Direct cost, total cost of ownership, and reducing risk in low cost locations

By Mark Zetter


Direct cost, total cost of ownership, and reducing risk are all topics on the minds of executives looking at offshoring or outsourcing to low cost locations.

The diagram below emphasizes a couple of important points as offshoring and outsourcing relate to direct cost, total cost of ownership, and reducing risk.

First, the diagram notes returns on investment (ROI) for manufacturing discreet, one-of-a-kind (low volume) products compared to non-discreet products with higher manufacturing velocity.

These two different manufacturing types each have their own distinct direct costs, total costs of ownership and, risk reduction components executives must evaluate.

Secondly, the diagram also conveys an understanding of productive vs. non-productive factory capacity utilization.

Again, this translates to direct cost and total cost of ownership since whether or not a contract manufacturing partner is able to manage his business effectively is directly related to how well, and how much, ‘his’ savings in direct cost and total cost can be passed on to his OEM customer.


Countries in low cost regions such as Asia and Eastern Europe may well be better positioned for many high volume manufacturing product needs. Furthermore, in many instances, these geographies may be ideal for offering a stronger ROI when executives are engaged in high-volume production.

In referencing the diagram, number 1 on the curve represents low-volume, highly-discreet manufacturing. This situation might exist where entire product manufacturing and assembly of completed products (such as a major satellite, or the Hubble telescope, or NASA’s Mars land rovers…one-of-a-kind-type, complex production items) are not likely going to fit with outsourcing in a low cost location business model.

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Meanwhile, number 2 on the curve represents higher volumes and lower-cost per unit manufactured products that historically have proven to fit better in low cost location outsource models. Items suited for this have a high degree of manufacture volume demand and repeatability such as cell phones, smart phones, personal digital assistants (PDA), and even telecommunications and networking switches and routers.

Item numbers 1 and 2 each influence direct cost and total cost of ownership for executives differently since depending on ‘where’ an executive decides to manufacture and assemble printed circuit boards (PCB) and box build integration will undoubtedly impact the direct and total cost of moving finished goods inventory (FGI) to get product to a distribution hub or within reach of the product marketplace – for consumption.

The ‘risk’ component enters into the decision as executives determine whether or not added travel (and time) could adversely impact product shipment schedules — among numerous other related concerns.

Productive vs. nonproductive factories and capacity utilization

The box within the curve represents productive vs. nonproductive capacity utilization. (Note: productive vs. non-productive capacity utilization is more related to contract manufacturing company-specific issues versus whether or not the contract manufacturer is based in a low cost location, since there are plenty of contract manufacturing companies located in low cost locations but not all are effectively managed)

Again, how the contract manufacturer is managed; how he effectively attracts and retains multiple customers are some of the influencers in determining how well-managed his factories are and whether or not he can run his factories at a higher capacity utilization rate. (If he does run his factories at a high capacity utilization rate, and he can save money doing so, hopefully, some of the savings can be passed on to the OEM customers)

Typically, a contract manufacturing factory capacity utilization rate of 75% to 80% is ideal for OEM executives. When so, in most instances, it is easier for contract manufacturers to manage return on invested capital (ROIC) and, given the capital-intensive nature of contract electronics manufacturing, this is important in a highly-competitive industry.

Furthermore, operating in this range allows the OEM product program some room for upside volumes should OEM product demand require more capacity.

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In the diagram, the letter ‘A’ (in the box) above the line represents ‘productive’ factory capacity utilization. Whereas, the letter ‘B’ represents nonproductive factory capacity utilization…all of this based on volumes and cost.

It’s important to note here most companies look at manufacturing as a cost center. Contract manufacturers have been able to use manufacturing as a productive tool and the better ones manage it as a profit center.

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