Just a decade ago, outsourcing to China seemed like a no brainer—with wages below one U.S. dollar an hour and a seemingly limitless labor pool, everybody was doing it! But the advantages have begun to narrow. Rising wages and currency fluctuations, along with higher shipping and freight costs and the unforeseen risks of doing business in a foreign country, have led to a shift in thinking and the return of certain manufacturing jobs. For small business owners in particular, the total cost of doing business, not just the cost of labor, must be considered before sourcing your production overseas.
According to a 2011 report from the Boston Consulting Group, any cost savings from sourcing overseas is being steadily eroded by rising wages in China, higher U.S. productivity, a weaker dollar, and increasing transportation costs. By 2015, BCG expects any savings to be negligible and that costs may even be higher in certain instances due to those unforeseen expenses. “Small businesses should not be outsourcing to a China unless there’s a lot of labor involved in their product,” says Dr. George Harris, president of Calyptus Consulting Group in Cambridge, Massachusetts. “All the other costs—transportation, tariffs, staff for logistics, inventory and warehousing—and when you factor in turnaround time and customer responsiveness, it’s a wash in terms of savings in many cases.”
Buying in bulk can be costly
Because so much lead time is needed for overseas shipments, businesses have to keep large inventory to be able to meet demand. “To be cost-effective when it comes to shipping, you have to buy in large quantities to pack a container and keep a lot of money in inventory,” notes Jason Piatt, president of Praestar Consulting, a lean management and Six Sigma consulting firm based in Waynesboro, Pennsylvania. “Tying up so much capital can put a strain on the resources of smaller firms.” And because there’s such a lag between when an order is made and when it’s received by the customer, a deeper or additional line of credit is needed to cover payment lags, which is still hard to come by for many small businesses.
So, the cost of warehousing that extra inventory should be factored in along with the chance of product changes. “If there are a lot of changes to a product, outsourcing offshore can become problematic,” Harris points out. “Once the order is placed, there’s a limited window to make changes and then once the order is shipped, it takes at least a month to reach a U.S. port.” And for many small businesses, their completive edge over larger firms is their ability to respond more quickly to customer demands and shifts in the market. “Especially in this economic climate, need and requirements have fluctuated,” says Piatt, “Those businesses that have been able to streamline their production [domestically] have been better equipped to adapt and be more responsive to these changes.”
Customer choice plays a role
For Ryan Hamilton, President and CEO of Akron, Ohio-based toy distributor Geared for Imagination, sourcing some of his production here rather than overseas was prompted by customer demand. “We kept getting a lot of questions from our retail customers if any of our products are eco-friendly and/or made in the U.S.,” recalls Hamilton. “Me and my partner decided to find toys we could make here in an economical and eco-friendly way.” Their Topozoo line of 3-D mix-and-match animal puzzles, made from recycled wood, are manufactured and packaged in northern Ohio, home to other toy makers such as Ohio Art Company, maker of the Etch-A-Sketch, and Little Tikes furniture and toys.
“While it requires physical setup getting the wood into the machine and post-processing labor, like sanding, finishing and quality control, all the cutting is done by a computer hooked up to a saw,” Hamilton points out. “Once you get it set up, you just let it run.” The mechanization of some of the labor allows for more pieces to be produced in less time, making it more economical to keep production stateside.
Though Hamilton’s stuffed animals are still manufactured in China because they’re so labor-intensive to produce, he says it has become increasingly challenging to conduct business overseas. “What used to be a relatively inexpensive and fairly seamless transaction has become unpredictably slow and expensive,” he explains. “Things are taking longer to get here due to higher fuel costs and once they get here, we’ve seen delays because ports are more tightly controlled.”
Having production nearby has made it easier to meet demand for their Topozoo products, which have been selling well since being introduced in 2010. “Because they’re manufactured within an hour of our warehouse, the products can be assembled and shipped more quickly and it has been easier for us to come up with new products and get them to market faster,” notes Hamilton. “We just launched a new series of aquatic toys for the summer and are doing some custom pieces for a few customers. This would not have been possible if we produced overseas, as it would be too cost prohibitive and too slow.”
Long supply chains can be harder to fill and to fix
When Jane Angelich, CEO of Bright IP Concepts based in Novato, California, started her company, part of her mission was to bring a safe, effective pet product to market that was also made domestically. Just as the design phase for her product, the supercollar, a dog collar with a built-in leash, was completed in 2008, the economy was on a rapid downward spiral. Manufacturers were reluctant to do business with a startup unless they were promised a lot of inventory, but Angelich eventually found a manufacturer willing to grow with her at a pace she felt comfortable with. In addition to sales through its web site, the supercollar has been picked up by other online retailers like Sharper Image, Brookstone, and SkyMall, and sales have steadily increased.
Angelich could have saved on labor by sourcing her product in China, but she was well aware of the unforeseen costs of doing business overseas. “I would always need an interpreter to communicate, and then you need to pay for someone to live there and watch over production,” Angelich points out. “As a small business, we don’t have the resources to do that.” And there are extra concerns about quality when bringing a new product to market. “If there was a part we needed to look at or something’s failed, we would need to see it, talk to the people putting it together, try to come up with a strategy to fix or replace it,” notes Angelich. “But when there’s 12 to 14-hour time difference, it may be too late to fix it before hundreds or thousands of units are made.”
Angelich, who lived in Toyko as part of her previous career with a Wall Street firm, also recognizes the cultural challenges that startups, in particular, will face when outsourcing to Asia. “It’s too expensive to fly over there on a regular basis,” says Angelich. “But it’s also not proper etiquette to just show up without notice. It would be considered an insult.” Her manufacturer in Chicago, on the other hand, is only a short plane ride away. “We made a design change based on customer feedback, and our COO went to the factory and met with people on the line and within a few days, everything was up and running,” notes Angelich. “That would not have been possible with an overseas factory.”
“Even for those businesses with a labor-intensive, high-volume product, a flexible customer base, and access to reliable transportation, it’s not a slam dunk,” Calyptus’s Harris says of the decision to outsource manufacturing overseas. After a small business crunches the numbers, he emphasizes that they also factor in intangibles like supplier responsiveness and the time devoted to handling all the logistics of the process. “For a small business, that’s a lot to take on,” he notes. And then there are the unknowns, like production or shipping delays and changing economic and political conditions. “There are a lot of ‘ifs’ to consider when working with an overseas producer,” adds Angelich. “Too many things would have to work perfectly to realize any savings.”
Top five things to remember when contemplating overseas production
- Beyond Labor: Labor costs should not be the determining factor. Consider the total cost of production per unit, including shipping/freight, productivity, warehousing, and additional staff.
- Higher Operational Costs: Don't overlook the need to keep a larger inventory of overseas-based products to make up for the time it takes to transport products and the extra expense of staff to handle logistics.
- Flexibility: Product and order changes take longer when working with overseas factories.
- Quality Control: Difficult to monitor quality unless you have a key person in-country to oversee production.
- Unforeseen Costs: Transportation delays, changing economic and political climate can cause major supply chain interruptions.