Lean outsourcing: It’s coming

By John Tuck

Lean outsourcing. Think about it. Here are two terms that are, on their face, contradictory. Outsourcing, of course, means that an OEM requires a supply pipeline in place of internal manufacturing. But an external pipeline is antithetical to lean manufacturing, where conveyance is considered a form of waste. Yet the combination of lean manufacturing and outsourcing is on its way. How is this possible? The answer is two words - Cisco Systems.

Starting in its fiscal Q3 ending in April 2006, Cisco will embark on a six- to eight-quarter transition to a lean manufacturing model. Since Cisco, a pioneer of virtual manufacturing, is heavily outsourced, converting to lean manufacturing model is tantamount to creating lean supply lines of outsourced product. In published remarks, Cisco's CFO stated that the transition "will be a controlled process, planned in close cooperation with our contract manufacturing partners."

It is well known that Cisco has consolidated its manufacturing supply base to four EMS providers. MMI Top 50 data show that Celestica, Foxconn (Hon Hai Precision Industry), Jabil Circuit and Solectron all manufacture for Cisco (March, p. 2). Is it a coincidence that two of these providers, Celestica and Solectron, already have well-publicized lean initiatives of their own dating back at least two years (April 2004, p. 1-2). Since Cisco declined to be interviewed for this article, it is unclear whether some of Cisco's providers influenced its decision to go lean. Still, an OEM like Cisco cannot shift to a lean model without having all of its outsourcing partners on board.

Cisco's adoption of lean outsourcing, to coin a phrase, is a significant because Cisco has been an early adopter in the outsourcing world. If Cisco's lean model yields reductions in core manufacturing inventory and improvements in inventory turns, as Cisco expects, these results will not be lost on competitors and other savvy OEMs.

As a concept, lean manufacturing, has been around for decades, and many leading businesses, including well-known OEMs such as Apple, Dell, Delphi and GE and HP, are practitioners. Yet indications are that the lean model has not been widely applied to outsourced supply chains as they exist today.

Why? When outsourcing, especially to places like China, an OEM creates a pipeline in which goods are moved but value is not added. In other words, the OEM has created waste. Thus, the OEM has gone in a direction opposite to that prescribed by lean manufacturing, explains Eric Olsen, Ph.D., an assistant professor at California Polytechnic University and lean practitioner with VentureOutsource.com, where he helps companies adopt lean manufacturing solutions. "You've added a bunch of waste essentially into the process by putting that huge conveyance pipeline into the process," he says.

Nevertheless, many OEMs have opted for longer pipelines in order to tap low-cost labor sources in various parts of the world. "Now the thing is, there's probably a lean way to do that and a non-lean way to do that," says Dr. Olsen. "Lean would say I've got to work very closely with my suppliers."

The most direct way to achieve this relationship is through the physical proximity of a regional supply chain. "I think lean points you to that regional model. Still, if that regional model doesn't give you that ultimate low-cost situation, somebody who sort of cracks that nut and figures out how to do that well with a longer pipeline by using some of these lean techniques and concepts and still gets as much waste out of the system as they can could potentially out-compete you," says Olsen. He suggests that use of electronic communications may offer a substitute for proximity to circumvent some of the difficulties in long-distance supplier relationships.

One method that OEMs can apply in a lean outsourcing model is to examine the operations of currently used EMS providers, particularly those in low-cost regions. If any providers "are still using old-fashioned or mass-productions techniques where they have tons of inventory, wasted labor in their production lines,...you're essentially leaving some money on the table," says Olsen.

"If you head down that lean path as an OEM, it's almost a prerequisite that eventually you're going to lean out your entire supply chain. And all your contractors are eventually going to be lean in some way," he says.

When an OEM converts to lean outsourcing, it can impact EMS providers in the supply chain. Take Jabil. The company recently reported that its production levels in the networking segment are expected to drop by about 25% in the May quarter followed by a 100% increase in the August quarter as a result of the lean manufacturing initiative of a communications customer. It is widely believed that this customer is Cisco. The 25% decrease stems from inventory being taken out of the supply chain as Jabil and its customer collapse a two-stage manufacturing process into one. The 100% increase in the following quarter reflects a conversion of business from consignment to turnkey.

EMS providers with a track record in lean manufacturing may have a competitive advantage with OEMs looking to go lean. "When you implement lean, you're going to want some kind of access to expertise," says Olsen. He adds, "I would be distrustful of a contract manufacturer that said, ‘I just implemented lean six months or a year ago,' as far as being able to get expertise from them." According to Olsen, it generally takes two to five years to achieve a lean culture in a company.

Implementing a lean outsourcing model is not without its challenges. If OEMs are to switch to a pull system called for by lean manufacturing, they must get a better handle on the demand of their customers. Only then can their EMS providers change from build to forecast to build to order.

Then there's the matter of where inventory ends up in lean supply chains. "Because the OEMs have the power, they pass it down to the subcontractors. And the subcontractors are the customer so they pass it back down to the component folks. But ultimately, somebody has to pay for that," says Olsen. "You're either going to pay for it with your component folks holding huge amounts of inventory....Or you're going to work with your component folks to reduce it to a level that is commensurate with the capability of the process."

Lean outsourcing may not be easy, but Cisco's lean program is a major endorsement of the concept.

John Tuck is publisher and editor of Manufacturing Market Insider. (www.mfgmkt.com)