Offshoring, Near-shoring, Re-shoring: IP security in Offshore Manufacturing (An Australian Perspective)

Importing

In recent years Near-shoring and Re-shoring have become popular buzz words in the manufacturing arena. The concept of returning manufacturing to a local or proximally close vendor has become popular with both the media and the general public.

Near-Shoring

Using the Wikipedia definition, Near-shoring is defined as: “The transfer of business or IT processes to companies in a nearby country, often sharing a border with your own country, where both parties expect to benefit from one or more of the following dimensions of proximity: geographic, temporal (time zone), cultural, linguistic, economic, political, or historical linkages.”

Near-shoring is typically associated with the Americas or Europe where the landmass has a physical connection between the country of origin for the product and a lower cost manufacturing centre where manufacturing can be conducted in a similar timezone with reduced logistic complexities and communication issues.

Re-Shoring

“Re-shoring is the transfer of a business operation back to its country of origin.”

The concept of re-shoring became popular around 2010 with Apple releasing a statement that it planned to bring back some jobs to the US from China. With China’s mandatory 13% annual wage increases and the realization of many factory workers that their abilities are in demand pushing for further individual increases, the point where removing manufacturing from China to another base, becomes economically viable for US companies may not be far off.

The Australian Perspective

Being an island country, Australia does not have the capability to conduct near-shoring to any degree that would impact the economics of manufacture. New Zealand may be a candidate for near-shoring however with the minimum wage in New Zealand being only incrementally lower than Australia (Figure 1 – 2014 Minimum Wage by Country (AUD)), the added logistics cost and increased delivery time would typically not provide any benefit over local manufacture.

Unlike the US, Australian wages are significantly higher than the majority of countries in SE Asia such that the concept of re-shoring for economic reasons is not likely to be apparent in the foreseeable future. The minimum hourly rate in Australia is more than 8 times that of a Chinese worker and since we do not have the time-zone difficulties that Europe and the US have when dealing with SE Asia the discussion of re-shoring for Australia is typically centered around Quality Issues and IP Risk.

Figure 1 – 2014 Minimum wage by country (AUD)

Informed Decision Making

ACTUAL COST

Offshore manufacturing carries with it an abundance of additional costs that are not always apparent or disclosed to the buyer.

Typically the factory will quote the buyer an EXW or FOB price for manufacture of their item. The knee-jerk reaction can often be “Wow, look at all the money we are going to save here! It costs us $X to manufacture in Australia but these guys will do it for half that price (or less)”

Comparing the factory quoted price with your domestic manufacture price is giving an unfair advantage to the offshore manufacturer and not presenting a realistic situation for your real cost of goods.

1. Common Incoterms

Get to know the terminology if you are considering offshoring. Knowing exactly what is being quoted and what is being omitted goes a long way towards making informed decisions.

EXW = Ex – Works which means the vendor will deliver your product to their warehouse (typically in the same building) how it gets from there to your warehouse in Australia is up to you. You will need to pay for freight to the nearest port, container shipping, insurance, unloading, customs, GST, quarantine (if needed), duties (if applicable) and delivery from the domestic port to your warehouse. Make sure you take all of this into account in your pricing comparison

FOB = Freight on Board which means the factory will arrange delivery an loading at the nearest port. You still need to arrange container shipping, insurance, unloading, customs, GST, quarantine (if needed), duties (if applicable) and delivery from the domestic port to your warehouse. Make sure you take all of this into account in your pricing comparison.

CIF / C&F = Container, Insurance, Freight / Container & Freight which means the order will be shipped to your designated domestic port. You will need to cover all domestic costs such as unloading, customs, GST, quarantine (if needed), duties (if applicable) and delivery from the domestic port to your warehouse. Make sure you take all of this into account in your pricing comparison.

2. Yield

Yield of your production with an offshore vendor may be improved or diminished depending on how the manufacturing transfer has been conducted and the controls set in place with the vendor to ensure faulty products are caught and remedial action implemented prior to despatch. I have helped a customer go from 80% domestic yield to 99.9% yield with an offshore vendor so the transfer of manufacture does not always mean you will have a plethora of quality issues.

However the yield is anticipated to move from your current experience, you should include this in your calculations.

3. Transfer of manufacture costs

Relocating your manufacture to an offshore vendor is typically not as simple as sending a set of files and placing an order. The process requires significant micromanagement in early stages to ensure that you receive a product that is both to your design and expectations. As a bare minimum a representative from your company or consultant will need to be on-site for vendor auditing and selection, initial discussions and kick-off, Pilot, Pre-production and Volume production manufacture. Ensure these costs are factored into your assessment and finances prior to commencing.

4. Maintenance of the supplier relationship

Once you have started manufacture and successfully shipped products to your customers, you should still make the effort to be on-site with your vendor at least every 3-6 months. This time can be used to conduct ongoing audits, review costing and other supplier metrics as well as to maintain and build the relationship between your company and your supplier. The supplier should see you as an invested strategic business partner rather than an opportunistic buyer. Don’t fall into the pattern of only getting in touch when something goes wrong. Ensure these costs are factored into your assessment and finances prior to commencing.

Quality Issues

The manufacturing industry has an uneasy history with outsourcing to Low Cost Countries for cost reduction purposes. Too many times we see the case where a domestic manufacturer has made the decision to move offshore to reduce costs and finds that quality is down, yield is abominable and the product and company name emerges from the outsourcing venture with a seriously tarnished reputation. The blame is usually laid on the offshore manufacturer. Belief is common that these “emerging country” manufacturers are incapable of reproducing our design with the same specifications and quality of the domestic option or materials and processes are within these countries are substandard.

Anyone who has actually visited or worked with manufacturers in these countries and is knowledgeable enough to know the difference can readily dispel these myths. While there may be a few facilities that could be described as incapable or incompetent with shoddy work practices, these are facilities that would be immediately removed from the vendor selection on first pass if minimal due diligence practices are applied by the domestic company. The majority of manufacturers in these countries can no longer be described as “emerging” or start-ups.

The facilities of today have regular, compulsory Lean and TQC training sessions conducted for staff on-site and have extensive continuous improvement initiatives in place from 5S work practices to multiple trained and experienced 6σ practitioners as permanent staff. In short most offshore manufacturers now have extensive experience working with multiple customers, high volumes and products with a level of complexity and precision that is virtually unfathomable to the domestic competitor. These manufacturers often have the cash flow generated from their operations to continually update machinery to be compatible with the latest design innovations.

Taking the above into consideration the inevitable question arises, “Why do we see so many attempts at outsourcing manufacturing to an offshore vendor end bitterly with a detrimental effect on the company and brand reputation when there are so many offshore manufacturers that are clearly capable of at least matching the domestic capability?” In short this is a question that needs to direct focus towards the domestic company seeking to outsource instead of trying to lay blame on the usual suspects.

1. Sampling

Samples are manufactured for the vendors benefit more than for the benefit of the customer. Look at them as a sales tool, not a representative product. "This is what we are capable of producing!" does not translate to "We will always produce this for you!" A sample is usually handcrafted and hand-carried through the entire production process. Hour after hour spent making sure everything is perfect and the customer is bound to be impressed and move forward with ordering. The manufacturing, QC and testing is often performed, verified and rechecked by senior management to ensure everything is done to the customer's requirements.

This process would become ridiculously expensive if employed in a volume production situation. So they show you the perfect sample and quote you for the reality of production. The management steps back after sample approval and allow the floor staff (on a much lower salary) to manufacture your product. These staff are capable of manufacturing or they would not have a job, but they are paid to produce high volumes not perfect products. If you have not carefully documented those aspects that are critical you the success of the product, and visually ensured that the floor staff are capable of following these procedures "to the letter" in a volume production situation, you really only have done a partial due diligence.

You should be on-site when the manufacturer is completing your first volume order. See how it is done in reality and know what concerns need to be addressed when they occur. Don't sit in your office and wait 6 weeks for a container of future landfill to arrive on your doorstep. Offshore manufacturing is not a venture that you can run successfully 100% from the safety of your office, sometimes it is necessary to go "down to the trenches" to make sure the vendor is working with your best interest at heart.

2. Offshore manufacturing is not the domain of your purchasing officer

There is a section of the business community looking to manufacture offshore with the following philosophy:

“I just want to be able to place a purchase order and get my product, I want to hand everything over to the offshore manufacturer and not have to worry about it”

These are those with a foolish idea that they can effectively cull their domestic workforce from senior management to floor staff in one hit, retain their purchasing / procurement department and the offshore manufacturer will “fill in the blanks”. If you fall into this group then you should really abort the idea of manufacturing your own product designs and look at working as a trading company and re-branding the products from another company with you own name. As a designer, only you know how you want your product to manifest when it reaches the customer. You know what matters to your customer base and how best to satisfy these requirements.

Taking the attitude that you want to distance yourself completely from your own product is doomed to failure.

3. Tolerances

There is a lot to be said for keeping check on the work done by your R&D engineers.

Have critical areas of the product design been given tolerance levels for the manufacturer to work within? Or have you received a first item from a local manufacturer and then tweaked the design around the standard offering from this company without verifying how this fits into your original design. For a short lived project the latter may be sensible, if you can safely assume the supplier will not become insolvent during the life of your product and you will never need to consider changing supplier. However if you have a longer lifecycle for your products and at some stage believe that you may be looking for cost reductions through alternative suppliers, following this path will typically result in every other supplier(domestic or offshore) delivering non-conforming product because they do not have realistic parameters to reference.

Another issue is the problem of setting extremely tight tolerances for non-critical components. If your design does not require a 0.001mm tolerance level then do not specify this. Manufacturers will try to match the drawing and often will not question the validity of the specification. This results in the use of high precision methods to attempt to manufacture your product and often the inclusion of a very high mark-up on production price to accommodate for the anticipated quantity of product that will be rejected for being “out of tolerance”.

4. Know your products in every aspect

Those looking to offshore manufacture need to know every detail about their product: material types for EVERYTHING: packaging, print, testing, pass/fail criteria, how it all fits together and what the customer expects when they receive your product.

Too often we fall into the behaviour of telling our suppliers to use the standard material or make a recommendation. We pass control of these items onto a third party and then standardize on the delivered item without having an understanding of how we would replicate the product should we need to change supplier.

Knowledge of these specifics are more critical when looking towards offshore suppliers. Asking and offshore supplier to make a recommendation based on the local standard does not result in the same products in look, feel or quality compared to the local supplier.

Packaging in most LCCs is designed only as a mean to keep product together while it is packed on pallets and loaded into a shipping container. Product material for the local market may be of a lower quality to attract a wider audience in a country with a lower socioeconomic standard.

Ip Security

1. NDAs ( Non-disclosure agreements)

When considering offshoring, the first thing you need to consider is how are you going to protect your product and legal rights. Your supplier will typically provide you with an English name that they "operate" under for international clients. In many cases this name has no legal connection to the actual business registration and as such when inserted into a contract or an NDA is NOT LEGALLY BINDING.

To look at this issue from a different perspective: Suppose you have identified that your company "Bob's Design and Fabrication" has a strong potential market in Russia and you decide to start pursuing clients from this country. One of the largest roadblocks you encounter in the first case is that your business is not accepted as legitimate or as a preferred supplier due to the fact that when you submit quotations the first thing that your potential clients see is the foreign business name. To get around this you decide to translate your business name into the local language. To save on costs you simply input your business name into Google Translate and get "Боб проектирование и изготовление".

Your company now gains acceptance into the Russian market and you start receiving clients. A problem arises where you are legally required to compensate a client for faulty product. You don't agree with the assessment or you don't wish to honor the contract (not passing judgement here) and so the matter is set to go to court for arbitration. Your client is unable to litigate against an Australian company in Russia so they decide to take the matter into our domestic court system. They submit a claim against your company with the company name as "Боб проектирование и изготовление". This is not a registered company in Australia so the case is not heard. So they then try to reverse the translation back to English for litigation. The business name now becomes "Bob's Design and Manufacture" which is different to your business name "Bob's Design and Fabrication" and so without any further means to legally identify your company as the supplier, the case cannot be processed and the client loses his attempt to litigate.

Seeing the potential loophole in NDAs and contracts as highlighted in the preceding paragraph, the issue arises as to How can you protect yourself when you are dealing with a supplier from a non-English speaking country? The answer is actually reasonably simple: Legal documentation (Contracts, NDAs etc) need to be bilingual in both English and thesuppliers native language and need to identify the supplier's company exactly as it has been registered in their country rather than the name they have provided to you for ease of communication.

2. "Black Box" Manufacturing

If you are planning on manufacturing a product that is made up of a variety of subassemblies and components or has a unique programming step in the finalisation process then “Black Box” manufacturing offers a suitable method of ensuring the vendor/s do not obtain sufficient information to replicate your product in its entirety.

“Black Box” manufacturing essentially uses 2 or more vendors to manufacture components of the final product such that each vendor does not possess complete design information and is therefore able to reproduce the product.

“Black Box” manufacturing does not negate the need for an NDA and you will need to get an NDA in place with each vendor as per the above. In order to ensure there is a lower risk of collaboration between each vendor in the interest of replicating your product, your company should engage a trustworthy 3 party for logistics of sub-assemblies between each vendor to remove or reduce the level of transparency each vendor has regarding the origin of sub-assemblies. Although the logistics costs will be higher it is also suggested you do not use a single town / city in a single country for all vendors manufacturing your sub-assemblies.

Ensuring you add this level of difficulty to the process of discovering which vendors are manufacturing sub-assemblies will provide an additional level of protection for your IP.

3. Domestic finalization

Once again assuming your product is made of sub-assemblies or has a unique programming step in the finalization, the option to ship sub-assemblies to a domestic company for final manufacture / programming ensures that at least the most sensitive processes and information in the manufacturing process is kept in Australia.

The risk of IP theft is lower since the process to litigate against a local manufacturer guilty of IP theft is less complex than when working with an offshore vendor which tends to discourage offence.

4. Be more than an order number

Offshore manufacturing is 70% relationship management and 30% technical / risk management. I previously mentioned that in your cost evaluations you should also factor that you will be conducting site visits on a quarterly to half-yearly basis. This is as much to build a long term relationship with your supplier as it is to review pricing and other metrics.

If a supplier sees your order as only a PDF and a cash transfer and cannot put a face to the company that they are working with, they will tend to believe your company does not have significant care about the product or who is manufacturing it for you. This in turn can make your product a target for IP fraud (if the vendor is so inclined) as the chance that you will find out they are selling your product for themselves is reasonably low considering you have not visited the factory. They can also weigh this up against the low risk of litigation from an offshore company and the amount of time they are likely to have “free reign” on sales of your product through their own channels prior to being discovered.

The decision to conduct IP fraud will be economically and relationship based. If you visit the supplier regularly and build a trusting relationship with them, the risk of IP theft is reduced because: 1. The supplier knows you personally (and hopefully does not despise you) ; and 2. The amount of time they are likely to be able to get away with selling your product is quite low resulting in a lower potential gain from their actions.

5. Not all low cost countries are the same

Be selective about where you send your products for manufacture. Some countries trade based solely on the lower cost and expect you to accept the IP risk involved with manufacturing in their country. It is not always the best decision to “jump on the bandwagon” with everyone else offshoring and manufacture in the same country (warts and all).

As you can see in Figure 1 – 2014 Minimum wage by country (AUD), the minimum wage in several countries in the region is comparable. Some “up and coming” manufacturing destinations (e.g. Thailand) actively promote their policy on IP fraud and that the country is a safe destination for manufacturing.

Doing a bit of research into the benefits and risks of each manufacturing option can save a lot of stress and hassle later on.


Brian Le Mon

Brian Le Mon

Principal at EQP Optimsation Solutions

A lot of pondering and analysis of my work history brought me to the realisation that, in essence, the key to building and running a sustainable business can be distilled down into 3 main factors: EFFICIENCY, QUALITY and PROFITABILITY. As a result EQP Optimisation Solutions was born. Contact me directly on 0433 687 545 for a confidential discussion to discuss business mentoring or consulting solutions and how we can EQUIP your business for a profitable and sustainable future.

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Ling Lee

Ling Lee , at Digital Marketing and Personal Branding

Wow! Thanks for the really detailed article!