Lean Manufacturing and Outsourcing

By Eric O. Olsen
and Mark Zetter

We have arrived at the nexus of two powerful trends in business process improvement and product manufacturing operations management. One, lean operations, offer streamlined flow of value to the customer with minimal inventory and waste. The other, outsourcing, offers dramatically lower cost of goods sold (COGs). Both can result in highly competitive pricing positions and healthy profit margins. Both trends are ostensibly valid responses to competitive price pressure, offering significant advantages with respect to cost. Combining the two would lead to an advantage, but one might ask, is 'lean outsourcing' an oxymoron? Many companies see the trends unfolding in this manner, viewing the outcome as no more than a tradeoff.

How do executives remain true to the tenants of lean while stretching their company value stream across the globe? How do companies build close relationships with suppliers if each party speaks, and acts, differently? How does an organization make value 'flow' when its raw materials, or products, might be arriving in batches the size of large, ocean-going ship containers, or perhaps even the size of the container ship? The situation becomes more complex when you realize many companies started their lean efforts in an attempt to save jobs by avoiding outsourcing and offshoring.

Identify value
For a partial answer, let's look at the first principle of lean thinking: Identify value. Womack and Jones, in their seminal work, "Lean Thinking" (Womack and Jones, 1996) lay out five principles, or steps, on lean thinking (Figure 1). Step one is to develop a thorough understanding of 'why' the customer is buying your product. Or, in other words, 'how' does he value the product or service your company provides.

Figure 1

Too often, companies take step one for granted and then immediately move on to mapping value streams; cutting waste, and implementing kanban systems and continuous improvement -- all the while, losing sight that neglecting a thorough identification of the 'value' can lead to not one, but possibly four, different outcomes. A two-by-two Value/Process Position Matrix displayed below
(Figure 2) describes these four potential outcomes.

Figure 2

It's important to keep in mind traditional manufacturers are becoming increasingly rare. For most companies, manufacturing executives are abandoning mass production and vertical integration models and are embracing a variable-asset business model or, outsourced contract manufacturing model, enabling companies and executives to become more globally competitive. In looking at contract manufacturers, or electronics manufacturing services (EMS) providers, those with a track record in lean manufacturing may have a competitive advantage with original equipment manufacturers (OEM) looking to go lean. (Tuck, 2006) A recent study by Oracle Corp., and conducted by Beacon Technology Partners (Baljko, 2005), confirms our own research that companies engaged in some form of lean implementation initiative have surpassed the 50 percent point.

Moving away from traditional manufacturing, there are two failure paths if the company gets only the value or the process correct. Companies that understand how their customers value 'their value proposition' (e.g., get the 'value' right) can fall into the short-term trap of chasing low-cost sourcing around the globe. These companies may enjoy a temporary advantage but, competitors soon find equal or better delivery process solutions and, ultimately, their position is not sustainable. Companies that incorrectly identify value may succeed in developing an effective system for delivering that value (e.g., get the 'process' right), only to see they have missed the market with an attractively priced product or service no one wants.

Being truly lean
The only sustainable position in the matrix is to be 'truly lean'. In this position, companies have correctly identified the value or, at least for the present, they have a better value proposition than their competitors. Executives must then proceed to empower their leaders and teams to design and execute processes to optimize delivery of the value identified. Every appropriate tool in a company's lean toolbox is made available. The process is completed correctly only with a generous amount of long-term thinking; proper guidance, employee involvement, and resource investment. Everything is fine. For awhile…at this point, you are the quintessential lean competitor.

However, to be 'truly lean' means a company has signed-on to chasing a moving target. Many manufacturing organizations seem to miss the dynamic nature of value.

Toyota, the foremost lean manufacturer in business today (with its now famous, industry-leading Toyota Production System (TPS), which many companies have tried to copy but few have been able to duplicate) views value as a combination of cost; quality, and time. Cost is the total expense involved in the delivery of the product. Quality is any deviation from standard. Time is best captured as the total elapsed process time from the start of a part, or transaction, to its delivery. (If this process is the order fulfillment process or cash-to-cash process then executives have a complete picture of where time is being effectively spent, or wasted, in the organization) Perhaps the key fundamental differentiator between lean and other management philosophies is lean's emphasis on time as a driving metric.

Figure 3 displays a unique way to view and think about the tradeoffs involved between lean and outsourcing. Value is conceptualized as the centroid of a 'waste triangle' with vertices at cost, quality, and time. (It's important to note that the centroid of the triangle depicts the prefect value target.) An organization's objective should be to bring the vertices of the triangle as close to the centroid as possible, thereby reducing its total area. A waste triangle with a small area is good. For purposes of this discussion, the squares in Figure 3 are setup to correspond to the Value/Process Position Matrix in Figure 2.

Figure 3

Whereas, traditional manufacturing (lower right, Fig. 3) serves as our baseline, a typical lean implementation (lower left, Fig. 3) results in a healthy reduction in wasted time due to the use of just-in-time practices. In such instances, it is not unusual for cycle times to be reduced 40-60%. There are commensurate reductions in waste associated with cost and quality as non-value added activities are eliminated; inventory is cut, and quality problems become easier to detect and correct. Readers can see the area of the triangle is significantly smaller.

Outsourcing (upper right, Fig. 3) has a similar effect on the area of the triangle. Meanwhile, its principle impact is on cost. Direct and indirect labor costs overseas can be a fraction of traditional North American labor costs. However, outsourcing can often bring with it longer lead times and potential quality problems as communication and response channels are extended and become less efficient. (Lean literature points to long lead times and communication inefficiencies as just a few of the hidden costs when outsourcing.)
The thought by many in the lean community is if all of these costs are accounted for, lean would also be the winner in the cost category. One misleading aspect of a typical outsourcing cost analysis is that the various 'direct' costs of outsourcing are just so low. From an overall value standpoint, the waste triangle is still small enough to make outsourcing a very viable, competitive option.

The waste triangle is a valuable concept for lean practitioners to keep in mind as companies pursue perfection in making value flow to the customer. Let's add one more variable (actually, let's add three more variables) before considering how manufacturing executives might implement a lean outsourcing strategy. These variables are cost risk; quality risk, and time risk.

Each of the vertices on the waste triangle represents not just one single point, but a range of possible outcomes depending on a particular strategy selected. For example, sourcing from Thailand or Vietnam may have a lower average cost, but this low cost comes with a certain amount of risk. Total costs realized may be lower or much higher. Therefore, outsourcing decisions must consider risk. This is especially true for lean manufacturers since they typically do not carry excessive safety stock to cover unforeseen glitches in the supply chain (Hendricks and Singhal, 2003). On the bright side, lean manufactures are well equipped to deal with all forms of variability, especially with the growing popularity of lean-sigma programs.

Pathway to lean outsourcing
So, how do companies go about implementing an effective lean outsourcing program? The following is a list of eight practical considerations for those companies on the dual lean and outsourcing path. Most of these principles will be familiar to lean manufactures; however, all eight are applicable to any outsourcing analysis:

1. Know what your customers value. Every company is capable of identifying a current value proposition in its marketplace. Outsourcing may bring this into better alignment with what customers want or, executives may find it damages the company's value. (For example, if customers currently depend on fast responses to frequent order changes, can a company provide this value through outsourcing?) As in life, there are no absolutes. Some customers would gladly trade some time for some dollars (or, whichever currency they happen to be dealing with). The point is to know where your company stands and where it is going with respect to value.

2. Trade physical proximity for digital proximity. 'The world is flat' is becoming a catch phrase these days (Friedman, 2005). Lean manufacturers know good communication and contact with a supplier is critically important. Executives must plan for companies to increase investment in information technology and travel.

3. Outsource to lean companies. Language and culture can be huge barriers. If possible, identify companies with lean implementation programs already in place. Lean can become the common language and culture between companies. If your company is only in its infancy with respect to lean, seek out a more mature lean company from which to learn. (As our firm has mentioned previously, we would be distrustful of an organization that said "we just implanted lean six months ago" as far as being able to get any expertise from them). It can generally take two to five years to achieve a lean culture in a company
(Tuck, 2006). Where possible, seek out the few, best companies to deal with.

4. Avoid the quantity discount trap. Many otherwise lean companies seem to forget this lesson when they source in low-cost geographies. When procuring, or buying, in North America, they readily pay a premium to buy in small batches, just-in-time. If setup or ordering costs is a driver for larger quantities, they seek to reduce it. The same applies in long distance sourcing.

5. Involve your customers in outsourcing decisions. Truly lean companies believe in transparency. Do not do or say anything that you would not want printed on the front page of the Sunday New York Times. Customers can provide a wealth of information and experience with respect to outsourcing. This also represents an excellent opportunity for companies to test theories about their value proposition.

6. Recognize risk. Every management strategy involves a degree of risk. In fact, customers pay a premium to suppliers who manage risk well. The mistake made by many companies when outsourcing is to not recognize risk as an explicit factor in the decision-making process. Lean companies identify risk in all forms of variability and work to reduce it.

7. Lean processes are easier to outsource. Understand your current processes. Invest wisely in making them lean. With less non-value add activities; less defects, and less waste in general, management has a much clearer picture of what is being outsourced. The knowledge gained makes managing such outsourced products and processes easier.

8. Measure the right stuff. The big five lean measures still remain the same for lean outsourcing: first-time through quality; dock-to-dock cycle time, build-to-schedule on-time delivery, overall equipment effectiveness, and total cost. Translate these measures to the supply chain level to drive and monitor continuous improvement.

REFERENCES

BALJKO, J. (2005) Lean all over. Electronics Supply and Manufacturing.
FRIEDMAN, T. L. (2005) The World is Flat: A Brief History of the Twenty-first Century, Farrar, Straus and Giroux
HENDRICKS, K. B. & SINGHAL, V. R. (2003) The effect of supply chain glitches on shareholder wealth. Journal of Operations Management.
TUCK, J. (2006) Lean Outsourcing: It's Coming. Manufacturing Market Insider, JBT Communications
WOMACK, J. P. & JONES, D. T. (1996) Lean Thinking: Banish waste and create wealth in your corporation, New York, Simon & Schuster.

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Eric Olsen, Ph.D. is former worldwide manufacturing education manager with Hewlett Packard and a senior consultant and lean practitioner with Venture Outsource. Dr. Olsen leads the firm's two-day, hands-on workshop Lean Outsourcing - Profiting from Global Operations designed to help companies increase profits and manage more efficient global supply chains.
E-mail: eolsen@ventureoutsource.com Lean outsourcing: www.ventureoutsource.com/events/conferences/leanmanufacturing.html

Mark Zetter is president of Venture Outsource. The firm helps companies worldwide make smarter business decisions.
E-mail: mzetter@ventureoutsource.com Internet: www.ventureoutsource.com