The Hidden Perils of Supply Chain Innovation

Outsourcing, lean manufacturing and just-in-time inventory are proven cost cutters. But they can stretch global supply chains to a breaking point.

Disruptions in the global supply chain can have a significant financial effect on any company. Outsourcing, lean manufacturing and just-in-time inventory, of course, have long been considered to be remarkable innovations in reducing an organization’s production costs and allowing it to focus on its core competencies. While there are obvious benefits in reducing the production costs, these strategies can stretch a global supply chain to a breaking point at which at which a company’s overall financial performance could suffer.

Opinion_Bug7Paradoxically, when services are outsourced to offshore providers, a customer can face some increased costs and risks compared to solutions involving on-shore resources. Offshore outsourcing, though potentially more cost-effective, may involve hidden costs. They can, for instance, include an expensive and lengthy process of vendor selection; a three-to-12 month  longer timeframe to complete work handover to the offshore partner; severance costs related to layoffs of local employees who will not be relocated  internationally; turnover costs; and costs associated with addressing language and other cultural differences.

Lastly, managing the actual offshore relationship can involve a major additional and sometimes unforeseen cost. Overall, a company may end up paying up to 50 percent more in front-end costs than initially expected and only achieve a cost savings of as much as 15 percent to 25 percent in the first year. That could be well below the expected 35 percent to 40 percent in savings — which might only be achieved in the third year of the agreement.

An increase in front-end costs may cause the outsourcing organization to agree to lengthen the initial term of the agreement in order to generate the required financial benefits. But that ultimately involves making a larger commitment and therefore increases risk. Aside from costs, there are risks CFOs need to consider when their company outsources to offshore companies. They include:  1) data-security breaches; 2) lapses in process discipline; 3) loss of business knowledge; 4) vendor failures to deliver; 5) lack of compliance with government oversight and regulation; 6) cultural differences; and 7) productivity fluctuations.

There are also risks involved in lean manufacturing and just-in-time inventory. At many manufacturers, of course, since most of the cost is associated with purchasing goods and services, keeping stock levels low seems like a sensible thing to do. Both lean and just-in-time manufacturing focus on controlling the stock levels of the sourced materials. Finished goods and internal sub-assemblies are within the control of the manufacturer, after all. Unfortunately, this is also where the highest risk in the supply chain resides: Disruptions in the supply of raw materials can cause missed customer shipments or, worse, shut your customer down.

5 thoughts on “The Hidden Perils of Supply Chain Innovation

  1. The next level for Supply Chain Innovation is supply chain finance (SCF). Risk is higher in the other three areas as discussed and SCF not all for companies or all sectors either.

  2. Interesting thoughts on supply chain management, I work for McGladrey and there’s a very informative whitepaper on our website that readers of this article will be interested in @ “Count, manage and move: Warehouse inventory control strategies”

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