Magazine Winter 2012

Is It Time to Rethink Your Manufacturing Strategy?

Factors such as oil price volatility, increasing labor costs in emerging markets and shifts in demand all come into play when deciding where to manufacture products.

David Simchi-Levi, James Paul Peruvankal, Narendra Mulani, Bill Read and John Ferreira Reading Time: 7 min 

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One crucial enabling factor for outsourcing or offshoring manufacturing was cheap oil. But now, crude oil prices and transportation costs have risen.

For the past 10 years, China was the answer to many manufacturing questions. That’s no longer automatically the case.

Supply chain disruptions, fuel price volatility, rising labor costs, advances in technology and a growing realization of the advantages of being physically close to customers are leading some manufacturers to conclude that they are better off with a regional strategy that may or may not include China.

This doesn’t mean that the United States or Western Europe will ever again be the manufacturing hubs they once were. For a company doing business in the United States or Western Europe, for example, a regional strategy is likely to mean Mexico or Eastern Europe. And it may not mean a lot for jobs, since technological advances and productivity growth keep reducing the need for labor in manufacturing. However, it does suggest that smart companies are likely to conclude that the optimal manufacturing strategy depends on working out a subtle equation that includes the materials that go into the product, the product itself and the expected growth of the customer base. This equation must be monitored continually so that manufacturing and logistics solutions can be dynamic and flexible to meet the ongoing changes in the market.

Since the mid-1990s, many companies have outsourced or offshored some or all of their manufacturing operations. For most, one crucial enabling factor was cheap oil: Long supply lines were economically feasible because transportation costs were relatively low. Hence, companies emphasized reducing manufacturing costs through (1) offshoring or outsourcing; (2) plant rationalization (leveraging production economies of scale and reducing capital investment); and (3) consolidating distribution centers and warehouses to reduce inventory levels and minimize fixed facility costs.

Now the equation has changed. Crude oil prices and transportation costs have risen, making them far more significant relative to inventory, production and fixed facility costs. This in turn has given rise to three new cost-optimization realities:

1. Regional distribution centers become more attractive. As oil prices increase, outbound transportation becomes more expensive. As a consequence, it may be necessary to minimize distances between distribution centers and retail outlets by adding warehouses.

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About the Authors

David Simchi-Levi is a professor of engineering systems at MIT. James Paul Peruvankal is a senior program manager at Revolution Analytics in Palo Alto, California. Narendra Mulani is managing director of Accenture Analytics. Bill Read is managing director of Accenture products industry management consulting. John Ferreira is a senior executive at Accenture management consulting.

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Comments (2)
Rabindranath Bhattacharya
Dr. Rabindranath Bhattacharya, Mumbai, India

Please refer to my earlier comment on the subject. Please read "Regionalising" instead of "Renationalising" on the 15th line. I am extremely sorry for the inadvertent  mistake.
Rabindranath Bhattacharya
Dr. Rabindranath Bhattacharya, Mumbai, India

A Customer would always like to have manufacturing supply point to be as close as possible to him so that he can get the desired service from the seller. This is what I observed in many parts of the world inclusive of India.  However 
since the demand growth of products  and operating cost varying varying from one region to another I fully agree with the author that manufacturing strategy is to be flexible enough to ensure that Supply chain operates efficiently. However, I feel, the split- operation of production could be explored/planned so that you are close to your customers in a high cost country. I mean low cost operations of a product are to be done in low cost countries ( manual and semi manual) and highly automated operations (assembly or final testing) done in high cost countries. This is equivalent to a combination of out shoring and in shoring. It is just like killing  two birds with one shot! In fact during my tenure in a US based company near Chicago we were successful in getting  basic operations done in an Indian company and final sophisticated operations in USA before supply to US customers, who did not get a chance to complain. Alternatively if the demand in Asia goes up in future we need to set up the entire supply chain in India to be close to customers (Renationalising the supply chain). 
In a nutshell, the situation is so dynamic in modern world that one must be highly innovative and adjust the supply chain quickly  to remain competitive and that is where the success lies. Their is no panacea for the problem.