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Higher Value for Higher Priced Employees November 22, 2013

Posted by Tim Rodgers in International management, Product design, strategy, Supply chain.
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You can complain about it, but offshoring is not going away. Businesses will always look to reduce cost, and wherever there’s a significant difference in labor cost, that difference is going to attract interest. I’ve spent almost my entire career working at companies that have moved their supply chain and production factories to locations that have lower labor cost. For manufactured goods this savings must be weighed against other expenses to determine whether there’s a net gain, such as shipping costs and finished goods in-transit. For knowledge work where there’s virtually zero cost to instantly move the output from one part of the world to another (such as software), the advantage is even greater.

You can complain about it, but if you want to justify a higher cost of labor in one part of the world, you have to demonstrate that this labor provides higher value. The added cost must be offset by some benefit, ideally something that can be quantified. It’s important to distinguish between sources of higher value that are fundamental and relatively stable vs. those that can be eroded over time.

Here are some examples:

1. “We know how to do it here, they don’t know how to do it there.” Your design team, and factory, and supply base may be well-established in one location, but you’re wrong if you think that can’t be replicated somewhere else. There are smart, well-educated people all over the world, and it’s easier than ever to access their skills, especially for knowledge work. There will be training, start-up, and switching costs, and those will have to be evaluated against the steady-state labor cost savings, but it’s not impossible.

2. Cost of quality. This is related to #1 above. You may be able to produce output at a different location with lower labor cost, but does the quality of that output lead to additional expenses later, such as rework, field repair, and loss of customer loyalty? These can be addressed with specific improvement plans, depending on the causes of poor quality, and are not necessarily permanent conditions. As above, the costs to improve or maintain quality at any location should be compared with the labor savings.

3. Geography. This is an example of a more fundamental difference that may justify higher labor cost. Many businesses benefit from close physical proximity to their customers, enabling them to respond quickly to changes in market demand and mix without the burden of a long finished goods pipeline from their production sites. A hybrid approach is late-point differentiation where platforms are built ahead at low cost and later customized depending on the specific order. Another benefit of geography is co-design, where frequent, real-time interaction with customers leads to a better fit to their requirements. Some companies will overcome this one by using available technology to communicate with remote teams, or performing rapid prototyping locally to verify the design before shifting volume production elsewhere.

Note that geography can also be an overriding factor when there are political or economic barriers, such as regulatory or “local content” requirements.

My point is that if you insist on doing the work in a location with higher labor cost, you can’t assume that the corresponding value will always be worth the higher cost. Your survival as a business depends on your ability to identify, develop, exploit, and maintain a source of competitive advantage. Your choices about labor cost and geographic location should support your strategy to maintain competitive advantage, and that strategy should be regularly reviewed and updated to make sure you’re getting the value your paying for.

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Comments»

1. Happy Holden - November 22, 2013

Very well written Tim!
I agree- For too long Americans had it easy because the rest of the World was recovering from Wars or were still in a “Developing” state. But they learned from the USA that Education was the KEY to a higher standard of living. First by sending their best students here to learn at our Universities, then by improving their own Education Infrastructure. Now their own Universities can offer those Graduate Degrees and don’t need the US.

So now-on a Global Basis- we face competition if the tasks can be done by normal workers and engineers. The US MUST FOCUS on “Very HIgh Value-Added” that foreign entities can’t match.

Rememeber-They seem to have better banking and financing than we do – (easier to get money for new ventures) and a willingness to take RISKS, while we seem to have abandoned manufacturing and other activities.

Tim Rodgers - November 22, 2013

Very good points. This reminds me of an article I saw almost ten years ago, possibly in Fortune magazine. The writer suggested that the US held two important advantages over the rest of the world with regard to spawning new businesses: (1) transparent financial markets and access to money, (2) an entrepreneurial culture that encourages risk taking. You need both, and the writer didn’t believe that combination could be found elsewhere in the world. I’m not convinced that’s true.


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