products and processes current, and are they translated if the vendor is in another country? Are they online so that all sites have the latest versions? When BMW outsourced the building of their new SUV to Magna Steyr, the contract was more than 5,000 pages long!²² Are the vendor’s employees prepared to execute your process and make your product successfully? Will they need training? How much? What will it cost? Once you train them, will they stay? Or will turnover require continuous intensive training? If your vendor is in an area that is relatively new to manufacturing, do the employees have basic skills such as coming to work on time and staying for an entire shift? Are they local employees, or do they commute from long distances and thus are more likely to leave their jobs and return home or stay home after holiday visits?

Interaction

The third factor Puranam and Srikanth describe is interaction. Basically, where within the supply chain is the vendor, and how tightly linked is the vendor with other links in the thread? Is the linkage so tight that it will require constant communication, either electronically or in person? Are you prepared to deal with the time, language, and cultural elements of this communication? If the vendor fails to meet the performance metrics in terms of time, quantity, and quality, what will be the impact on the other links in the chain? Will you need to build extra safety stock (with its cost) into the system to protect against the risks?

Failure to consider and prepare for these drivers of cost leads to the situations described in the Deloitte & Touche and Pricewaterhouse-Coopers reports. Few if any of them appear explicitly in the accounting statements. Kripalani described five offshoring best practices.²³ The one most relevant here is the following: “Be prepared to invest time and effort.” The CFO of Penske admitted, “It took a heck of a lot more involvement on the part of myself and my team than I expected.”²⁴ Of course, time is money, which is additional cost. Penske invests heavily in training, including their processes and even English-language training to facilitate communication. According to a director of Gartner Research, “What’s often lacking in offshore partners ‘is a lot of deep process knowledge.’”²⁵ Things taken for granted in domestic employees may be totally outside the experience of employees in other countries. Processing insurance applications, for example, may be mystifying to someone who has never had nor ever heard of insurance.

New Areas of Management

Finally, managing a global supply chain may introduce new areas of management one normally does not encounter domestically. One is transportation. Although companies must manage their transportation domestically, there are many second-, third-, and fourth-tier logistics providers who will manage the details. This can also be true globally, but the global transportation manager may be confronted with entirely new issues. Most global transportation of goods is by water. Ocean transportation is far cheaper than other modes, especially since the only viable alternative is air transportation. For other than bulk goods, ocean movement involves containers. The following are some of the issues faced by the global supply-chain manager:

• How do I “stuff” my containers to improve efficiency and reduce the number of containers I need? A good stuffing algorithm can reduce the number of containers by up to 15%.
• Through which ports do I bring in my goods? Ports in western Canada are actually closer to Asia than ports in California. What is the infrastructure connecting the port to my facility or customers?
• Should I use only full containers or should I share containers and risk having my shipment held up by the customs service because of someone else’s goods in the same container?
• What do I do with empty containers? Shipping empty containers is the same thing as “deadheading.” It generates costs but no revenues.
• What ocean routes do I take to avoid pirates?
• What do I do if the borders are closed (e.g., September 11, 2001) or if the longshoremen go on strike?

Air transportation is much faster and more expensive, but it involves many of the same issues. Pirates are not a problem with air transportation, but natural events such as volcano eruptions can interrupt the flow of parts and goods. The eruption of Eyjafjallajökull in Iceland in 2010 caused the cancellation of 100,000 flights.

Transportation is not the only issue. Political risk became almost a forgotten issue in the 1990s. The new century has brought the problem back to the surface with a vengeance. What if our facility in another country is nationalized by the government (such as Libbey Glass in Venezuela)? Is it a critical link in our supply chain, or do I have alternatives? Chrysler, for example, built a factory in Peru that produced only half the parts needed to assemble a car. Had it been nationalized, it would have been worthless. What if there is political unrest in popular outsourcing sites, such as Thailand and Tunisia, or in regimes thought to be stable, such as Egypt and Libya? Is China as stable as we think? What if there is a war among drug gangs as seen along the border in Mexico, where the maquiladoras are located? What if the government begins inflating the money supply and causes hyperinflation (such as happened in Zimbabwe)? Countries in emerging markets “are rife with political risks—weak legal systems, makeshift infrastructure, volatile cities and weak regimes.”²⁶ The wise firm involved in global supply chains will assess the overseas situation, do a risk analysis, and prepare contingency plans. The wise firm domestically will do the same, but the issues may be quite different.

Summary

Keep the following in mind when you are managing or preparing to manage a global supply chain:

• Know your costs and their impacts—even the costs that do not show up in the accounting statements.
• Assess your risks and develop measures to mitigate them. If you have business interruption insurance, check to see if it covers interruptions because of breaks in your supply chain.
• Know your vendors and your customers well before you start doing business with them.
• Be aware of all the decisions you will have to make; don’t get caught by surprise.
• Be prepared to devote more time than you ever imagined would be necessary.
• Outsource because it makes good business sense, not because everyone else is doing it.