Extended supply chains have many moving parts in manufacturing and logistics that require regular maintenance.

The rush to reduce costs in manufacturing and procurement fueled a surge in outsourcing and offshoring over the last decade that has almost taken on a life of its own. The major business assumption driving this trend was that it was less expensive to purchase goods and manufacture overseas because labor and raw materials and, therefore, capital projects, cost less.

At the same time, a “me, too” mentality was taking hold – “If everyone else is doing it, it must be the right thing to do.” In fact, it was some of the early successes that may have helped drive this momentum.

Has the tide turned? Is it time to question some of those decisions?

Several factors, including rising energy costs, currency devaluation and demographic changes in the “low cost” countries, are challenging the accuracy of those earlier assumptions. Depending on the country of origin, the combined impact of these factors has escalated costs by anywhere between 10% and 40% over the past three years. A rigorous and continuing analysis of a company’s supply chain network can reveal the true costs, benefits and risks of manufacturing and distribution decisions.

The only accurate measure of success in any decision to offshore manufacturing is the total delivered cost (TDC) of the product to the final customer – not the price at which it can be purchased or the manufacturing cost in the “low cost” country. The TDC breaks down into obvious and hidden, tangible and intangible components.

One under-appreciated cost component that has recently come to the forefront is the cost of quality. In the worst-case scenarios of toys with high lead content, melamine-contaminated pet foods and chondroitin-laced Heparin, multinationals certainly got their low prices, but paid the monumental costs of widespread recalls, fines, lost customer goodwill and damage to reputation.

The debacles that result from ignoring the cost of quality are not new to this decade, nor are they limited to Chinese exports. During World War II, for example, US-made aircraft pistons for British fighters had to be scrapped because the US manufacturer used a conversion rate of 2.54 cm to 1 inch, which was not precise enough for aircraft engine tolerances, demonstrating that quality control over offshore production can be tricky at best. Today, in the aircraft industry, Boeing is purchasing a Global Aeronautica, LLC fuselage sub-assembly plant in order to regain control over the 787 Dreamliner manufacturing process. Clearly, ensuring the control of final product quality is a key factor in the outsourcing decision process – whether the source is domestic or off shore – even before the logistics factors enter the equation.

Tangible Planned Costs

In addition to quality, there are other costs, obvious and otherwise, that can be overlooked when companies are not thorough in their analysis of the TDC. Take the case of a specialty chemicals manufacturer that received an excellent price from an offshore manufacturer for a key raw material. While it accounted for ocean freight costs, it neglected to include import duties. Ultimately, its “great price” resulted in a TDC of about 15% more than its original delivered cost for local materials.

The first step to avoid this type of mistake is to perform a complete analysis of the TDC, assuming everything goes according to plan (unplanned costs will be considered below). The following table compares the most common domestic and offshore transportation costs that should be included in this type of analysis.

Logistics Cost	Domestic	Offshore
Drayage from factory to embarkation port	No	Yes
Terminal handling fees at embarkation port	No	Yes
Port taxes	No	Yes
Ocean freight	No	Yes
Insurance	Yes	Yes
Documentation fees	No	Yes
Import duty	No	Yes
Terminal handling fees at debarkation port	No	Yes
Truck/rail freight to distribution center	Yes	Yes
Distribution center costs	Yes	Yes

In addition, export taxes or tax rebates may apply, depending on the country of origin for the shipment.

Although distribution center costs are listed for both domestic and offshore manufacturing, the types and magnitudes of the costs are likely to be quite different between the two supply chains. For example, imported materials may require additional handling and processing to be re-palletized to conform to the “standard” pallet in use in the country of consumption.

The warehouse footprint and average dwell time of the material in the warehouse will typically be larger for the imported materials. Even if the order size, and thus the cycle time, of the goods are the same for both imported and domestic materials, the safety stock required to provide the same level of service can be significantly higher for the imported material. This is evident upon inspection of a simple safety stock formula for a fixed order quantity with variable lead-time: