Managing offshore outsourcing

Almost every major U.S. furniture company is purchasing finished or semi-finished products in Asia. Many are buying from foreign-owned factories. Some are building their own factories. Combined, the migration of manufacturing from the United States to Asia has been compared to the industry shift from my hometown, Grand Rapids, Mich., to High Point, N.C. It is an accelerating change that is affecting every corner of the home furnishings industry - design, marketing, manufacturing, distribution and retailing. Within each enterprise the changes raise operational, legal and financial issues.

What are the issues that might concern companies when they begin this process or, further down the road, when they want to fine-tune? I have seen and experienced some of the horrors. Then I studied professional remedies on the job and in the classroom. And, I have survived to experience success.

Here are a few points worth checking before launching an outsourcing or import program. Reviewing the basics periodically is also good practice, especially for managers who aren't involved on a day-to-day basis. This list might also be a reasonable way to evaluate a company's overall success in offshore resource management.

1. Design - Design standards travel. Even though it's often left in the dust in the race to find labor cost savings, good design is arguably the most important fundamental. Design integrity will increase the opportunity for profit. Unique design sustains the gross margin compared to "me too" design, which fails to provide a reason to pay. Matching design to resources will directly affect manufacturing costs and customer satisfaction.

Today, there are not many barriers to complexity, material or finesse. Some overseas manufacturing centers are better suited to mass-market products, while other areas have nurtured a cadre of highly skilled furniture craftsmen.

But the core issue is communications and matching of resources. For example, two-dimensional drawings are often misunderstood, even by experienced prototype builders. The communications problem is magnified overseas. So it may be worthwhile to have foam half-models made from CAD programs if the product has unusual three-dimensional forms. It is also good practice to have more than one source available, so that designs can be matched to resources. Failures occur when a design concept is forced into an operating facility. It's the round peg in a square hole problem.

Integrating the design and the designer into the entire process provides many opportunities for higher margins, a smooth prototyping process, fewer manufacturing issues and more efficient shipping. Even though the decision to source products offshore may be driven primarily by cost benefits, the designer's perspective is still critical to the ultimate success of the venture.

Furniture manufactured efficiently overseas can win design awards, drive sales growth and provide especially high gross margins . . . all at the same time. Good design is good business, and good design benefits everybody.

2. Quality - For many years the Asian furniture products that managed to get into U.S. distribution were often inferior to domestic products. Design was clumsy, wood was improperly dried, joinery was often badly engineered, craftsmanship was crude and packaging was primitive. Even the content of basic materials, such as aluminum, could not be taken for granted. These problems still do exist in many Asian factories. But some companies have solved these issues. Even the most respected brands in the country are manufacturing in Asia. Good design can happen in Asia.

The issue is: How does one select a quality source and then how can consistency be maintained? The answer is, the inspector. The inspector may be an agent, a purchasing manager, a plant manager or a specialized person hired just for the purpose. Too often, the function is taken for granted. It is good practice to know who the on-site inspector will be, who pays him and how often and how carefully the inspections are conducted.

3. Price - The difference in the cost of manufacturing between the United States and Asia is compelling. There are also differences between the underlying costs in different countries. For example, Vietnam is emerging as a relatively new source of efficient and highly skilled labor. But chasing the lowest-cost source isn't as important as developing comprehensive professional relationships with good business people. How do you know you're getting the right quality at the right price? Who is doing the research? How is your research person compensated?

4. Delivery - The normal problems of schedule changes and transportation delays are magnified in foreign trade. Careful selection of a freight forwarder is a critical step in setting up an offshore outsourcing system. The freight forwarder is responsible for arranging fast and efficient transportation, including air, sea and land bridge arrangements. It is good practice to periodically interview three different firms. A regional world trade center can help identify candidates. International bankers are also good sources for leads to this type of resource.

5. Gross margin - Companies that are getting started may underestimate the gross margin required to cover all of the costs of a properly managed import program. It's very hard to raise prices after the products are in distribution. Management and warehousing are significant cost issues. The gross margin in offshore resourcing may need to be higher than the gross margin from internal U.S. manufacturing operations.

6. Customs - Is the company able to handle the technical aspects of customs clearances? The process cannot be entrusted entirely to a customs broker. A carelessly orchestrated shipping and customs process can add two weeks to delivery intervals. The days and weeks that are often lost in this process exacerbate financing costs and aggravate customers. Customs clearances can be started while ocean freight is still on the water, pre-cleared for arrival. Every manager involved in the process, from top management on down, needs to know the five basic documents required for customs clearance.

7. Terms of payment - The original contract will specify terms, and this can easily decide the ultimate success or failure of the entire project. Some terms, such as those requiring an irrevocable letter of credit (ILC) before manufacturing begins, can have a very injurious effect on the buyer's access to capital. For leveraged companies, signing an LC is just like signing a check. What are the most common terms of payment? Are letters of credit the norm? Will offshore sources sell on-account? The answer is that most import trade is done on-account. But if that isn't acceptable, there are several other options that don't drain financial resources as much as an LC. There's a new electronic financial tool called an international trade acceptance draft that might suit both partners.

8. Duty drawbacks - Is someone checking on this opportunity to recover duties paid on imported parts? If the company is exporting some products that include parts, which were originally imported to a U.S. assembly point, there is a system of recovering the duty, which was originally paid on the imported parts.

9. Manufacturing ethics - Top management needs to take responsibility for oversight on this issue. Will the company be supporting sweatshops? Is it ethical to support foreign businesses that pay their workers a fraction of our U.S. minimum wage? The answer is that there are a few very good, and also some very bad, employers in Asia. Many Asian export factories provide workers with substantial financial advantages, and some provide educational opportunities. It is worthwhile and prudent to take an interest in this aspect of the relationship.

10. INCO terms - Everyone who needs to know must understand the INCO terms - terms issued by the International Chamber of Commerce. Because of the underlying legal and financial implications, terms (and abbreviations), such as Ocean Bill of Lading, Free Alongside (FAL), Duty Drawback, Non-Vessel Operating Common Carrier (NVOCC), must be explained to people who work in purchasing, transportation and finance.

11. Support agencies - What organizations and government agencies can help? Exporting is controlled by the U.S. Department of Commerce. Importing is controlled by the U.S. Treasury Department. Our government is particularly interested in bringing manufacturing business into the United States, so the Department of Commerce has established a remarkable Gold Key program that can open important doors to export. Sixty percent of the containers that arrive on our shores go back empty. There are opportunities to foster an expanded international awareness within the company that works both ways.

12. Global risk - A good way to reduce the rumors and sporadic news events to a workable business tool is to subscribe to a responsible information service.  Political Risk Services deserves consideration. The lowest-cost way to get some of this type of information would be to subscribe to  Global Business , a free monthly business magazine.


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About the author
John Aves

John Aves wrote a monthly column for FDM and FDMC magazines on the furniture industry, furniture design, and international trade.