2. UNDERSTANDING THE TRUE COSTS
The purpose of bailing the water (saving costs) is so your
boat (company) stays afloat (earns a profit).
Focusing only on COGS (Cost of Goods Sold) will strongly
correlate directly to improved gross margins and partially
correlate to improved net margins or overall profits for the
company.
3. UNDERSTANDING THE TRUE COSTS
“The further the distance
between the host location
and the outsourcer, the
more the uncertainties and
risks are. These
uncertainties and risks can
lead to large unexpected
costs which offset gains
from cheaper labor, or even
worse, result in enormous
loss to the outsourcer.”
Transportation costs /
Reverse logistics costs
Administrative cost of
maintaining relationships
with new suppliers; including
the travel costs to and from
your supplier
Cost resulting from longer
lead time and poor delivery,
such as increased inventory,
obsolescence, expediting,
downtime
Negative purchase price
variance (NPV)
4. UNDERSTANDING THE TRUE COSTS
“The further the distance
between the host location
and the outsourcer, the
more the uncertainties and
risks are. These
uncertainties and risks can
lead to large unexpected
costs which offset gains
from cheaper labor, or even
worse, result in enormous
loss to the outsourcer.”
Cost entailed by inferior
quality, such as additional
quality inspection, rejection,
rework, downtime, scrap,
warranties
Delayed shipment (revenue)
Additional NRE costs for
tooling and fixtures
Additional staffing
Duties and taxes
Inventory and Inventory
carrying costs
Overseas supplier training
and engineering support
expenditure
5. UNDERSTANDING THE TRUE COSTS
There are areas that
can negatively impact
your profitability that
are a part of a world-
wide economy.
Currency fluctuation risk; if
you are building in a region
where the US dollar has
declined against the host
currency.
Cost related with Intellectual
Property (IP) protection
Dealing with local
government for special
policies, constraints or even
corruption;
brand reputation degrading
and loss of market share
6. UNDERSTANDING THE TRUE COSTS
(a basic Income Statement)
Income Statement for XYZ Company
Net Sales (Revenue) $166,000,000
Cost of Goods Sold and Operating Expenses $140,000,000
COGS %age 84%
Gross profit $26,000,000
Gross profit %age 16%
Sales, general, and administrative expenses (SG&A) $13,000,000
Operating Profit $13,000,000
Other Income (Expenses) -$250,000
Interest expense $2,500,000
Provision for Federal Income Taxes $800,000
Net Income $9,950,000
Net Income %age 6%
7. UNDERSTANDING THE TRUE COSTS
The following slide is to show where
outsourcing events affect the income
statement.
Significant items affect the income
statement below COGS & Gross Margin.
8. "Before" using Manufacturing Cost Impacts to
USA Company Income Stmt
Manufacturing
Negative PPV for shortage materials
w/offshore sources who do not have
access to all materials
Net Sales (Revenue) $166,000,000 lowering of unit costs
Cost of Goods Sold $100,000,000
decline of dollar relative to an
offshore valuation & therefore impact
to your unit costs to the negative
Operating Expenses $40,000,000
transportation costs more expensive
with offshore outsourcing model
COGS %age 84%
travel, communications, added
resources to work with & manage
offshore outsource partners
Gross profit $26,000,000
NRE costs associated with additional
equipment/tooling/fixturing for
offshore source
Gross profit %age 16%
executive costs to travel & be
involved w/offshore outsource
partners
Sales, general, and
administrative expenses
(SG&A) $13,000,000
other company functions who staff to
assist w/managing offshore
outsource partners
Operating Profit $13,000,000
Other Income (Expenses) ($250,000)
duties / taxes with foreign countries
who build your products
Interest expense $2,500,000
write-down associated with product
recalls/losses due to major quality
issues found w/offshore outsource
companies
Provision for Federal Income
Taxes $800,000
financial xactions required w/offshore
outsource companies
Net Income $9,950,000
Net Income %age 6%
financing greater levels of inventory as a
result of elongating your supply chain
w/offshore sourcing
9. UNDERSTANDING THE TRUE COSTS
On the following slide we add typical
examples of outsourcing situations to the
income statement.
Do these sound familiar to you???
10. "Before" using Manufacturing Cost Impacts to
USA Company Income Stmt
Manufacturing
Negative PPV for shortage materials
w/offshore sources who do not have
access to all materials
offshore CM could not locate all
parts in lead-time you needed for
delivery, higher than Std cost paid to
brokers to fill immediate need
Net Sales (Revenue) $166,000,000 lowering of unit costs
cost reduction of 10% for going
offshore
Cost of Goods Sold $100,000,000
decline of dollar relative to an
offshore valuation & therefore impact
to your unit costs to the negative
dollar has declined for 2 years, by
15%, your offshore CM is raising
your cost by 10% due to the dollar
decline
Operating Expenses $40,000,000
transportation costs more expensive
with offshore outsourcing model
your logistics costs are higher by 2%
with routing your products via ocean
freight
COGS %age 84%
travel, communications, added
resources to work with & manage
offshore outsource partners
added 1 Jr. Buyer to help with the
offshore mgmt of your new offshore
outsource CM
Gross profit $26,000,000
NRE costs associated with additional
equipment/tooling/fixturing for
offshore source
adding tooling & test equipment
needed for new outsource CM
Gross profit %age 16%
executive costs to travel & be
involved w/offshore outsource
partners
your VP of Ops & COO wish to visit
your new offshore CM for mid-year
review
Sales, general, and
administrative expenses
(SG&A) $13,000,000
other company functions who staff to
assist w/managing offshore
outsource partners
added Cost Accountant, Legal, QA,
Engineeringpersons added to
support the offshore CM
Operating Profit $13,000,000
Other Income (Expenses) ($250,000)
duties / taxes with foreign countries
who build your products
your products have a tax for
importing into the USA based on
Harmnized Tarriff codes
Interest expense $2,500,000
write-down associated with product
recalls/losses due to major quality
issues found w/offshore outsource
companies
you shipped some product which
required recall due to lead found in
the paint, product was scrapped
Provision for Federal Income
Taxes $800,000
financial xactions required w/offshore
outsource companies
added Accounting Transactions,
(Letter of Credit)
Net Income $9,950,000
Net Income %age 6%
financing greater levels of inventory as a
result of elongating your supply chain
w/offshore sourcing
your intransit time has increased
from 2 days to 4 weeks, you now
carry additional inventory so you can
maintian ocean shipments and keeep
your logistics costs down to 2%
11. UNDERSTANDING THE TRUE COSTS
On the following slide we add the
associated costs for the previously
outlined situations in order to show the
financial impact to our income statement.
12. "Before" using Manufacturing Cost Impacts to Change Change "After" using
USA Company Income Stmt Dollars %age offshore
Manufacturing Manufacturing
Negative PPV for shortage materials
w/offshore sources who do not have
access to all materials $50,000 0.05%
Net Sales (Revenue) $166,000,000 lowering of unit costs ($10,000,000) -10.0% $166,000,000
Cost of Goods Sold $100,000,000
decline of dollar relative to an
offshore valuation & therefore impact
to your unit costs to the negative $10,000,000 10.0% $100,050,000
Operating Expenses $40,000,000
transportation costs more expensive
with offshore outsourcing model $2,000,000 5.0% $42,190,000
COGS %age 84%
travel, communications, added
resources to work with & manage
offshore outsource partners $40,000 0.1% 86%
Gross profit $26,000,000
NRE costs associated with additional
equipment/tooling/fixturing for
offshore source $150,000 0.4% $23,760,000
Gross profit %age 16%
executive costs to travel & be
involved w/offshore outsource
partners $10,000 0.08% 14%
Sales, general, and
administrative expenses
(SG&A) $13,000,000
other company functions who staff to
assist w/managing offshore
outsource partners $280,000 2.2% $13,290,000
Operating Profit $13,000,000 $10,470,000
Other Income (Expenses) ($250,000)
duties / taxes with foreign countries
who build your products ($100,000) 40.0% ($290,000)
Interest expense $2,500,000
write-down associated with product
recalls/losses due to major quality
issues found w/offshore outsource
companies $50,000 -20.0% $2,875,000
Provision for Federal Income
Taxes $800,000
financial xactions required w/offshore
outsource companies $10,000 -4.0% $800,000
Net Income $9,950,000 $7,085,000
Net Income %age 6%
financing greater levels of inventory as a
result of elongating your supply chain
w/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 only
with 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 offshore
manufacturer.
13. UNDERSTANDING THE TRUE COSTS
Each of you can use this model for a single
product or a group of products in assessing your
situation.
Assess your:
– Volumes
– Where on product life cycle
– The Risks
– Technology
– All the potential cost factors that can be encountered
– The Transitional costs
14. UNDERSTANDING THE TRUE COSTS
(Benefits to YOU !!!)
By understanding the potential costs & risks, you can actually
construct a simple income statement model to analyze your
supply chain decisions & what their overall impact would be.
You can form a stronger work relationship with your Accounting
Controller & together help align improved supply chain
decisions with aligned functions.
You can up level the discussions with your peers, boss, &
others that a simple cost savings goal, might not achieve what
a “smarter” supply chain can achieve.
Your financial rewards with successfully managing your
sourcing.
15. Additional Information:
Bringing it All Back Home: The Reshoring Initiative
by John Sprovieri
April 1, 2011
“According to a 2009 survey by Archstone Consulting, 60
percent of manufacturers use only rudimentary calculation
methods to determine what it costs them to offshore,” he
explains. “On average, they miss about 20 percent of the
total costs of offshoring.”
to download a free copy of the total cost of ownership
spreadsheet, visit www.reshorenow.org
16. Additional Information:
'We spend how much internally to manage our contract
manufacturers?!'
By Pamela J. Gordon, CMC
New analysis tool reveals that many OEMs spend more internally on
managing outsourced manufacturing than for outsourced value added
services
The model reveals that for an outsourcing spend of approximately
US$100 million, most OEMs spend internally in support of their
outsourcing program more than 20% that total program's invoice.
(Smaller outsourcing engagements typically incur even higher internal
expense.) In many cases, the OEM's internal cost exceeds the
price paid for the product's manufacture -- minus material.
17. Additional Information:
Total Cost Modeling for Overseas Sourcing/Outsourcing
by Ninghua Song
Overseas outsourcing/sourcing in manufacturing industry can be costly. The cost
savings may not be as great as they seem. Recently, many UK manufacturers
have transferred their production to low cost regions all over the world including
Mexico, India, and China. Among the various motives for these international
outsourcing/sourcing projects, seeking cost effectiveness is most frequently
mentioned.
The further the distance between the host location and the outsourcer, the
more the uncertainties and risks are. These uncertainties and risks can
lead to large unexpected costs which offset gains from cheaper labor, or
even worse, result in enormous loss to the outsourcer. Therefore, in order
to have a complete picture of all the potential costs of the offshore
outsourcing projects, companies should adopt a total cost model.
18. Additional Information:
How To Reduce Offshore Hidden Costs
By Zinnov Offshoring Research and Consulting
Companies spend anywhere between $20,000 and
$70,000 on the salary of the internal vendor
selection manager. (That assumes that vendor
selection is one of several projects handled by that
person.) Travel, communication and the time-cost of
senior management and engineering resources
increases the price tag.
19. Additional Information:
Transition Costs: the success of the transition
process often defines the success of the offshore
initiative. To be on the safe side, companies are
increasingly spending more during the transition
process. Arranging for onsite or offshore team visits
or a combination of both is a key transition
mechanism that has proven to have a high success
rate. However, the associated costs can sometimes
be prohibitive.
20. Additional Information:
Assumption: This three-year project is worth $5 million/year and the number of offshore
resources is around 120.
a. Offshore team visit to onsite
Team size = 12 engineers
Billing rate = $3,000/month
Onsite living expense = $3,000/month
Travel = $2,000/month
Total: 3 months of visits by 12 offshore engineers = ~$288,000
b. Onsite visit to offshore
Usually the number of client's engineers needed to visit offshore during the
knowledge transfer is smaller than the number required to visit onsite.
Team size = 5 engineers
Salary = $8,000/month
Offshore living expense = $2,000/month
Travel = $2,000/month
Total: 3 months of visits by 5 offshore engineers = ~$180,000
c. Combination of both
We estimate that the combination of both with shorter offshore and onsite
visits will cost around $230,000.
21. Additional Information:
The transition cost should be calculated as a
percentage of the project cost over a period of 3
years due to the length of offshore engagement. The
transition cost is approximately 1% to 2% of the
project cost for a transition period of 3 months.
Also, because the offshore team isn't productive
during this period, the cost of the rest of the offshore
team (~$1 million for 3 months) should be added to
the transition cost.
That brings the transition cost to about 8% of the
total project cost -- with the client actually losing
money during the initial months.
