China has long had a reputation for low cost manufacturing and many UK companies have tried to cut costs by getting components or products made by Chinese manufacturers. However, warns Dr Ken Platts of the Institute for Manufacturing (IfM), the savings may be much less than you think.
For many years China has been seen as the place to get things made cheaply. Western companies, trying to cut costs and remain competitive in increasingly cut-throat global markets, have seen manufacturers in China and other developing economies as the answer to their problems.
However, while the quoted cost for making a component or product may be less than it would be in the UK, research carried out at the IfM shows there are additional costs which can add an average of 50% to the total bill. The cost of these extras is likely to be significantly underestimated by the companies concerned.
The IfM research is the first attempt to try to capture all the costs involved in sourcing goods from China. The project carried out six in-depth case studies of UK companies who have sourced products or components from Chinese firms.
The companies studied ranged from a high-tech printer manufacturer with a turnover of £190 million to an electrical control panel business with a turnover of £2.5 million. Some companies were looking for Chinese manufacturers to make whole products, others just wanted individual components, some form of assembly or a combination of the two. The main driver for considering outsourcing for all the companies was to reduce their costs.
The project came up with a list of 14 set-up costs – one-off expenses which may be required at the start of a deal. The most significant of these were staff time and travel costs involved in researching and visiting potential suppliers.
The research went on to quantify 35 ‘ongoing’ costs, over and above the quoted price for supplying the product or component. Two of the most significant of these were the transportation and insurance costs involved in bringing the goods all the way from China to the UK. The figures varied from company to company, but for one of the companies studied the costs amounted to nearly 16% of total ongoing expenses.
Concerns about quality of the goods made in China were behind some other additional costs. The MDs of two of the case study companies felt they needed to travel to China in person to inspect the quality of the products before they were shipped to the UK.
Warehousing was another source of extra costs. Companies stored more stock in the UK as a safety buffer against possible transport problems getting goods from China. Additional stock was also held due to the larger order quantities needed to get prices down. For one company, warehousing represented as much as 18.8% of the cost.
Taxes, technical support, handling complaints and quality failure were some of the other areas where companies experienced significant extra costs.
Some costs were only felt by a few companies but represented a particularly nasty shock for those concerned. For example, the company that needed to unexpectedly expedite an order from China was faced with a much higher bill than if the goods were simply coming from the UK.
All in all the detailed analysis obtained from the case studies indicated that the additional costs added an average of 50% to the original quoted price. However there were very large variations. The best case showed that the additional costs added only 14% to the quoted price, whereas in the worst case, the final cost was four times the quoted price.
The project went on to compare these figures with how much companies thought it cost them to outsource goods from China. A mailed survey revealed that most companies underestimate the add-on costs involved by a significant amount. While the case studies showed an average add-on cost of 50%, the perception of the companies surveyed was that they only added an average of 25%, again with a large variation. It is clear from this that companies are significantly underestimating the costs involved and they need to be much more
thorough in identifying the true costs of overseas outsourcing.
Although the research was based on companies that outsourced to China, we believe that the findings might be equally applicable to other overseas outsourcing for example India, Thailand or Vietnam.
• Dr Ken Platts is a Cambridge University Reader in Manufacturing and Head of the Centre for Strategy and Performance at the Institute for Manufacturing. Click here to download a report about this research. http://bit.ly/pu27Z2