The trend towards moving operations to low-cost developing countries continues to accelerate. The list of manufacturing companies which have now set up operations overseas includes many household names, Dyson, Dell, Daimler Chrysler, Philips, Whirlpool, Bosch and Siemens among others.
They have all been attracted by labour, overhead and infrastructure costs that are a fraction of those in the West, a rapidly developing skills base and fast growing markets enhanced by China’s entry into the WTO and Eastern European block entry into the EU.
When considering the cost and market potential, the business case for relocation often looks very attractive and it is easy to get carried away with all the hype. However, companies often fail to take account of the significant risks associated with undertaking the transfer. There are many examples of the challenges they face:
"We moved our production to Eastern Europe but we are still exposed to dollar-based competitors"
"We just can't keep good engineers in the Czech Republic - we train them up and then they leave"
"The Chinese competitor was copying our product and marketing it almost as soon as we opened up"
"We just underestimated the time it would take to build up production volumes after the move"
"The logistics times in our supply chain just increased overnight"
"We know we should have told the customer about the move to China but we didn't think they would be interested"
So why are companies so often dissatisfied with their migration?
Based on a large number of relocation projects into Eastern Europe, the Far East and South America, we believe that problems typically lie in one of three areas:
- An inadequate business case
- Poor management of the risks during the transfer itself
- A failure to establish best practice processes at the new location.
An inadequate business case
When considering a move to a low cost economy, businesses are attracted by the headline figures of “direct wage costs only 10% of domestic wage costs”. However this tells only part of the story. Whilst shop floor workers are often much less expensive than in Europe, managers and professional people are usually much closer to our salary structures. In fact one of our clients told us that in parts of Mexico, shop floor people are only 20% the cost of US workers, whereas engineers and accountants are virtually the same cost!
Even though salary costs may be lower per head, in our experience it is difficult to achieve the same levels of productivity, and therefore you must make an allowance for efficiency losses. This productivity differential will be at its highest at the start-up of the new facility, and should reduce with learning and a drive for increased productivity. Add to this the training and support needed for the ramp-up, and there is a significant cost that the business must recognise and must work to contain.
To get full benefits from a move, a business will also want to re-source most of its material and component supply to local suppliers. As any purchasing professional will tell you, qualifying a new supplier is not a trivial task and is not accomplished overnight, or with just one visit! As with production efficiency and the learning effect in your own factory, you will almost inevitably encounter teething problems when bringing on board a new supplier. This usually manifests itself as either late shipments or quality issues. These problems can all be resolved, but it does take time and management effort and we often find that the true costs of making these changes are not recognised.
A new factory is quite often farther from your customer than the existing business, and so the cost of transportation and warehousing can be a significant balancing cost in the whole benefits equation. It may seem obvious, but we have seen it overlooked or dismissed as “something those logistics people can sort out”!
An important feature of a business case in our view is the robustness of the solution, and it is really important to identify the key sensitivities and risks to the business case. Knowing where the key levers are to delivering the maximum benefits allows the project team to manage the project accordingly and to maximise the chances of success.
Poor management of the risks during the transfer itself
The starting point for success is based on the implementation approach. PA’s approach to undertaking a relocation projects follows three distinct phases as highlighted in the first diagram in this PDF.
Phase 1, normally lasting about 4-6 weeks, develops a management plan for the implementation. The management plan contains all the relevant information for undertaking the transfer and is in effect the “bible” of how to do it.
The management plan covers the project organisation and resources, the plans and strategies for relocation of each production line, plans for transferring the support processes, the approach to be adopted to involving and informing key stakeholders such as customers, suppliers and employees and a comprehensive risk register.
The management plan is the key document that is signed off by the business to agree the implementation of the relocation.
Phase 2 focuses on the detailed planning required for delivery of the programme, covering all aspects from legal and regularity requirements through to detailed planning of the production line moves. This phase should not be underestimated: PA’s experience, similar to other project situations is that time and resource spent planning will be recovered 10 times over during the implementation phase.
Phase 3 is the implementation itself and starts when the first line is moved to the new facility and completes when the final transfer is completed and new facility is up to production volumes. Dependent on the size and nature of the transfer this can take 6 to 12 months. Critical to a successful relocation programme is understanding and managing risks. This is often where external support to a company can add most value as they bring a ready understanding of the risks. In our experience, some of the key learning and risks for factory relocations can be summarised as in the second diagram in this PDF.
Each of these risks and others associated with a specific programme need to be actively managed and reviewed on a regular basis before and during the implementation.
Even with robust planning and risk management things will go wrong. The final factor for a successful transfer is to have a transfer team that is thinking ahead, anticipating what could go wrong and adapting along the way. Much of this will come down to the quality of the transfer team you put in place to manage the transfer, but there are a few key pointers that can help. These include:
- Allowing time and resource for things to go wrong
- Engaging and communicating early and broadly
- Recognising and understanding the cultural differences
- Knowing which issues to escalate and when
- Having robust early warning systems
- Involving customers and asking for help
- Being suspicious when things are going smoothly.
Each of the transfers that PA has been involved in have been completed on time and to cost, and perhaps more importantly, without disruption of supply to the customer. They have not all gone smoothly. The risks and issues discussed in this article are all events that we have seen occur. However, the benefit of our proven approach is that problems are managed and the customer does not see a degraded service. In fact the end customer sees a professional organisation managing a complex project. This can enhance reputation with major customers.
A failure to establish best practice processes at the new location
Once the transfer is completed there is always a risk that companies believe that the work is complete and the benefits will start to flow automatically.
A major compressor manufacturer transferred production to Slovenia between 1992 and 1998 found that by 2000, the customers were assuming an eastern European price and plant efficiency was well below their Western European plants, and consequently the business case had disappeared.
To avoid this companies have to realise that the transfer is only the first step in achieving the benefits. Once the transfer is completed the focus has to shift to building a world class facility in the low cost location.
There are three key elements to this:
- Don’t assume because labour is cheap that the operation can be less efficient and still make a good profit
- Set high goals and expectations for the factory in terms of performance
- Bring along lean manufacturing and supply chain principles and build a culture of change management and continuous improvement.
It is all too easy to fall into the trap that the compressor manufacturer did. The assumption has to be that labour prices will increase in the low cost country at a faster rate than in developed countries and that customer will demand lower prices.
Investment decisions and efficiency assessments are often made on the basis that labour is cheap. Consequently, the same pressure is not applied for efficiency improvements. If this is the case then it is inevitable that over time profitability will be eroded.
The first element to ensuring the business case is delivered after the transfer is to ensure that the local management team are targeted with goals and ambitions similar to those for existing plants.
You would expect productivity to be lower initially after the transfer but goals need to be put in place which drive productivity up to levels of performance in other plants or even better.
This applies equally to the other areas of operational performance such as quality and customer service.
Lean manufacturing and supply chain is becoming part of doing business in developed countries, but the approaches and techniques are new to many low cost countries.
It is essential to put in place lean processes such as pull planning, kanbans and 6 sigma quality once the new production facility is up and running. This should be supported with training and development for the local management team.
Teamworking, such as self-managed teams, should also be implemented. This is an area where low cost countries have particular difficulty, because they are more used to hierarchical management structures. In this case, it best to implement the team approach slowly, gradually taking decision making away from the management team so that the cultural challenges are minimised.
Once the latest approaches and processes to manufacturing are implemented, the low cost factory needs to focus on continuous improvement activities, linked to the targets that have been agreed.
Summary
Moving manufacturing to low cost countries can deliver significant benefits for the business but only if the business case is well thought out up front, the risks are managed during the transfer and once in the new location a world class manufacturing approach is adopted. Including each of these aspects in your transfer programme will ensure you “take away the pain and maximise the gain”.
This article was published by and extracted from The Institute of Operations Management magazine "CONTROL" VOLUME 30 NO. 6.
The Institute of Operations Management is the UK's professional body for persons involved in production, operations and supply chain management. It provides professional qualifications, training courses and technical publications . For more information visit www.iomnet.org.uk.
