Outsourcing: Your Job or Theirs?
By George C. Elliott, Elliott-Luepker & Associates
It was not too long ago when I stood in front of a group of managers and made the following statement. “If you do not have 1.33 Cpk Quality, you have no right to outsource.” (Editor’s Note: for more information about Cpk, see the sidebar to this story). The group was silent. Their looks were more questioning than anything, except for the few that had already made the decision to outsource to a low cost country (LCC). I continued, “At the end of the day, it is simply, a matter of values… something, that should not be taken lightly.”
It is our obligation as managers and leaders to strike a balance of responsibility and accountability for the organization’s constituents including shareholders, employees, management, and suppliers. It is what I call a “Balanced Value System,” similar words to “Balanced Score Card Management,” yet bearing a very different meaning. I have never seen a balanced score card that specifically states that protecting the jobs of current employees, expanding employment, and honoring the legacy of the organization is a priority. In my early career, I was taught that my most important leadership role was to grow the business and protect the jobs of the people who brought us to the dance. I still believe that we have that same responsibility. We must be able to look all constituents directly in the eye and say we have been fair and just and have done all we can in their best interest.
Every organization in business today faces ever-increasing competition. Each day there is someone out there raising the bar of enhanced quality and performance at a reduced cost, and in some cases, a substantially reduced cost.
What Can an Organization Do?
In the past when faced with strong competition, many organizations turned to downsizing, down paying, and divestiture. Today, the favored alternative to increasing competition seems to be immediate outsourcing.
In most cases the outsourcing objective is a 20 percent product cost reduction. Generally it is expected that this reduction is taken from direct or variable product standard. The great majority of such reductions would certainly come from direct labor savings…which often weighs in at a 40 to 60 percent reduction in direct labor costs. Fully loaded unskilled labor costs in countries like China, Vietnam, Thailand and India can run as low $1.50 to $3.00 an hour against a U.S. average between $23.00 and $25.00. Even Japan has priced itself out of the LCC category, and is now paying production workers a fully-loaded, “true living wage” of around $20.00 an hour.
But, competition is not just about wages. It is about total cost, about design, about quality and about service, all of which combine to present the full product value proposition. Let us remind ourselves that it was, and is, quality that has both challenged and ravaged the U.S. auto industry. Yes, there are many improvements that have been made, but many industries have a long way to go. It is embarrassing, for instance, to read down the list of any auto quality ratings to find only one or two, if any, U.S. domestic autos in the top ten of a reliability scale.
Even if a 20 to 30 percent cost improvement is required to remain competitive in the international market, the first action should be a robust, impartial measure of quality, organization effectiveness and an in-depth analysis of organizational complexity and standard cost validity. The difference alone in 1.0 Cpk and 1.33 Cpk first time quality covers the whole ticket. Quality has been accurately analyzed and documented over the years. The financial and productivity difference in total cost between 66 parts per million and 2600 parts per million defective transcends the linear simplicity of numbers. Rework, inspection, prevention, warranty 1.0 Cpk and even staffing level are directly affected by such performance 1.33 Cpk.
Am I arguing against outsourcing? The answer is a qualified “yes.” To me it should be a last resort alternative. Outsourcing carries with it a very large up front investment and significant, measurable risk. On the cost side alone, effective plant managers in China have quickly defined their value, currently commanding wages between US $60,000 and $100,000. It is not unusual for an effective operations manager to earn wages beyond US $50,000 a year.
Look at the Hidden Costs
There is also a long list of “out of standard” start up and sustaining costs that are both difficult to measure and are often ignored or rationalized away, but that make outsourcing a less than 100 percent certain alternative. Some of the most important cost and risk assessment areas might well be:
• Currency Vulnerability
• Endangered Patents and Intellectual Property
• Infrastructure Issues
• Growing Energy and Raw Material Availability
• Increased Material and Labor Costs
• Leadership Shortages
• Security Cost and Delay
• Supply Chain Challenges
• Loss of Company Loyalty
• Increasing Freight Costs.
Outsourcing is both about cost and about values. Before walking away from our domestic leadership accountability we must first be willing to run at the same staff levels we demand in the LCCs. We must be willing to dedicate the resources to achieve the level of quality that commands long-term customer allegiance.
Outsourcing is both an operational and strategic decision. It has long-term effects on the organization and very specifically challenges the legacy of the company, the loyalty of the employees and the management values. Even the thought of letting this kind of decision be made as purely a cost reduction activity should make one extremely uncomfortable.
Delegating the outsourcing decisions to a procurement function is a significant issue as well. Purchasing professionals typically have no responsibility for employment and have little to do with setting domestic standard costs. In most cases they too might well be facing a direct conflict of interest, as they report product cost savings against the very domestic contracts they recently negotiated.
Unless an organization is producing a truly high-volume, high-labor cost product; unless an organization has a clear and concise way of accounting for all associated costs; and unless an organization has dedicated itself to the achievement of “first time” 1.33 Cpk quality and pure “lean” staffing, the advantages of outsourcing are only an alternative to the tough job of effective management.
To be absolutely clear: If an organization’s leadership stewards have achieved true first time 1.33 Cpk quality or above and are certain that their organization meets the standards of daily performance excellence—and until that same organization reaches out to their employees with a sincere involvement culture—in the vast majority of situations, outsourcing is only the easy way out, often resulting in little if any real savings.
About Cpk
Cpk is an international standard measure of quality. The minimum automotive standard for many years was 1.33 Cpk, which is 66 parts per million defective. The formula is simple, as I note in the following for the card industry. It is the spread of the quality specification (size of card—depth of a specific color print—the centering or placement of the graphics)— divided by the actual variation. What percentage of the cards fall within the specification? Technically that is Cp and Cpk is a more specific measure that also adds a constant to adjust for the centering of the perfomance.
1.00 Cpk then would be that all the cards produced fall on a normal distribution of quality within + or - 3 standard deviations from the center of the specification. If the specification is the exact same width (+ or - 3 standard deviations from the center point) by random occurrence, 2600 cards per every million printed would be out of specification. The popular Six Sigma quality standard is a state of production excellence whereas only 3 cards for every million are out of specification; a really tough, if not impossible achievement. As is well known, the lack of disciplined quality is one of the greatest cost reduction opportunities in any organization, be it service or manufacturing. There are studies that the difference in 1.0 Cpk and 1.33 Cpk can be as much as 20 to 30 percent of variable cost…(sorting costs, customer returns, rerun or double product to get the same number of cards, added inventory to guard against poor runs, and loss of customer satisfaction).
George Elliott is chief executive officer of Elliott-Luepker & Associates, a firm specializing in organizational cost restructuring and the establishment of a High Performance Involvement Culture. He can be reached at 904-285-9264 or email: Gcellio@attglobal.net.