Doctor's Note (August): Managing Outsourced Manufacturing Operations

Last month, Invista, one of the largest producers of polymers and fibers, announced that it was entering the engineering polymers business. While Invasta is well positioned to make the nylon 6.6 itself, it will use a number of toll manufacturers (contract manufacturers) to compound the products.

The strategy to outsource parts of manufacturing is not new. The semiconductor companies commonly outsource operations like assembly and test, and in some cases their “fab” operations as well. From a manufacturing cost standpoint, this makes a lot of sense because it allows the third parties to specialize in certain operations and then take advantage of economies of scale by doing that same operation for number of different companies.

Outsourcing manufacturing operations inevitably extends the supply chain. Some estimates are that almost 30% of the anticipated manufacturing savings are lost in increased supply chain costs. In other words, for every dollar saved by outsourcing, 30 cents can be eaten up in increased supply chain costs. The costs come not just from the obvious increased inventory buffers and transport costs, but also from slower response and information lags. As an example, contract or toll capacity is generally agreed to up front based on demand projections. But very little attention is paid to the inevitable demand fluctuations and uncertainty that necessitates increased lead time and higher inventory.

It is a fortunate truth that much of this cost can be managed. What is unfortunate is that very few companies are taking advantage of the available technology. The perception is that once a part of manufacturing is outsourced, all aspects of managing that part of the material flow are eliminated. Companies that use external manufacturing can take three steps to reduce their supply chain costs:

1. Create and maintain an integrated supply chain datamart that will allow planners to reliably determine the status of the supply chain on demand. This has to be negotiated with the contract manufacturing providers as part of the initial agreement.

2. Include the external manufacturing organization in monthly tactical planning. In other words, treat the outsourced manufacturing step as an internal resource for planning purposes.

3. Put in place a monitoring system that tracks both the manufacturing costs, as well as the supply chain performance so that corrective action can take place early.