Why a backup plan isn’t a luxury it’s a necessity OR “I am not saying I told you so, but I told you so!”
This Blog will discuss some of the most important factors to consider when performing a cost benefit analysis of your supply chain as it applies to overseas manufactured components in your company’s lighting products. The paper will discuss the Lighting Industry’s use of overseas manufactured components as a percentage of total production in the U.S., the Five Supply Chain Factors that must be considered when incorporating foreign manufactured components, some of the methods that can be used to mitigate the risk inherent in including these components and will conclude with why it is necessary to have a backup plan or Plan B for your supply chain.
In today’s globally interconnected business world, sometimes it is hard to see the forest for the trees when it comes to supply chain issues, particularly when it comes to domestic production versus international production of products/components for your company.
For many U.S. Companies, it makes fiscal sense to have some percentage of their manufacturing done overseas. The latest figures from the Federal Reserve Bank (FRB) Report dated August 2018, show that only 19.6% of goods sold in the U.S. are manufactured overseas, but this is a somewhat misleading figure because this only accounts for goods that have 51% or more content manufactured overseas. For many companies, to maintain their “Made in the USA” labels, 51% of their content must be U.S. content, meaning up to 49% of their content can be manufactured overseas and yet these goods are not included in the foreign manufactured data group.
A more accurate assessment of the overall international content of goods sold in the U.S. comes from the U.S Bureau of Economic Analysis Report dated October 2019. In this report is estimated that 43.2% of all goods sold in the U.S. has some foreign components. The three countries that provide the largest share of these foreign manufactured components are China, South Korea, and Mexico.
There are many reasons for companies to outsource some or all their manufacturing to other countries (lower costs, work-force issues, regulatory issues etc.) and doing so can bring benefits to those company’s balance sheet. But there are also potential risks that need to be included in the cost benefit analysis when outsourcing manufacturing overseas. This paper will discuss some of these risks as they specifically apply to the U.S. Lighting Industry, which is a $5.6B/year industry as of 2018.
The U.S. Lighting Industry is representative of U.S. manufacturing models, with approximately 43% of all lighting products sold in the U.S. market incorporating some foreign manufactured components. In the commercial lighting segment of the U.S. market the total is slightly higher at 49%. The transition to LEDs has somewhat accelerated this process and the percentage of foreign manufactured components is predicted to rise to nearly 59% within the next three to five years per the Organization for Economic C0-operation and Development’s (OECD) report dated January 2020. So, for every light fixture sold into the U.S. Market, whether in the commercial or consumer market niche, could have up to 59% of its content from overseas manufacturers. Now all of these figures and studies were done prior to the Covid-19 Pandemic and it may take several years before the full extent of the repercussions of this pandemic are known, but what is known is that it is now more important than ever to have a risk mitigation plan and continuity of supply chain plan in place going forward.
As a Supply Chain Manager, it is incumbent upon you to ensure your supply chain’s stability and viability in the short and long term. To do this effectively, it is essential to balance a myriad of complex calculations and risk factors. This is even more important when your company’s products are using foreign components in domestic production, because a supply chain interruption may not only delay product deliveries, but may result in having to shut down domestic production lines causing ripple effects throughout the organization and even adversely affect future market share.
FIVE SUPPLY CHAIN FACTORS TO CONSIDER:
- Distance Factors – For many companies in the U.S. doing business overseas means either China, South Korea, or any number of other countries in the Far East. This means for those companies on the West Coast at least a 6,000-mile distance between your vendor and your facility. For those on the East Coast it is at least an 8,000-mile gap between where your parts are manufactured and where they are assembled. For supply chain professionals trying to maintain an extended supply chain these distances bring in all manner of additional factors to consider and plan for and against.
- Shipping/Transportation Factors – Shipping and transportation is one of the largest factors to include in any cost benefit analysis and needs to be addressed not just in the cost of shipping, but also in the time-lag from shipment from the vendor to receipt into the U.S., process through Customs and then additional shipment to your facility, as well as a risk factor due to geo-political issues. The cost of shipping components thousands of miles, the inherent risk in some of the volatile areas the ships must transit through and the time it takes for the proverbial “slow boat from China” are all factors that must be looked at when doing a full cost benefit analysis.
- Weather/Natural Factors – As a component of the shipping/transportation calculation, supply chain professionals must also include any weather- related or natural occurring factors into their planning process. Weather or natural factors that must be accounted for can include events like hurricanes/typhoons, earthquakes, flooding etc. Weather related events can impact a company’s ability to get components for days or even weeks depending on the severity and can create a short term stop in domestic production if not planned for. Now in addition to weather related issues, all foreign supply chains have to deal with the ongoing issues of the Covid-19 pandemic and the very real possibility that this is just the first of many World-Wide Pandemics in our future. The possibility of entire nations quarantining their populations used to be things you only read about in Science Fiction novels, but now are real world concerns. We now know that this type of events can and will affect critical supply chain throughout the world and have ripple effects throughout a company’s product offerings. The potential must be accounted for and some considerations made to adjust for them within any supply chain plan.
- Geo-Political Factors – In today’s World, any supply chain considerations should also include geo-political factors when assessing the viability of their supply chain. Factors such as regional instability, wars, terrorism, and diplomatic relations must also factor into any cost benefit analysis. Even for countries relatively close to the U.S. these considerations must be made. For example, many companies are doing business in Mexico because of its low labor costs and closeness to the U.S., but within the last several years, Mexico has become more and more turbulent because of the rising violence associated with the Drug Cartels. In fact, Mexico was ranked the most-worsened country this year on the U.N.’s Fragile States Index (FSI), tying with Ethiopia for the bottom spot. Although Mexico has long had a history of violence, political corruption and organized crime, the problems have all worsened within the last two years countering a decade-long trend of stability there. For those companies doing business in China, geo-political and diplomatic considerations must be made. Even though China has become the U.S.’s leading trade partner over the past decade, there are still many geo-political issues that could impact trade relations between the U.S. and China including increased tariffs, a trade war, questions concerning Taiwan and rising tensions between China and the U.S. vis-à-vis China’s South China Sea expansion desires. Any of these issues could delay or even curtail shipments between the U.S. and China in the future and must be addressed in any risk mitigation plan for a company’s supply chain. Even in countries where the U.S. has a stable trading relationship, such as South Korea, has inherent risk factors (North Korea) that must be included in any analysis.
- Safety Stock Factors – Because of the potential time-lag due to distance, shipping/transportation issues and as a risk mitigation factor for any weather related or geo-political calculations, having additional safety stock of all components that are purchased overseas is another factor to consider when doing a cost benefit analysis. For many companies trying to incorporate a Just-In Time or Kanban system the need for a safety stock increases the complexity of the process, inhibits JIT processes, and ultimately negatively impacts the bottom line.
RISK MITIGATION IN TURBULENT TIMES
There are several methods any Supply Chain Manager can look at to help mitigate the risks inherent in including components manufactured overseas, this paper will look at three potential methods to help mitigate exposure.
- Increase Lead Times – One method to help alleviate any risk factors inherent in buying components manufactured overseas is to increase your overall lead times for these components within your procurement process. By increasing the lead times, you are incorporating a “fudge” factor to help alleviate any issues you may have with delayed or interrupted shipping schedules due to unforeseen circumstances. The downside of this method is that any increase in the lead time has a ripple effect through your production processes and will make it harder to optimize your processes or incorporate these components into a JIT or Kanban process. In the end, the additional time will equate to additional cost and impact your company’s bottom line.
- Carry Additional Safety Stock – Another method to help alleviate any risk factors inherent in buying components manufactured overseas involves carrying additional safety stock of any component that is manufactured overseas. This method will negate the need for increasing lead times, but will create other factors that must be considered both Pro and Con. From a Pro perspective, carrying additional safety stock will allow you to maximize your production processes and incorporate a JIT or Kanban system more effectively, thus reducing your overall lead times for your customers and running a more efficient production line. From the Con side, by carrying additional safety stock you have increased your Cost-to-goods-sold when you include the additional inventory, storage, handling etc. and have shifted the inventory burden from your supplier to yourself. In the end, if the supply disruption is not a short-term event, you may still have to shut down your production lines until supplies can be re-started.
- Split Contracts – One of the most effective methods of alleviating any risk factors inherent in buying components manufactured overseas is to split the purchasing contracts between overseas and domestic producers. For example, many companies have begun awarding two contracts for these components, with 85-90% of the total requested production going to the overseas supplier and a smaller percentage (10-15%) going to a domestic supplier. What this does is provide a threefold benefit for the supply chain. First, there is a much shorter logistical supply chain meaning if product is needed in a hurry you have a much easier transportation hurdle to make. Secondly, if the overseas supplier has a short-term disruption, you can ramp up domestic production to counter any shortfalls you may have because your domestic supplier is already suppling components to you and you won’t have to start from scratch with a new supplier. Finally, if the disruption turns out to be a long-term issue, you can transition the entire production to the domestic supplier either permanently or while you are investigating other sources overseas. The downside to splitting contracts is that it will increase your overall cost-to-good sold both by increasing the number of contracts that you have to manage and slightly increasing the cost per part, but this additional cost will be incremental and should not be inhibitive. Over the past several years, many U.S. manufacturers have closed the price gap with many of the overseas suppliers and are competitive in pricing while maintaining the qualitative edge that they have over many of the overseas producers.
In conclusion, in today’s interconnected World it is easy to sometimes forget that events can overtake even the best laid out supply chains. It is imperative that companies today have a risk mitigation plan in place to ensure the constant and uninterrupted flow of components into their production processes. In the White Paper above, we have looked at the five factors to consider when buying components overseas and some of the methods in which Supply Chain Managers can mitigate their company’s exposure. The bottom line is that the best laid plans always need a Plan B or Plan C or even a Plan Z.