By: Rebecca Carnes, Design-2-Part
In 2004, Stan Hogrebe, president of Dazor Manufacturing Corp., made a bottom line comparison that many CEOs of product manufacturing companies have made in the past. As he looked at the dollar-to-dollar difference between the costs of parts in China versus the United States, his eyes lit up.
On paper, the savings by sourcing to China were significant, and with a background in finance and accounting, Hogrebe thought the decision was clear cut. “We needed to look for ways the company as a whole could pull costs out of the product, and one way was to outsource a number of the operations that we historically had in-house,” Hogrebe said, adding that about 60 percent of its production was converted to overseas. “I had to have a workforce reduction of about 40 percent, which was how we were able to pull costs out of the company in order to be competitive in the marketplace.”
But Hogrebe’s initial elation at the prospect of big savings soon faded, and along with it came the “problem that once you do that (go overseas), there’s not a lot of turning back quickly.” Once the initial orders were set in motion, the gears of production began 3,000 miles away and nearly half of Hogrebe’s workforce was let go. In fact, it took Hogrebe about five years to return production back to the United States after the Chinese price mystique quickly faded.
The first clue that China’s cheap prices weren’t going to be the saving grace for the company came when quality control testing at Dazor showed inferior materials were being used intermittently by the Chinese, and increasing product failures began to surface for the first time. “So we basically reduced the cost of the product by going overseas and, in doing so, we lost important component quality control,” said Hogrebe. “You can have materials tested at labs to make sure they comply with your standards, but many times when you get the lab reports back, it may or may not be a comparable material. Then you start to get rejects and quality-related issues, and determining who’s responsible for which costs is a constant battle. At the same time, you have to make sure you have the components on hand to produce parts and products to fill customers’ orders.”
Dazor (Dazor.com), in St. Louis, Mo., is a global manufacturer and distributor of professional-grade task lights, desk lamps, lighted magnifiers, and digital microscopes serving the industrial, medical, dental, jewelry, gemological, and laboratory research markets. Twenty percent of their business is sold overseas into China, Taiwan, Korea, India, and Europe, and the company generates about $10 million in annual revenue.
Discovering the Hidden Costs of Overseas Sourcing
When Hogrebe decided to send work to China, the “direct” cost comparison was a no-brainer, but what wasn’t readily apparent were the hidden, “indirect” costs that crept up and infiltrated the balance sheet. According to Hogrebe, the indirect costs associated with holding larger quantities of inventory, the constant communication issues, and noncompliant parts for which you may not receive credit are all significant variables in a total cost equation. So are the quality deterioration between approved samples and subsequent shipments, increasing price inflation, and the ability to make changes quickly. “After we took a hard look at all the cost variables involved, not just the quoted unit price, it made business sense to bring back a number of component parts—including our die casts, metal bending, extrusions, and even our painting processes—into the U.S.”
About 18 months ago, Hogrebe decided to dramatically reverse his decision to offshore by looking in his own backyard for domestic suppliers. Tired of making multiple trips to China, Hogrebe was happy to find Mark Preuss, sales engineer for Production Castings, Inc., an aluminum and zinc die caster in nearby Fenton, Missouri.
Preuss has gained some customers, including Dazor, who have been burned overseas, mostly by receiving inferior parts through what he calls a “first-batch syndrome” where the first order comes in acceptable, but subsequent orders quickly deteriorate. He has set up a website (www.productioncastings.com) that highlights his company’s capabilities, as well as the pitfalls of overseas work, and has even sent out a blog entry overviewing the complications of overseas sourcing to about 500 potential customers. Preuss stresses the fact that many times, CEOs—or purchasing managers pressured by bottom-line CEOs—make an accounting decision when turning to China, instead of a manufacturing decision. Then, the old adage, “You get what you pay for, and if you’re going to go the cheap route, you’re going to get something that’s cheap,” becomes true, he said. But when looking at the decision from a manufacturing standpoint, one can consider the obvious costs, such as freight duties, travel, and extra paperwork, as well as the complications of low-quality parts, miscommunication, frozen money, legal liabilities, and longer lead times.
Here are some reasons, outlined by Preuss in his blog, for potential customers to consider re-shoring or, possibly, to choose a domestic supplier in the first place:
- Costs of overseas travel
- Miscommunication issues
- Frozen money held in long term bank accounts when paying upfront
- Shipment costs and potential damage
- Substantial added paperwork
- Inventory storage costs
- Long lead times
- “First-batch Syndrome”
- Legal liabilities
- IP risks
“The short-sightedness of just looking at the dollar cost when China gives somebody a quote on paper looks cheaper, but nobody’s factoring in all those other overheads,” Preuss said. “And when you do a cost-value comparison, such as these Fortune 100 companies are doing now, they realize they’re spending a lot of money to get that casting from China, or that product from China, over to here. It’s coming back, but it’s slow because it’s hard for a lot of these companies to realize that they made a sourcing decision that was wrong.”
The decision to re-shore was made easier, said Hogrebe, because the cost gap is shrinking while domestic suppliers are delivering higher-quality products with more efficiency due to innovation advances during the past several years. The price gap has narrowed, he said, due to rising Chinese labor costs, rising overseas materials costs, and overseas transportation costs. But also sweetening the deal are advancements by domestic suppliers.
“They took the opportunity to automate and get better at what they’re doing. Domestic suppliers have become more efficient by focusing on their core competencies, and, as a result, have increasingly become very cost competitive comparing total cost of ownership. And when you start to factor in the convenience and efficiency that I can drive an hour or less to meet the owner of the company to discuss any issues or design-related changes, the value of that is something that you don’t immediately see on the balance sheet. But it is in the operation and eventually makes its way onto the balance sheet. Proximity is a big factor, and so are communications and the ability to make changes on the fly. The cost accumulation of all these factors have made domestic outsourcing, in comparison to outsourcing overseas, clearly cost justified in our situation,” Hogrebe said.
While labor intensive work, such as decorative castings that have to be buffed by hand, is where China has the advantage, Preuss said that the die castings his company produces can stay quite competitive with those made in China. “We’ve automated all of our equipment here. All of our die casting machines are robotically controlled, and we don’t have a lot of labor in our castings. When the cost of labor is removed from our process, China can’t compete against that. So it’s products like ours that they’re looking to bring back here. It makes us [more] competitive price-wise, and it makes us much more efficient and provides a better quality part. Since everything is automated, you have better process controls in place to prevent producing defective products. By the time you factor in duties, freights, and all the overhead to procure parts, we’re a bargain compared to China.”
Word Spreads About Hidden Expenses
Preuss said he is starting to see a trend with product manufacturers realizing the hidden costs and problems with doing business overseas. Just recently, he was meeting with representatives from a Fortune 500 company looking to re-shore their castings to his company due to delivery and cost increases, as well as quality problems. A recent net present value (NPV) analysis of changing suppliers from China back to the U.S. reportedly showed that the value of future cash flows minus the purchase price wasn’t to their benefit.
“When he (the representative) looked at a three-year NPV, we were a better bargain than castings from China when considering freight, increased inventories, duties, and engineering costs,” said Preuss. “This man literally spent eight months this year in China working out problems with his supply chain there and trying to fight cost increases, and he’s fed up with it. He’s tired of managing the Chinese programs. He said they’re looking to bring 30 to 40 percent of business back to the United States.”
There’s a lot of potential business out there from product manufacturers who are trying to decide whether or not to go domestic, Preuss said. “There’s a lot of business to be gained that way. We are basically a one-stop shop, so we can do everything when a customer comes to us, from concept, to build, to design, to manufacture. We can do it all. That’s not necessarily the case in China.
“So my big selling point is that when you have experts on staff here, you don’t have that in China,” he continued. “It may run through four or five different factories in China before you get it, so there’s so much room for error. The big thing I tell people is that there’s less opportunity for it to fail with us, and we’re close. We’re always trying to bring back to North America what left, because I don’t think they’re getting as good a product. And when somebody actually rationally sits down and analyzes all the reasons why they left and realizes what they’ve been through, it’s really easy to convince them to come back.”
Hogrebe has brought back about 90 percent of his offshored parts, only leaving items such as fluorescent light bulbs, which are not being produced domestically. When looking for a domestic supplier, he said, proximity and the ability to deliver in a timely fashion while maintaining the highest quality are all key factors. Hogrebe said he did a lot of hands-on interviewing, touring facilities, making sure he understood the operation, and getting a sense of their current capabilities and what the domestic supplier will be able to do in the future.
“We look at their processes, we actually go on site, walk through the factory, and look at the shop floor itself. Is it clean? Is it organized? I work with the owner, talk to the owner, tour the facility with the owner, and have him explain the machinery that they have. I also have him explain what their continuing plans are for keeping costs down in the future, so that once you enter a relationship, six months later you won’t see an escalation in price other than what you would anticipate as ordinary and customary in the materials commodity markets.”
A big concern for Hogrebe when dealing with his Chinese supplier was the poor quality of the materials being used and, as a result, certain die castings were breaking. When the materials were being tested for alloy composition, the materials differed from shipment to shipment. Some castings would come in with very poor ductility and simply broke, causing the final product to have damage during shipping—all due to the casting. The poor quality from China was beginning to cause concern among certain customer accounts, he said.
“But with Production Castings, I know when I talk to Mark Preuss and look at their facility and what they represent that they’re going to use as a component material or an alloy, I have high confidence that that’s what’s going to be used [from] shipment to shipment,” Hogrebe said. “Whereas, the Chinese or other sources overseas may try to cut costs and, not knowing where a component will actually be used in a final product, they don’t know or care what potential damage could come from that. The Chinese are very good at making a part look the same, but it very well may not perform the same.”