Keeping Outsourcing In Hand
November 1 1989 by Douglas Cannon
Outsourcing, which was once a function relegated to the purchasing department, is today a strategic tool that affects an organization’s ability to gain and maintain its position within highly competitive global markets.
The management decision about what parts of a finished product can and should be outsourced-that is, what parts of the product can be engineered and manufactured better and less expensively by an outside supplier than they can be produced in-house-can dramatically affect the direction a company will take in terms of product differentiation and quality, level of technology and product time to market.
Outsourcing actually reflects and extends a firm’s corporate philosophy. The management decision can contribute to the survival of the product line, the work force and even the corporation.
A STRATEGIC ISSUE
Outsourcing is not new. The economist Adam Smith advocated it more than 200 years ago, writing “…the maxim of every prudent master of a family [is to] never attempt to make at home what it will cost him more to make than buy.”
The whole process of outsourcing by American manufacturers first became widespread in the automotive and aerospace industries, although most companies have been outsourcing to some degree throughout their existence.
Today, however, the expectations and effects of outsourcing have evolved far beyond costing to encompass corporate strategic planning. Once management has targeted the market in which the corporation is positioned to excel, outsourcing (which is sometimes called “partnering”) allows it to take the steps necessary to optimize that position.
Some companies decide whether to out-source based on a review of their internal costs of manufacturing. For example, the manager of cost strategies for a medical equipment maker notes that the decision to outsource is made after evaluating internal costs, then comparing quotes from outside sources to the full manufactured price of the product. Cost, he says, is really the primary consideration on which the company bases its decision to outsource (although vendors should also be able to demonstrate an acceptable level of quality control).
But to outsource successfully, corporate management must go beyond cost analysis and must also ask, “In what technologies do we really want to excel and take the leadership position?” Recognizing that no company can be the absolute best at everything, executives must decide where to focus and expand management, engineering and manufacturing capabilities.
Simultaneously, capital resources must be directed to support long-term growth consistent with the corporate goal.
“Our goal is to be number one in networking,” says the vice president of corporate purchasing at one high-tech firm which defines “networking” as establishing close relationships with key suppliers as well as with all the segments of the parent corporation. “We need win-win relationships in supplier dealings. For high-tech firms like ours, it can mean life or death in terms of world competition.”
Successful supplier relationships are important because of the advantages suppliers can add to the manufacturer’s product in terms of quality/reliability, overall reduction in costs, and ability to bring new products quickly to market.
The universal objective of every company considering outsourcing is to expand on existing strengths in areas where the company is already differentiated from the competition, gaining worldwide recognition for the product line.
MANUFACTURING VS. OUTSOURCING
The goal of management is not to outsource as much as possible, but to get new products to market quickly and competitively. New products like the process control systems made by Bailey Controls used to require three years from inception to market introduction. Today, development and introduction time for even more complex systems must be half that to maintain competitive technological leadership. The shortened time to market calls for the expertise and manufacturing support of trusted, state-of-the-art suppliers.
Meeting customer needs during times of rapidly changing technology has been the most critical issue in the transition from “purchasing” to outsourcing. Like many companies with an international scope, Bailey initiated aggressive outsourcing programs in the early 1980s. That is when the international market for measurement and control systems shifted quickly from those based on older electronic systems and pneumatic and mechanical components to microprocessor-based electronic systems.
There are some who also point to the example of the larger U.S. automakers, whose unwillingness to outsource early in this decade left them playing catch-up with the Japanese automakers, who, through outsourcing, brought more innovative products more quickly and economically to the U.S. market than our own domestic auto manufacturers.
THE SUPPLIER-MANUFACTURER-CUSTOMER LINK
The successful outsourcing program links design, purchasing, production and marketing. Management of the program has to understand the rapidly changing technologies of both customers and vendors to determine what outside needs and capabilities exist. Then, management determines what type of partnership is needed between the corporation and its suppliers to effectively introduce new products within a competitive time frame, at a competitive cost.
An example of effective outsourcing at Bailey is the recent commercialization of a direct mass flowmeter. Developed and marketed in just two years, the flowmeter was introduced in significantly less time than new instrumentation products traditionally require.
The direct mass flowmeter is a process measurement device which quantifies the mass properties of fluid flowing through a conduit. In the early stages of development, Bailey solicited a number of strategic vendors to assure that the new product design was consistent with those vendors’ manufacturing processes. At that point, we recognized that successful product development would require the coordination of complex investment casting technology, automated welding, precision sensor fabrication and state-of-the-art tube-bending techniques.
The direct mass flowmeter introduced to the market thus resulted from a unique combination of technologies, most of which were supplied by vendors whose design-stage input resulted in a significant reduction in the number of parts needed for the final assembly. When introduced, the performance and gross margins of the direct mass flowmeter actually exceeded initial program expectations. In 1988, the product was named the winner of the Chemical Processing Instrumentation Award.
It is our experience that the prudent manufacturer maintains those technological capabilities that differentiate his products from the competition’s products. Internal leadership and innovation capabilities are assigned to develop highly differentiated products and components. It is also imperative to keep some product design, development and coordination functions in-house-not because vendors are incapable of meeting those needs, but because those functions contribute directly to product differentiation and market leadership.
THE PRODUCT LINE
The nature of the product also affects management’s decision to outsource. For example, Network 90, the foundation of Bailey Controls’ product line, is a microprocessor-based distributed control system that can be configured to provide plant-wide systems control of up to 30,000 input/output points. As with any sophisticated product, that level of technology requires that specialized vendors become involved at the initial design stage.
It’s important to maintain consistent communication with technologically advanced vendors-both on current programs and on plans for future development. For example, like many major aerospace and automotive companies that outsource, Bailey Controls is kept appraised of the direction that vendor technology will take both next year and five years from now. This ensures that the finished product is designed to remain compatible with suppliers’ long-term capabilities, allowing the manufacturer who outsources to introduce new products more rapidly than the competition.
As in every team, communication (in this case, of evolving technologies) remains crucial. Clear, open communication is important whether the vendor’s products are commodity related or more technical, such as microprocessors.
Before begining to work with a vendor, it is important that they prove their ability to provide 100 percent good parts. Quality, whether it’s in process control equipment or in a new household appliance, is the most important ingredient because in a broad sense it’s a measure of howwell that product satisfies the customer’s needs. Experience proves that the cost of receiving a bad part is unacceptable; a manufacturer can’t add quality-just more cost-to a bad part. Improved quality, while it may distribute cost to the front end of the process, invariably reduces finished product cost.
THE ROLE OF ENGINEERING
While we don’t outsource a major part of our engineering, Bailey management finds it advantageous to turn over engineering for part of a new product to the specialized vendor as early as possible. Early vendor engineering involvement is critical for components in which a company differentiates itself from competitors, such as electronic parts. It tends to be less important in areas like castings and stampings, where the customer’s need has changed a lot in relation to technology. However, there are exceptions and we do know of one metal stamper whose engineering team redesigned a component for an appliance manufacturer and saved nearly 80 percent of the component cost through application of specialized metal stamping expertise.
Many manufacturers initiate cooperative participation with vendors at the design stage, when the vendor can help the customer keep current with design and manufacturing technology. “We make sure that engineering teams from our company and from our vendors meet very early in the design process–often at the conceptualization stage, which is pre-specification,” says the director of corporate purchasing at an internationally known maker of electronic equipment.
“That way, the product features that contribute to end-user satisfaction are designed in before the part is engineered. We design to fill our customers’ needs, so we rely heavily on the knowledge and expertise of our suppliers,” he emphasizes.
“We also design in terms of the manufacturers’ processes. We prefer to work with the suppliers’ engineering personnel, who often know more than we do about their specific aspect of production. This really leverages our R&D dollars,” he adds.
External engineering involvement as part of an outsourcing program has been a major point of contention-particularly in automotive companies. Supporters of traditional corporate culture claim that utilizing outside designers and engineers will make products more generic. One long-term engineer at Ford, for example, points out that fragmenting component design-particularly on products like cars, where design is crucial to product identity-damages product “character.” He also claims that outsourcing puts product design responsibility into too many hands, risking fragmentation of proprietary information. “You can’t outsource engineering and testing,” he says, because if the work is good, the outside firm will not keep the customer company up-to-date on new developments.
Those are valid issues and evidence that the best outsourcing programs must be well managed. However, those arguments should not be used as excuses to accept less-thanoptimum engineering expertise just because it is available in-house, and therefore, appears more cost-effective.
THE JIT DELIVERY ADVANTAGE
Close working relationships with trusted vendors are also evident with just-in-time (JIT) delivery programs. Successfully implemented, JIT involves coordination through the entire design and manufacturing functions. The program significantly reduces inventory costs and enhances capability to respond to customer needs. But JIT doesn’t work for every facet of manufacturing; success varies, depending on the type of supplier. For example, many manufacturers note that they have never been let down on the delivery of highly competitive, commodity products like sheet metal.
Our experience has been that suppliers of electronic components have not always been as timely, due to the major fluctuations in that industry. As a result, many manufacturers coordinate several suppliers to ensure a smooth flow of components to take full advantage of JIT technologies. Local and regional distributors are also becoming more responsive to resolving the historical feast/famine cycle of electronic chip availability.
We also have a definite preference for delivery of complete components-totally formed, machined, welded, plated, etc.-to minimize internal handling and streamline production. In the past, for example, there was a tendency to receive a formed part, process it, then send it back out for finishing. To exploit the strengths of JIT, many manufacturers now receive parts and components as complete as possible. That not only reduces handling and shipping costs, but it also minimizes investment in inventory.
At a seminar addressing outsourcing issues, the manager of vendor engineering for a camera manufacturer said, “We have limited part manufacturing capability and by choice limit ourselves to technology not available elsewhere. When it comes to making cameras, we prefer to purchase all of our parts and prefer to purchase them as complete as possible-plated, painted, complete-so that when they come in-house, the parts go right into assembly.”
Among the advantages he cites are lower cost-per-piece, lower inventory costs, and reduced manufacturing space and manpower requirements.
Other innovative delivery programs, such as “kitting”-receiving pre-assembled kits of parts delivered right to manufacturing-also reduce costs. While our experience is that pre-assembled kits are more expensive than parts delivered loose, the increased productivity and decreased in-house inspection, handling and repackaging costs more than make up the difference.
THE PURCHASING ROLE
Successful outsourcing greatly expands the role and the responsibility of the purchasing department. Purchasing must know what’s available on standard components and have established multiple vendors for routine raw materials. For highly sophisticated components, multiple sources are often impractical, so purchasing works with those suppliers to establish responsible delivery programs by forecasting requirements and advising immediately of expected changes.
In successful outsourcing, it becomes the responsibility of purchasing to communicate to vendors the projections of production and cost reduction plan forecasts. This means, of course, that the corporation, at all levels, is working according to predetermined corporate objectives, with long-term material forecasts planned to meet manufacturing objectives. In Bailey’s case, forecasting allows us to plan for possible component shortages and to manage purchasing by anticipating problems.
OUTSOURCING AND THE WORK FORCE
Outsourcing can challenge the labor force but at Bailey Controls, employees have a firm knowledge of the company’s need to remain competitive and a keen awareness of the result of lost competitive position. Through daily exposure, employees also see the need for increasing levels of sophistication if a product is to survive in the competitive marketplace. As a result, they are aware of the decreasing internal labor content factor in the total production cost-whether it be process control equipment, appliances, computers or cars. At Bailey, we consistently outsource operations that are no longer significant to product technology, such as punch-press and machining operations, to contractors who provide those services at a lower cost than we can.
It is obvious to employees when capital and space for expansion are directed toward the new technologies that keep a company successful and competitive. At Bailey, by expanding into new products and technologies, we have grown in a manner that stabilizes the work force better than companies that fail to stay competitive and thus experience massive layoffs. And like the majority of progressive manufacturers, we’ve found it critical to offer training to upgrade skills, encouraging new opportunities for employee growth within the more technical product lines.
While policy varies among companies and industries, we give employees up to one year’s notice of an impending technological shift that will affect employment-so they can either train for that new position or have as much time as possible to seek alternative employment. Outplacement is considered only as a last option. In the work force at this location, even in light of rapidly shifting technologies, we lost only 20 direct-labor positions in the last fiscal year and experienced a 20 percent sales increase.
Douglas Cannon was president of Bailey Controls Company until his recent retirement. Bailey, a division of Babcock & Wilcox, a unit of McDermott International, Inc., was scheduled to be purchased on