August 31, 2011    Volume 18, No. 13

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The Case Against Shifting Production To China; Hidden Costs And Growing Risks Make U.S. Attractive For Manufacturing


By Richard McCormack

Rising costs in China along with dozens of hidden costs are making it more economical to either keep manufacturing in the United States or bring it back from China, according to research into the true costs of outsourcing.

Companies are not adequately accounting for dozens of hidden costs and growing risks associated with outsourcing production to China, according to David Meeker of Neoteric Product Development based in Acton, Mass., and a lecturer at the Massachusetts Institute of Technology. When companies tally all of the costs of offshore outsourcing and adopt new design techniques for streamlining manufacturing, the cost advantage of moving production to China disappears.

"If you look at all the costs and total them up and you do a really good job of doing design, the chances are you can manufacture in the United States just as competitively and with a lot less risk and a lot less lead time," says Meeker. "You have more control over what you are doing."

Companies are mesmerized by low labor costs and by low-ball quotes from Chinese suppliers for parts and components as well as turnkey manufacturing. "People in business say, 'Wow, look at this price!' But that's all they look at," says Meeker. "They don't consider the costs of having a quality problem and having to send someone over there to fix it, or opening an office there, or the costs when the container ship arrives after a rough trip on the ocean and the four weeks it takes to get here," he says.

There are high quality manufacturers in China now, "but you pay a premium to get them and the question is, is that premium that much lower than what you can find in the states?" Meeker asks.

In a research paper on the subject presented at a recent meeting of Boothroyd Dewhurst's Design for Manufacture and Assembly International Forum in Providence, R.I., Meeker outlines many of the additional and hidden costs involved in shifting production to China. They find that they add up to 24 percent of the total product price, a conservative number that "does not include provisions for many of the risks and intangible costs that relate to specific products," he says.

Shipping and logistics adds 17 percent; finding a viable Chinese vendor adds 1 percent; quality issues add 4 percent; travel and communications add 1 percent and "all others" add another 1 percent to the total price of a product manufactured offshore.

In a case study comparing costs in the United States and China, Meeker and his colleague Jay Mortenson found that it is cheaper by 8 percent to produce a current design in China. There are substantial savings associated with purchased parts from China that include direct labor (79 percent savings versus U.S. labor rates), indirect labor and salaries (61 percent savings), benefits (75 percent savings), overhead (40 percent savings) and selling, general and administrative (SG&A) (11 percent savings).

When adding logistics to the China price, the cost advantage of producing in China shrinks to 8 percent: $13.85 for a case-study product made in China versus $14.99 in the United States.

But when design for manufacturing and assembly (DFMA) software is applied to the same product, the China advantage vanishes. The China cost declines to $9.79 versus the U.S.-made product at $9.47.

"My real message is if you are serious about moving your plant, you need to sit down and truly understand all of the costs and look at the trends of where all of the costs are going," which are all up, says Meeker.

Labor rates and benefit packages in China are increasing. Shipping rates, taxes, customs services and duties are increasing. The value of foreign currencies is appreciating, making overseas production less profitable. There are more regulations and bureaucracies engaged in foreign direct investment with new sets of rules. Companies are being required to share their most prized asset: their intellectual property. Most companies don't know how to write contracts in Chinese, and those contracts are not upheld in Chinese courts. High worker turnover increases training costs and reduces quality, with some facilities experiencing between 40 percent and 60 percent yearly turnover in staff. Human rights and ethical lapses can ruin a company's reputation.

"Costs are often missed because they are not allocated to product costs," says Meeker. "Often costs are paid for by the corporation from various budgets," he writes in his research paper. Inspection, supplier management and customs compliance, expedited shipments, onsite and remote supplier management, supplier development and problem resolution, higher utility costs, costs for skilled maintenance, steep learning curves and training, higher quality control systems and regulatory compliance are only some of the costs that are not tallied by companies. "Focusing on the cost reduction of individual parts may obscure the cost reductions from the entire product design," according to Meeker. "Logistics and customs costs may eliminate the labor cost savings. Elimination of wasted material, requiring close control of the manufacturing process may prove elusive at offshore facilities."

Some products are simply not good to produce offshore -- those made with highly automated precision processes; those that are bulky and heavy; products that require flexible scheduling; and products that undergo many revisions, causing an increase in quality failures.

Added to these factors are numerous risks that are often ignored: complying with changing customs regulations, fines and penalties; geographic risks from natural disasters; logistical risks such as the availability of shipping and port capacity, clearing times and losses in transportation; poor infrastructure that leads to delays and quality issues; judicial, political and social instability; and the growing problem of contract manufacturers using the same equipment to make exact replicas for competitors.

Unfortunately, it is difficult to get companies to describe their travails in outsourcing their production to China, says Meeker. As a result, there are few case studies describing how things have gone wrong.

In his presentations at industry conferences describing the high cost of moving to China, Meeker has had dozens of executives approach him afterwards saying " 'It's not what it's cracked up to be,' " he says. "When you look at all of the data and you put the bottom line to a project and look at the cost, it's not as attractive as it was. It does not make sense to be over there. This is a classic story of nobody wants to admit their own mistakes in public. But the tide is turning. I have a giant pile of press clippings with lots of companies saying they are bringing their production back. They went overseas and got burned with lots of problems and now they want to understand how they can bring it back."

Fortunately, there are design for manufacturing and assembly software systems that can give American manufacturers a cost advantage over Chinese production, he adds.

Meeker can be reached at meeker@mit.edu.


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