In Depth: Global Supply Chain  The Hidden Costs of a Global Supply & Demand Chain

[From Supply & Demand Chain Executive, August/September 2004] The recent popularity of offshoring is based, in part, on the widespread belief that moving production to lower-cost countries or shifting sourcing to overseas suppliers will result, automatically, in dramatic savings. But veteran industry observers warn of potential hidden costs of offshoring.

Victor K. Fung, for one, believes that simply shifting production to a lower-cost country is not enough. The chairman of Li & Fung Limited, Hong Kong's largest trading company, Fung spoke at "Longitudes 04: Mapping the New World of Synchronized Commerce," a conference organized in April by UPS and the Harvard Business School. In his presentation, Fung noted that manufacturing costs typically comprise just 25 percent of a product's price, while what he called "soft costs" make up the remaining 75 percent and those "soft costs," such as transportation and warehousing, are frequently higher in developing nations with less advanced infrastructure.

In addition, when a company moves production offshore or begins sourcing from suppliers overseas, lead times inevitably increase for goods brought into the country. Extended lead times, in turn, diminish the accuracy of forecasts as companies are forced to project demand further out than when they were producing goods closer to end consumers. To compensate, companies may find themselves holding additional inventory domestically or risk being unable to meet unexpected demand.

Rick Moradian, vice president for consolidation and deconsolidation with APL Logistics, says that many companies are coping with this challenge, in part, by beefing up their logistics functions. "In an international arena, you have a far more sophisticated logistics management team that understands everything from air to ocean to rail to port-related activities, customs clearance activities, regulatory issues and compliance issues, as well as the idiosyncrasies at the individual country level." Companies are also investing in more sophisticated visibility technologies to ensure they know where their goods are in the supply chain at all times and to boost their ability to respond to demand changes, for instance, by redirecting goods in transit.

For his part, Greg Aimi, research director for supply chain management with technology consultancy AMR Research, agrees that the decision to move toward a more global supply chain can have unintended consequences. "On the surface, the labor costs of manufacturing might be lower," Aimi says. "But let's say that the quality on your products drops by 20 percent. If I don't have quality, and my lead times are longer, I might wind up having to produce 30 percent more of the product. And then where is the quality being detected? Hopefully, it's not at the consumer level, because if you're a big brand and your quality has suffered, that hurts you in ways that you can't perceive or calculate right off the bat."

In general, Fung suggests that companies must take a more holistic approach in planning their global supply and demand chains. In practice, that means "disaggregating" the supply chain and ensuring that the different functions within the supply chain occur in the most advantageous location. "You take the entire manufacturing process and look at each stage and slice it," Fung said at the Longitudes conference. "At each stage, you're looking for best-in-class. You go to the best location and tie the whole thing back together again using [information technology] and logistics."