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FACTS NOT FADS: Taking a second look at outsourcing to China

ChinamanufacturingWasn’t it was just thundering Scottish-accented leftist manufacturing union officials, NCC-ers, Larouchites and talkative wackos with halotosis at ALP branch meetings who were pre-occupied about the location of manufacturing?

It made and makes perfect sense for companies to keep the high-value parts of their operation where the best-trained, smartest product designers and innovators were and to outsource their grunt work to cheaper places that could do the manufacturing and ship it back for sale. 

But like every fad – and offshoring has been the biggest trend in US and Australian manufacturing in the past twenty years – it might have gone too far and hasn’t always been rigorously tested as economically smart in the short or long term.

In the United States, electrical equipment conglomerate power-house GE has revived its nearly mothballed and flogged-off Appliance City in Kentucky (the home of KFC) because outsourcing to China:

■ involves substantial risk of the product being counterfeited;

■ is more expensive than it used to be because oil prices have soared, taking cargo-ship fuel prices with it;

■ has caused wages in China to skyrocket, with wages five times what they were fifteen years ago, rising 18% per annum.

The Atlantic tells the interesting story of GE’s GeoSpring heater and why they decided to shift production of it from an outsourced factory in China with which they had little interaction to their own facility they own and control.

That decision prompted a burst of innovation as Charles Fishman in the Atlantic explains:

To get ready to make the GeoSpring at Appliance Park, in January 2010 GE set up a space on the factory floor of Building 2 to design the new assembly line. No products had been manufactured in Building 2 since 1998. An old GE range assembly line still stood there; after a feud with union workers, that line had been shut down so abruptly that the GeoSpring team found finished oven doors still hanging from conveyors 30 feet overhead. The GeoSpring project had a more collegial tone. The “big room” had design engineers assigned to it, but also manufacturing engineers, line workers, staff from marketing and sales—no management-labor friction, just a group of people with different perspectives, tackling a crucial problem.

“We got the water heater into the room, and the first thing [the group] said to us was ‘This is just a mess,’ ” Nolan recalls. Not the product, but the design. “In terms of manufacturability, it was terrible.”

The GeoSpring suffered from an advanced-technology version of “IKEA Syndrome.” It was so hard to assemble that no one in the big room wanted to make it. Instead they redesigned it. The team eliminated 1 out of every 5 parts. It cut the cost of the materials by 25 percent. It eliminated the tangle of tubing that couldn’t be easily welded. By considering the workers who would have to put the water heater together—in fact, by having those workers right at the table, looking at the design as it was drawn—the team cut the work hours necessary to assemble the water heater from 10 hours in China to two hours in Louisville.

In the end, says Nolan, not one part was the same.

And what happened next could have massive implications for the assumption that all manufacturing should be offshored to the cheapest and nastiest place possible:

So a funny thing happened to the GeoSpring on the way from the cheap Chinese factory to the expensive Kentucky factory: The material cost went down. The labor required to make it went down. The quality went up. Even the energy efficiency went up.

GE wasn’t just able to hold the retail sticker to the “China price.” It beat that price by nearly 20 percent. The China-made GeoSpring retailed for $1,599. The Louisville-made GeoSpring retails for $1,299.

As explained earlier, many have long thought that it makes perfect sense – and is a good thing for the world – where possible to outsource labour intensive activities to the cheapest possible places capable of doing the work. But we have not thought much about one consequence that the head of GE’s product design highlights:

For years, too many American companies have treated the actual manufacturing of their products as incidental—a generic, interchangeable, relatively low-value part of their business. If you spec’d the item closely enough—if you created a good design, and your drawings had precision; if you hired a cheap factory and inspected for quality—who cared what language the factory workers spoke?

This sounded good in theory. In practice, it was like writing a cookbook without ever cooking.

Lou Lenzi now heads design for all GE appliances, with a team of 25. But for years he worked for Thomson Consumer Electronics, which made small appliances—TVs, DVD players, telephones—with the GE logo on them. Thomson was an outsource shop. It designed stuff, then hired factories to make much of that stuff. Price was what mattered.

“What we had wrong was the idea that anybody can screw together a dishwasher,” says Lenzi. “We thought, ‘We’ll do the engineering, we’ll do the marketing, and the manufacturing becomes a black box.’ But there is an inherent understanding that moves out when you move the manufacturing out. And you never get it back.”

It happens slowly. When you first send the toaster or the water heater to an overseas factory, you know how it’s made. You were just making it—yesterday, last month, last quarter. But as products change, as technologies evolve, as years pass, as you change factories to chase lower labor costs, the gap between the people imagining the products and the people making them becomes as wide as the Pacific.

What is only now dawning on the smart American companies, says Lenzi, is that when you outsource the making of the products, “your whole business goes with the outsourcing.” Which raises a troubling but also thrilling prospect: the offshoring rush of the past decade or more—one of the signature economic events of our times—may have been a mistake.

Offshoring was a fad, based initially on a sensible idea that became increasingly less subject to rigorous analysis, with time.

Our economic history is riddled with fads, bubbles, manias and booms. The most important thing you can read on that (and annually re-read) is the long since out-of-copyright “Extraordinary Popular Delusions and the Madness of Crowds”. It reminds us what we should know already but always forget, herd mentalities can quickly form in human thinking and when applied to markets can lead to very strange outcomes. Outsourcing every possible bit of manufacturing to very-distant cheap-labour economies has been a bubble that originally made sense but has inflated to an irrational bursting point.

GE is one of the greatest, biggest companies in the world. It outsources to China many billions of dollars of products. But it’s recognised it went too far, making too many assumptions that weren’t tested with facts, and is clearly going to build on its crazy experiment with local manufacturing and do a lot more of it, making more money than they would, mitigating counterfeiting risk, giving local workers jobs and driving innovation in ways that wouldn’t otherwise have been possible.

This is not just an American story, although it’s terrific to read of that great country getting back on its feet after an agonisingly painful GFC.

Australian manufacturing faces similar challenges. And similar opportunities. Those running Australian companies and policy makers need to think very carefully about GE’s Lou Lenzi said about the lost knowledge that results from outsourcing manufacturing.

Globalisation has been a tremendous force for good. But to the extent it costs us knowledge and the capacity to innovate it has gone too far and needs to be subject to data-driven rigour. It’s not just short-term jobs we risk but our long-term future too.

Let the new fad of insourcing commence.

 

 

 

Discussion

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  1. Good to hear just need a simpler to read version for newpapers

    Posted by Malvern | December 2, 2012, 19:52
  2. Great post!

    Look forward to inshoring in Australia

    It doesn’t address the Australian incentive to offshore ie offshoring allows the manufacturing company to sell the low priced product to a shell company in a low tax country which onsells the product to the end destination at a high price so the profits are taken in the low tax environment

    Posted by billie | December 3, 2012, 10:09
  3. Or you could just post a link to the Atlantic website.

    Posted by Anonymous | December 3, 2012, 18:24
  4. I seem to have woken up in bizarro world where Conroy and Vex all of a sudden pretend to care about internet freedom and offshoring. There must be an election on the way.

    Posted by chris | December 3, 2012, 18:57
  5. Excellent article VEX and thanks for the link. I’ll be passing it on.
    I’ve worked for several firms who used Chinese manufacturers and all had quality issues. The melamine milk scandal of 2008 may have been the red flag (sorry couldn’t resist) that marked the beginning of the end for Chinese industry: if they were willing to poison the milk their own children drank, why would they give a rat’s rear end about anything they made for us white devils?
    China’s presumed status as the new superpower for the 21st century’s superpower may need reassessment.

    Posted by Gregoryno6 | December 3, 2012, 20:59
  6. A good article, apart from that last bit suggesting that we might start manufacturing in Australia again. Unlike the US, Australia never had a viable manufacturing sector, it always relied on tariff walls to survive. There is no real market here or anywhere else for Australian cars, TVs, or laser printers. The Hills Hoist is pretty much the beginning and the end.

    Posted by rubberduck | December 4, 2012, 7:45
  7. Well, I own one of these Geo Spring first Generation models. Myself along with many- many others have had the misfortune of having system failures. The parts that they are sending us are from the US manufacturing site. GE did not” bring good things to life” with this water heater!

    Posted by MargoC | December 4, 2012, 9:04
  8. An interesting article, and one that demonstrates that low-cost manufacturing of high-quality (with low production waste) products are a rare commodity in China. I’ve seen first-hand the shocking working conditions in Chinese factories and the tendency for even those factories to do their own out-sourcing to a mate’s dodgy workshop down the road!

    But American manufacturing still has a lot to learn. Just google “Ford Fusion Fire Recall” and you’ll get my drift…

    Posted by Fred | December 4, 2012, 12:17
  9. Red China is a menace to freedom. A wealthy Red China is a well funded menace to freedom with the means to enslave citizens over an extended geographic area.

    Stupid white businessmen make Red China rich. Stupid white businessmen don’t care about freedom. They are autocrats as CEO’s and prefer to deal with autocratic corrupt regimes because they are easier to manipulate to their own selfish ends and they sense kindred spirits.

    If stupid white businessmen had the foresight that Thatcher and Reagan and John Paul II had in the 1980′s in relation to the Soviet Union, we would have been rid of the communists in China in the last few years of the 20th century or the early years of this century. Instead they have created a voracious monster much more threatening than the USSR because it is so much more closely linked into our economies – in particular Australia’s.

    The USA could easily ditch China as it has a trade deficit with it. We rely too much on Red China as we run a trade surplus with it and so much of our mining led economic growth is dependent on them continuing to buy from Australian located firms (many of which they effectively own or control).

    Posted by Giuseppe De Simone | December 4, 2012, 19:06
  10. If only we can stop union rorts, extortion and featherbedding killing jobs in Australia we will see the repatriation of Australian jobs. Australian unions are strangling the car industry which is headed offshore within the next decade to escape their clutches. Only government handouts are keeping the car industry temporarily afloat. The only way to save the Australian car industry would be to free it of the union stranglehold.

    Posted by Tom | December 5, 2012, 9:33
  11. i find it hard you believe that you are blaming unions Tom. Self proclaimed working class hero dean Mighell was going to import clothing from China a number of years ago. ask Michelle Oniell how good this was for her claims to get more money for her members. so dont blame unions, buisnessman Migheil was trying his best to make more cash and free the textile industry from the union stranglehold you talk of. you moron !

    Posted by tom2 | December 6, 2012, 4:50
  12. Tom2 I am a working class hero. pay no mind to my own organisers who are out there calling me a dog along with everyone else. Take it from me I am a big fat Hero

    Posted by Dean She-Mighell | December 6, 2012, 8:02

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