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Move Your Operations to China? Do some lean math first.

Jim Womack
1/10/2003
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I recently got a phone call from a reporter for The Wall Street Journal with a simple but provocative question: "If you are a manufacturer in a high-wage country such as the U.S., can you ever be lean enough that you don't need to relocate your operations to China?"

 

The reporter's reasoning was that China has an enormous labor pool in its coastal development zones, with 300 million additional migrants to these areas expected in the next ten years. So labor costs may stay at their current low levels for decades.

 

He further reasoned that a large fraction of the cost of manufactured goods is ultimately wages (for touch labor plus support staff, managers, and engineers, and the workers designing and making process machinery and extracting and processing raw materials.) He then concluded that no matter how much cost an American or Japanese or German firm removes by getting lean, costs in China (or, if you prefer, India), based on cheap labor, will always be much lower. Hence, "Won't you need to relocate?"

 

My answer to this simple question was also simple: "Do some math before you move and make sure it's lean math." Here are the items you need to include in your calculation:

  • Start with the piece part cost for an item where you are. 
  • Compare this with the piece part cost for the same item in China or India (or Vietnam or Poland or...) (It will almost always be much lower.) 
  • Add the cost of slow freight to get it to your customer.

Note that you have now done all the math that many purchasing departments seem to perform. Let's call this mass production math. To get to lean math you need to add some additional costs to piece-part plus slow-freight cost to make the calculation more realistic:

·          The overhead costs allocated to production in the high-wage location, which usually don't disappear when production in transferred. Instead they are re-allocated to remaining products, raising their apparent cost.

·          The cost of the additional inventory of goods in transit over long distances from the low-wage location to the customer.

·          The cost of additional safety stocks to ensure uninterrupted supply.

·          The cost of expensive expedited shipments. (You'll need to be careful here because the plan for the part in question typically assumes that there aren't  any expediting costs, when a bit of casual empiricism will show that there always are.)

·          The cost of warranty claims if the new facility or supplier has a long learning curve.

·          The cost of engineer visits or resident engineers to get the process right so the product is made to the correct specification with acceptable quality.

·          The cost of senior executive visits to set up the operation or to straighten out relationships with managers and suppliers operating in a different business environment. (Note this may include all manner of payments and considerations, depending on local business practices.)

·          The cost of out-of-stocks and lost sales caused by long lead times to obtain the part.

·          The cost of remaindered goods or of scrapped stocks, ordered to a long-range forecast and never actually needed.

·          The potential cost, if you are using a contract manufacturer in the low-cost location, of your supplier soon becoming your competitor.

 

This is becoming quite a list - and note that these additional costs are hardly ever visible to the folks in senior management or purchasing who relocate production of an item in a low-wage country based simply on piece-part price plus slow freight. However, lean math requires adding three more costs to be complete:

·         Currency risks - which can strike quite suddenly when the currency of either the supplying or receiving country shifts.

·         Country risks - which can also emerge very suddenly when the shipping country encounters political instabilities or when there is a political reaction in the receiving country as trade deficits and unemployment emerge as political issues.

·         Connectivity costs of many sorts in managing product hand-offs and information flows in highly complex supply chains across long distances in countries with different business practices.

 

These latter costs are harder to estimate but are sometimes very large. The only thing a manager can know for sure is that they are very low or zero if products are sourced close to the customer rather than across the globe.

 

If you do the lean math, will it always mean that you don't need to relocate? Absolutely not. For example, if you are planning to sell within high-growth,  ow-wage markets like China or India you will almost certainly need to locate most or all of your production for those markets within those markets. This is simply because lean math works in the opposite direction as well. Transport, inventory and connectivity costs and country and currency risks are much lower if you produce within the market of sale.

 

However, in my experience a hard look at the true cost situation will suggest that relocation is not the first line of defense for producers in high-wage countries. Rather it's to get truly serious about a lean transformation through the entire value stream for the product in question.

 

If you find that you do need to relocate, even after doing lean math and applying the full complement of lean methods, my experience is that moving all of the steps in the value stream for a product to an adjacent location in a low-wage country within the region of sale - Mexico for the U.S., Poland for Germany, and, yes, China for Japan - is likely to provide the lowest total cost.

 

I'd love to hear your own thoughts and experiences with this question, which has emerged as the largest single issue many managers are wrestling with in high-wage countries. If you've got some better (leaner!) math please let me know and I will pass it along to the entire Lean Community.

 

Best regards,

Jim

Jim Womack

Founder and President 

Lean Enterprise Institute (LEI)

11 Comments | Post a Comment
Fabio Menegon August 25, 2011

Jim, I'm 100% with you on this post and on the previous from LEI talking about inshoring in USA. 

I would like to add that on a social level the cost of all this transportations goes beyond what you mentioned:

1) Think about all the oil we are using for transportation: oil is finishing and getting more and more expensive (and the more we use the more and faster it will get expensive)... plus it generates a lot of pollution.

2) We are transferring money to countries that are unethical and politically unstable receiving goods in exchange, but goods are perishable and sooner or later will go to the trash. Money instead will never go to the trash and will be available for those unethical governments... and this is how USA debit got 26% owned by China!

Bob Kerr August 25, 2011

Jim, I could not agree more on your post.  I was involved in an exercise very similar to what you are talking about back in 1995.  We were making a product in Canada that was costing us $5.50.  We could buy the same product, landed, at $3.50 and it sounded like a good deal to our accountants.

When we looked at the total cost of purchasing we found that the ‘calculated cost’ would be $5.25.  As you correctly pointed out, there are some additional costs that you just can't calculate, but you know they are there.

As Fabio commented, we are also now facing costs to our environment, which are getting a little easier to calculate.

Jack Harrison August 25, 2011
We also add the cost of slowed inovation:  We need to exhaust the pipeline of the old configuration before we can implement the new.
As they say: "Speed Kills", and it's difficult to be agile when your source is 10,000 miles away! 
LeanGuy August 25, 2011

I totally agree having worked in India. Having worked in India I know first hand that this is true. Often companies invest so much in moving operations that they work pretty hard to show 'it paid' to move operations. 


If you have been ivolved with this you start asking the question how can people make money in these countries. The infrastructure is a real problem. The culture is incredibly ddifficult...

Aditya August 25, 2011

I totally agree with the lean math concept. It's true that most organizations ignore such hidden costs. But there are cases where an organization caters to both western and eastern/domestic consumers. In such cases, I guess the math gets a little more complicated.

The only way to optimize is probably to decide on the capital investment based on the domestic market share. Would you agree?

Mingsong Huang August 26, 2011
I only partly agree what in the article. For the lean, actaully, we also care much about it in China. So everything for lean could be implemented in USA also could happen in China. 
Actually now we have a lot of guys with intelligence and good knowleage and also experience (for example, me).
And China also could be big market. I think most companies come for this reason.

The above is just my opinion and if you have comment you could reach me at huang_ms7207@hotmail.com.

Thanks
Mingsong Huang 
ex-NPI leader August 26, 2011
Jim,
When I was leading a huge project we had to buy around 15 moulds. We requested several quotes from global suppliers. Finally, due to costs and delivery times, we decided to go with a chinese supplier. The initial time was 15 weeks for first parts delivery. Finally 80% of the moulds arrived after  35 weeks. Main issue was dimensions out of spec´s in parts injected. 
Additional costs:
- Around 20 DHL´s with wrong parts.
- Travel with internal moulds experts from Belgium and Spain to China to give support to supplier.
- 5 months delay on time to market.
Cost is a good reason to choose your supplier but it should not be the only one.
AieaDragon August 26, 2011

Spot on article!

 

Same goes for Wars (men, machinery/equipment, food, etc.) half-way around the World.  If they still want it, the USA should hand over Afghanistan to any of the neighboring Russian countries.  Let the neighboring Russian country do anything they want with Afghanistan so long as the terrorists don't reset their roots in Afghanistan.

 

As for China, all the USA has to do is to make the Companies that transport the cheap goods back to the USA on their Ships to charge China 10x to 100x more than normal!  By the way, you will always have quality deficiencies and defects from China. 

I was surprised when I tried to buy a pair of shoes at Sears in Hawaii and I couldn't find a pair of shoes made in the USA!  It appears that almost evrything is made in China.  American Corporations need to be more Patriotic to Americans.
Andre Andreazzi October 17, 2011
I would like to add one point of view. In the article it's being considered a manufacturer, so, there is a physical product. And I would ask about service and let me tell why I am asking. We have started Lean on a Testing Software process with the entire team within the same location, the process was stable and the team was fully aware of how to test and all the tools. When Lean came the team could measure the performance and keep improve. after a while part of the team was replaced by people in a lower cost Geo (aprox 50% lower). After an year the performance of the "new team" was lower by 50% aprox and with lower quality also. And also the costs of travelling and all the set up required is not being considered. Can I use the same math? Am I right in thinking that the relocation was a bad move? Thank you and regards
Stephane November 3, 2011

The attrition rate is also higher in China and India than Europe and US. A direct consequence is that it generates extra-costs in recruitment, training ,coaching new comers and insuring processes and way of workings are commonly known and applied. Potentially it creates also risks on misunderstood product requirements, loss of quality, delivery time hence additional costs such as high maintenance, penalty fee for failed delivery,etc...

Simon Carr November 21, 2011
HI Jim,
As coming onto the whole lean ethics late in the day. I have seen many companies i have worked for outsource, their operations. Like as you say this was the driver of the day, and many national companies suuccumbed to the enticement of low cost???
But this may seem fine for the planners, and buyers this seems a brilliant move to squeeze a few more pence out of the chain. But as someone that has to make things work, at thebottom of the chain, it only makes things more difficult . As the lead time becomes stretched and difficult to work with. Returns beconme virtually imposible, which reveals another hidden cost, that may not be accounted for.
So it may be that although it seems a good idea to move operations to cheaper markets. I urge companies to reconsider and reconsider agian before making a possible fateful move