OFFSHORE CONTRACTMANUFACTURING: UNDERSTANDINGTHE TRUE COSTSAPICS, THE GREATERSAN JOSE CHAPTER
UNDERSTANDING THE TRUE COSTS The purpose of bailing the water (saving costs) is so yourboat (company) stays afloat (earns...
UNDERSTANDING THE TRUE COSTS “The further the distancebetween the host locationand the outsourcer, themore the uncertaint...
UNDERSTANDING THE TRUE COSTS “The further the distancebetween the host locationand the outsourcer, themore the uncertaint...
UNDERSTANDING THE TRUE COSTS There are areas thatcan negatively impactyour profitability thatare a part of a world-wide e...
UNDERSTANDING THE TRUE COSTS(a basic Income Statement)Income Statement for XYZ CompanyNet Sales (Revenue) $166,000,000Cost...
UNDERSTANDING THE TRUE COSTS The following slide is to show whereoutsourcing events affect the incomestatement. Signific...
"Before" using Manufacturing Cost Impacts toUSA Company Income StmtManufacturingNegative PPV for shortage materialsw/offsh...
UNDERSTANDING THE TRUE COSTS On the following slide we add typicalexamples of outsourcing situations to theincome stateme...
"Before" using Manufacturing Cost Impacts toUSA Company Income StmtManufacturingNegative PPV for shortage materialsw/offsh...
UNDERSTANDING THE TRUE COSTS On the following slide we add theassociated costs for the previouslyoutlined situations in o...
"Before" using Manufacturing Cost Impacts to Change Change "After" usingUSA Company Income Stmt Dollars %age offshoreManuf...
UNDERSTANDING THE TRUE COSTS Each of you can use this model for a singleproduct or a group of products in assessing yours...
UNDERSTANDING THE TRUE COSTS(Benefits to YOU !!!) By understanding the potential costs & risks, you can actuallyconstruct...
Additional Information: Bringing it All Back Home: The Reshoring Initiativeby John SprovieriApril 1, 2011“According to a ...
Additional Information: We spend how much internally to manage our contractmanufacturers?!By Pamela J. Gordon, CMCNew ana...
Additional Information: Total Cost Modeling for Overseas Sourcing/Outsourcingby Ninghua SongOverseas outsourcing/sourcing...
Additional Information: How To Reduce Offshore Hidden CostsBy Zinnov Offshoring Research and ConsultingCompanies spend an...
Additional Information: Transition Costs: the success of the transitionprocess often defines the success of the offshorei...
Additional Information: Assumption: This three-year project is worth $5 million/year and the number of offshoreresources ...
Additional Information: The transition cost should be calculated as apercentage of the project cost over a period of 3yea...
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Offshore contract manufacturing (2)

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Offshore contract manufacturing (2)

  1. 1. OFFSHORE CONTRACTMANUFACTURING: UNDERSTANDINGTHE TRUE COSTSAPICS, THE GREATERSAN JOSE CHAPTER
  2. 2. UNDERSTANDING THE TRUE COSTS The purpose of bailing the water (saving costs) is so yourboat (company) stays afloat (earns a profit). Focusing only on COGS (Cost of Goods Sold) will stronglycorrelate directly to improved gross margins and partiallycorrelate to improved net margins or overall profits for thecompany.
  3. 3. UNDERSTANDING THE TRUE COSTS “The further the distancebetween the host locationand the outsourcer, themore the uncertainties andrisks are. Theseuncertainties and risks canlead to large unexpectedcosts which offset gainsfrom cheaper labor, or evenworse, result in enormousloss to the outsourcer.” Transportation costs /Reverse logistics costs Administrative cost ofmaintaining relationshipswith new suppliers; includingthe travel costs to and fromyour supplier Cost resulting from longerlead time and poor delivery,such as increased inventory,obsolescence, expediting,downtime Negative purchase pricevariance (NPV)
  4. 4. UNDERSTANDING THE TRUE COSTS “The further the distancebetween the host locationand the outsourcer, themore the uncertainties andrisks are. Theseuncertainties and risks canlead to large unexpectedcosts which offset gainsfrom cheaper labor, or evenworse, result in enormousloss to the outsourcer.” Cost entailed by inferiorquality, such as additionalquality inspection, rejection,rework, downtime, scrap,warranties Delayed shipment (revenue) Additional NRE costs fortooling and fixtures Additional staffing Duties and taxes Inventory and Inventorycarrying costs Overseas supplier trainingand engineering supportexpenditure
  5. 5. UNDERSTANDING THE TRUE COSTS There are areas thatcan negatively impactyour profitability thatare a part of a world-wide economy. Currency fluctuation risk; ifyou are building in a regionwhere the US dollar hasdeclined against the hostcurrency. Cost related with IntellectualProperty (IP) protection Dealing with localgovernment for specialpolicies, constraints or evencorruption; brand reputation degradingand loss of market share
  6. 6. UNDERSTANDING THE TRUE COSTS(a basic Income Statement)Income Statement for XYZ CompanyNet Sales (Revenue) $166,000,000Cost of Goods Sold and Operating Expenses $140,000,000COGS %age 84%Gross profit $26,000,000Gross profit %age 16%Sales, general, and administrative expenses (SG&A) $13,000,000Operating Profit $13,000,000Other Income (Expenses) -$250,000Interest expense $2,500,000Provision for Federal Income Taxes $800,000Net Income $9,950,000Net Income %age 6%
  7. 7. UNDERSTANDING THE TRUE COSTS The following slide is to show whereoutsourcing events affect the incomestatement. Significant items affect the incomestatement below COGS & Gross Margin.
  8. 8. "Before" using Manufacturing Cost Impacts toUSA Company Income StmtManufacturingNegative PPV for shortage materialsw/offshore sources who do not haveaccess to all materialsNet Sales (Revenue) $166,000,000 lowering of unit costsCost of Goods Sold $100,000,000decline of dollar relative to anoffshore valuation & therefore impactto your unit costs to the negativeOperating Expenses $40,000,000transportation costs more expensivewith offshore outsourcing modelCOGS %age 84%travel, communications, addedresources to work with & manageoffshore outsource partnersGross profit $26,000,000NRE costs associated with additionalequipment/tooling/fixturing foroffshore sourceGross profit %age 16%executive costs to travel & beinvolved w/offshore outsourcepartnersSales, general, andadministrative expenses(SG&A) $13,000,000other company functions who staff toassist w/managing offshoreoutsource partnersOperating Profit $13,000,000Other Income (Expenses) ($250,000)duties / taxes with foreign countrieswho build your productsInterest expense $2,500,000write-down associated with productrecalls/losses due to major qualityissues found w/offshore outsourcecompaniesProvision for Federal IncomeTaxes $800,000financial xactions required w/offshoreoutsource companiesNet Income $9,950,000Net Income %age 6%financing greater levels of inventory as aresult of elongating your supply chainw/offshore sourcing
  9. 9. UNDERSTANDING THE TRUE COSTS On the following slide we add typicalexamples of outsourcing situations to theincome statement. Do these sound familiar to you???
  10. 10. "Before" using Manufacturing Cost Impacts toUSA Company Income StmtManufacturingNegative PPV for shortage materialsw/offshore sources who do not haveaccess to all materialsoffshore CM could not locate allparts in lead-time you needed fordelivery, higher than Std cost paid tobrokers to fill immediate needNet Sales (Revenue) $166,000,000 lowering of unit costscost reduction of 10% for goingoffshoreCost of Goods Sold $100,000,000decline of dollar relative to anoffshore valuation & therefore impactto your unit costs to the negativedollar has declined for 2 years, by15%, your offshore CM is raisingyour cost by 10% due to the dollardeclineOperating Expenses $40,000,000transportation costs more expensivewith offshore outsourcing modelyour logistics costs are higher by 2%with routing your products via oceanfreightCOGS %age 84%travel, communications, addedresources to work with & manageoffshore outsource partnersadded 1 Jr. Buyer to help with theoffshore mgmt of your new offshoreoutsource CMGross profit $26,000,000NRE costs associated with additionalequipment/tooling/fixturing foroffshore sourceadding tooling & test equipmentneeded for new outsource CMGross profit %age 16%executive costs to travel & beinvolved w/offshore outsourcepartnersyour VP of Ops & COO wish to visityour new offshore CM for mid-yearreviewSales, general, andadministrative expenses(SG&A) $13,000,000other company functions who staff toassist w/managing offshoreoutsource partnersadded Cost Accountant, Legal, QA,Engineeringpersons added tosupport the offshore CMOperating Profit $13,000,000Other Income (Expenses) ($250,000)duties / taxes with foreign countrieswho build your productsyour products have a tax forimporting into the USA based onHarmnized Tarriff codesInterest expense $2,500,000write-down associated with productrecalls/losses due to major qualityissues found w/offshore outsourcecompaniesyou shipped some product whichrequired recall due to lead found inthe paint, product was scrappedProvision for Federal IncomeTaxes $800,000financial xactions required w/offshoreoutsource companiesadded Accounting Transactions,(Letter of Credit)Net Income $9,950,000Net Income %age 6%financing greater levels of inventory as aresult of elongating your supply chainw/offshore sourcingyour intransit time has increasedfrom 2 days to 4 weeks, you nowcarry additional inventory so you canmaintian ocean shipments and keeepyour logistics costs down to 2%
  11. 11. UNDERSTANDING THE TRUE COSTS On the following slide we add theassociated costs for the previouslyoutlined situations in order to show thefinancial impact to our income statement.
  12. 12. "Before" using Manufacturing Cost Impacts to Change Change "After" usingUSA Company Income Stmt Dollars %age offshoreManufacturing ManufacturingNegative PPV for shortage materialsw/offshore sources who do not haveaccess to all materials $50,000 0.05%Net Sales (Revenue) $166,000,000 lowering of unit costs ($10,000,000) -10.0% $166,000,000Cost of Goods Sold $100,000,000decline of dollar relative to anoffshore valuation & therefore impactto your unit costs to the negative $10,000,000 10.0% $100,050,000Operating Expenses $40,000,000transportation costs more expensivewith offshore outsourcing model $2,000,000 5.0% $42,190,000COGS %age 84%travel, communications, addedresources to work with & manageoffshore outsource partners $40,000 0.1% 86%Gross profit $26,000,000NRE costs associated with additionalequipment/tooling/fixturing foroffshore source $150,000 0.4% $23,760,000Gross profit %age 16%executive costs to travel & beinvolved w/offshore outsourcepartners $10,000 0.08% 14%Sales, general, andadministrative expenses(SG&A) $13,000,000other company functions who staff toassist w/managing offshoreoutsource partners $280,000 2.2% $13,290,000Operating Profit $13,000,000 $10,470,000Other Income (Expenses) ($250,000)duties / taxes with foreign countrieswho build your products ($100,000) 40.0% ($290,000)Interest expense $2,500,000write-down associated with productrecalls/losses due to major qualityissues found w/offshore outsourcecompanies $50,000 -20.0% $2,875,000Provision for Federal IncomeTaxes $800,000financial xactions required w/offshoreoutsource companies $10,000 -4.0% $800,000Net Income $9,950,000 $7,085,000Net Income %age 6%financing greater levels of inventory as aresult of elongating your supply chainw/offshore sourcing $375,000 15.0% 4%Significant impact to Net Margin based on array of cost events which impact several sections of the Income Stmt associated onlywith outsourcing, and specifically the difference between USA based manufacturing versus offshore based manufacturing.All are based on very real risks and costs with the severity of the impact dependent upon your product, product life cycle, design,manufacturing requirements, labor content versus material content, sophistication and management of your outsource offshoremanufacturer.
  13. 13. UNDERSTANDING THE TRUE COSTS Each of you can use this model for a singleproduct or a group of products in assessing yoursituation. Assess your:– Volumes– Where on product life cycle– The Risks– Technology– All the potential cost factors that can be encountered– The Transitional costs
  14. 14. UNDERSTANDING THE TRUE COSTS(Benefits to YOU !!!) By understanding the potential costs & risks, you can actuallyconstruct a simple income statement model to analyze yoursupply chain decisions & what their overall impact would be. You can form a stronger work relationship with your AccountingController & together help align improved supply chaindecisions with aligned functions. You can up level the discussions with your peers, boss, &others that a simple cost savings goal, might not achieve whata “smarter” supply chain can achieve. Your financial rewards with successfully managing yoursourcing. 
  15. 15. Additional Information: Bringing it All Back Home: The Reshoring Initiativeby John SprovieriApril 1, 2011“According to a 2009 survey by Archstone Consulting, 60percent of manufacturers use only rudimentary calculationmethods to determine what it costs them to offshore,” heexplains. “On average, they miss about 20 percent of thetotal costs of offshoring.” to download a free copy of the total cost of ownershipspreadsheet, visit www.reshorenow.org
  16. 16. Additional Information: We spend how much internally to manage our contractmanufacturers?!By Pamela J. Gordon, CMCNew analysis tool reveals that many OEMs spend more internally onmanaging outsourced manufacturing than for outsourced value addedservicesThe model reveals that for an outsourcing spend of approximatelyUS$100 million, most OEMs spend internally in support of theiroutsourcing program more than 20% that total programs invoice.(Smaller outsourcing engagements typically incur even higher internalexpense.) In many cases, the OEMs internal cost exceeds theprice paid for the products manufacture -- minus material.
  17. 17. Additional Information: Total Cost Modeling for Overseas Sourcing/Outsourcingby Ninghua SongOverseas outsourcing/sourcing in manufacturing industry can be costly. The costsavings may not be as great as they seem. Recently, many UK manufacturershave transferred their production to low cost regions all over the world includingMexico, India, and China. Among the various motives for these internationaloutsourcing/sourcing projects, seeking cost effectiveness is most frequentlymentioned.The further the distance between the host location and the outsourcer, themore the uncertainties and risks are. These uncertainties and risks canlead to large unexpected costs which offset gains from cheaper labor, oreven worse, result in enormous loss to the outsourcer. Therefore, in orderto have a complete picture of all the potential costs of the offshoreoutsourcing projects, companies should adopt a total cost model.
  18. 18. Additional Information: How To Reduce Offshore Hidden CostsBy Zinnov Offshoring Research and ConsultingCompanies spend anywhere between $20,000 and$70,000 on the salary of the internal vendorselection manager. (That assumes that vendorselection is one of several projects handled by thatperson.) Travel, communication and the time-cost ofsenior management and engineering resourcesincreases the price tag.
  19. 19. Additional Information: Transition Costs: the success of the transitionprocess often defines the success of the offshoreinitiative. To be on the safe side, companies areincreasingly spending more during the transitionprocess. Arranging for onsite or offshore team visitsor a combination of both is a key transitionmechanism that has proven to have a high successrate. However, the associated costs can sometimesbe prohibitive.
  20. 20. Additional Information: Assumption: This three-year project is worth $5 million/year and the number of offshoreresources is around 120.a. Offshore team visit to onsiteTeam size = 12 engineersBilling rate = $3,000/monthOnsite living expense = $3,000/monthTravel = $2,000/monthTotal: 3 months of visits by 12 offshore engineers = ~$288,000b. Onsite visit to offshoreUsually the number of clients engineers needed to visit offshore during theknowledge transfer is smaller than the number required to visit onsite.Team size = 5 engineersSalary = $8,000/monthOffshore living expense = $2,000/monthTravel = $2,000/monthTotal: 3 months of visits by 5 offshore engineers = ~$180,000c. Combination of bothWe estimate that the combination of both with shorter offshore and onsitevisits will cost around $230,000.
  21. 21. Additional Information: The transition cost should be calculated as apercentage of the project cost over a period of 3years due to the length of offshore engagement. Thetransition cost is approximately 1% to 2% of theproject cost for a transition period of 3 months. Also, because the offshore team isnt productiveduring this period, the cost of the rest of the offshoreteam (~$1 million for 3 months) should be added tothe transition cost. That brings the transition cost to about 8% of thetotal project cost -- with the client actually losingmoney during the initial months.
  22. 22. Questions ?

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