The Corporate Illogic of Outsourcing and Offshoring

[TexasTowelie]

You must go, now, and read a critically important piece questioning the logic of sending American manufacturing jobs offshore. It’s titled Losing Sparta (hat tip Dikaios Logos) by Ester Kaplan in VQR. We have written regularly about how we have been repeatedly told by managers and executives that the case for offshoring was often not compelling, particularly when risks, such as higher financing and shipping costs, exposure to foreign exchange losses, and inventory risk were included. This makes perfect sense when you consider that for most manufactured goods, factory labor is a mere 10-15% of total wholesale cost, and any savings in factory labor will be offset by higher shipping and greater managerial costs (more coordination, performed by much more highly paid workers). It is thus more accurate to regard a lot of offshoring as not being about cost savings, but a transfer from ordinary workers to managers and executives.

The article focuses on a world class manufacturing plant in Sparta, Tennessee, owned by Phillips that made florescent light bulbs. The workers were highly dedicated and strived to implement continued improvements in productivity. Factory pay was $13 to $15 an hour, which were good wages for that area, particularly since it included several weeks of vacation and excellent health care benefits. From the story:

Employees stuck around for years, knew their jobs inside and out, and had a rare esprit de corps. When they faced tight deadlines, fabricators would volunteer to come in as early as 4 or 5 a.m. so they could get a head start before the paint crew arrived at six. In December 2009 the Sparta facility was named by Industry​Week as a Best Plant of the year, one of the top ten in North America. In the months that followed, it won Best Plant within Philips’s global lighting division as well as the firm’s global “Lean Challenge.” That summer, plant managers invited state officials and legislators to Sparta to celebrate.

Yet Phillips decided to shutter the plant in 2010. It was impossible to get a straight answer out of Phillips and the explanations offered for moving production to Monterrey, Mexico, did not add up. And the article points to the broader mythology, that if Americans only compete better, worker will do better. Sparta, and overall statistics show that to be a myth. One of the most striking and often-shown charts is how productivity gains stopped being shared with workers around 1976.

But why shutter a plant that continued to wring more and more performance out of its workers? Consider:

This “engaged workforce,” in the words of IndustryWeek, had hiked production on some lines by more than 60 percent, cut changeover time between small orders by 90 percent, and reduced the number of defective parts by 95 percent, making the plant one of the most productive in America.

More at http://www.nakedcapitalism.com/2014/07/corporate-illogic-outsourcing-offshoring.html .

[Demeter]

1. My suspicion

not just union-breaking, but dissing the workers who refused to produce crap that broke and was dangerous if used as directed.

After all, if you are the one, or your child, who would be injured, you would refuse to cheapen a product to order.

[Mopar151]

2. Been through something a bit like this myself.

Likely has to do with 2 things - some kind of chargeoff/writedown play that boosted bottom line, and executive jealousy/contempt for the workers, precisely because they were decently paid and "engaged".

[laundry_queen]

3. It never ceases to amaze me

how few people pay attention in business school. I'm one of those nerdy types that remembers almost everything I'm taught at school (my kids love asking me for homework help, because I remember everything) and this kind of stuff was severely emphasized in my classes. First of all, many exec's compensation is not balanced properly - which means it's almost always in their financial interest to sacrifice the long term outlook of their company to short term gains. The conventional wisdom is that stock options balance the whole 'profit sharing' and 'bonus' mentality, but with uneducated speculation driving stock gains (as mentioned in the article that when they offshore, stock prices go up) this is no longer working. Companies have to come up with new ways to compensate execs that are in line with the long term health of the company. Again, 'health of the company' not health of the stock prices.

It was also drilled into our heads that when making a big decision we must consider ALL costs. Not just immediate costs. So, for instance, if a company wants to offshore, they have to consider not just what are transportation costs now, but what might they be in the future? What if gas prices go up? How high do gas prices have to go before moving production is no longer profitable? now, do that same analysis for everything - quality control, training new workers, monitoring of overseas operations, risk of natural disasters (after the 2004 Tsunami, many companies lost product in their plants in Indonesia), risk of PR disasters due to poor worker conditions (and costs of monitoring those conditions as well as predicted costs of risks like a building collapse) etc. So many execs think, "labor+shipping is cheaper than production here" and don't go much further than that (because it helps their personal bottom line).

We did a lot of case studies on corporations that made the decision to offshore and regretted it. In many cases, it ended up costing them more in terms of warranties, shipping and PR.

Good article, thanks for posting it.

[Mopar151]

4. Thank you for the excellent post

I'm a shoprat - somebody hadda explain double-entry bookkeeping to me once, and I had to lie down in a dark room.......
I did learn a lot about finance from a smart plant manager I used to work for - and he was big on MANAGEMENT OF DOWNSIDE RISK. I would advocate all day long for some sort of index of this stuff right in the SEC-spec. P&L statement.

[Romulox]

5. There's nothing special about a lightbulb plant. Come visit Detroit, and explain why

"this time, it's DIFFERENT!"

[antigop]

6. someone should tell that to Hillary "outsourcing will continue" Clinton and Bill (GATT, NAFTA) nt