Diversifying your Supply Chain - Part 1: Prioritizing your Product Line Actions
This is Part 1 in my series of articles on How To Diversity Your Supply Chain. In this part, I will expand on the decision criteria to prioritize your best product line candidates for diversification.
You obviously cannot move or replicate all of your production and sources of supply at once; it will take time. The key is to evaluate and prioritize your product lines to determine which are the best candidates to diversify (and perhaps replicate) first. Remember: Our mission in diversification is primarily to reduce supply chain risk but will also improve customer satisfaction if done well.
To start, we need to understand why companies have typically fragmented their supply chains globally but then do not diversify/replicate them on a regional & local basis. Some rationales are logical and valid; some are myths and can do tremendous damage to your supply continuity. Below are some of the most common rationales:
Labor/Purchase Cost Savings: This means going to the lowest cost producer/supplier that can be found. So many organizations are evaluated on favorable purchase/production cost variance, even though this rarely considers the total acquisition cost. For instance, how much transportation cost is required to get it to me? Are there tariffs & duties to be paid for importing? How much inventory do I need to hold during the lead-time it takes to get the product to me? (Inventory eats up your available cash) Am I buying massive minimum order quantities (which I don't need) to get a great unit price?
Note: Unit price/cost is important to keeping your total costs down, no doubt. But you can easily add up to 25% to purchase price with these other costs. Focus on total acquisition cost.
Certain Regions of the World are Simply Better at Certain Products: This is mostly myth. Aside from some natural resources development (i.e. metals), the capability to produce products is primarily a factor of "know how" that is developed and nurtured, instead of left to wither away (read: textiles manufacturing or electronics assembly in the US).
The "better" regions analogy typically boils down to products that require high labor content and taking those products to regions of the world that have lower labor costs - in other words, we're back to cost savings. With all of the factory automation, smart technology and lean manufacturing concepts that can be deployed, products can be competitively produced in most regions of the world if you truly consider the total acquisition costs (and are willing to develop those capabilities).
Note: For most product-making companies, direct labor (people making the actual products) is less than 10% of the total cost of the product - in other words, it's not the primary cost element.
My Volumes aren't High Enough to Justify Multiple Sources / Production Lines: Certainly if you're buying or producing 10 or 50 of something on a yearly basis, it's hard to justify diversifying (replicating) your supply sources. But these aren't the products that put you're business or customers at high risk. This is why we'll focus on prioritizing your product lines in this article. In my later posts, I will describe in detail how you can achieve diversification even with lower volume products.
The Cost of Duplicating Production/Supply Sources aren't Affordable: This is a similar issue to that of lower volume products. Yes, multiple production lines or suppliers can require replicating tooling, molds, fixtures and other expenditures. But there are many modern tools & methods that have vastly reduced the costs of making tools and transacting purchase orders. Again, we will describe these methods, along with alternative manufacturing sources (contract mfg., consortium mfg., additive mfg.) that can be used in a later article.
Will Lose Economies of Scale by Diversifying my Supply Sources: While this is a textbook business school argument, much has changed since those books were written. Clearly, if you have two under-utilized factories, you won't be as efficient as you would be operating in one. However, most companies are quite good at and have optimized their footprint and machine utilization. And there really aren't many "economies of scale" to be had when you need to add more capacity by adding a machine or tool - so, perhaps, the next machine or next tool/fixture you buy should be deployed to an alternative source of supply? And the costs of transacting purchase and factory orders has been greatly reduced with systematic planning, automated transaction processing, and other such systems and automation methods. In other words, the old "rule of thumb" (or ROT!) that a PO or factory order placed costs $50 or more each is mere pennies today.
So, with that background, let me offer a systematic approach to evaluating your product lines to establish your highest priority targets for diversification:
1. Start with your high volume products. The traditional Pareto analysis will do here. The products that make up the top 80% of your volume will be the 20% of the products you need to focus on. Focusing on the higher volume products also are likely the products you can most justify making investments in to diversify and replicate your supply sources.
2. Compare the lead-time expectations of your customer to what your actual lead-time is. In other words, by product line, focus on the high volume products that your customers expectations of lead-time from order-to-delivery are far shorter than your actual capability to deliver (ordering & getting your required bits & pieces, producing or assembling them, and shipping the completed unit to the customer). The axioms here are: a) having huge lead-time disconnects between your capability and customer expectations puts your business at-risk, regardless and b) the longer the lead-time it takes to deliver, the more time for things to go wrong.
3. Evaluate the # of Supply Chain "Hand Offs" in your Product Lines: This is a little trickier to grasp and takes some data analysis but is critical to understanding just how "complex" your supply chain has become. A "hand-off" is the number of suppliers and product movements that are required to make your end product.
Let's take an example: Say you assemble a product that requires parts from 30 different suppliers; 10 of those suppliers ship from overseas and thus, need to truck to their port, hand-off to a sea/air transporter, and finally hand it off to trucker to get it to you - the other 20 suppliers ship directly to you; Once you have all the parts, you must send out parts for outside processing, say, 2 times, before you can build/ship the final product. In total your product required 52 "hand offs" before you can make the final product. I know, seems like an incredible number but is very typical.
Obviously, the more hand-offs, the more opportunities for supply chain failure. Trying to minimize the hand-offs and identifying the high-volume, long lead-time products with too many "hand-offs" is the prioritization focus here.
4. Determine the Costs of Diversification (Duplication): Once you've prioritized your product lines using the first 3 steps above, the final step is determining the cost effectiveness (payback) of your potential diversification. The easiest products to make a decision on are products growing quickly, where you are needing to make incremental investments (machines, tooling, fixtures, etc...). In these cases, deciding to make that new investment in a duplicate factory/supplier is quite clear.
For more stable demand products that aren't requiring incremental investment (which are still high volume, long lead-time and complex "hand-offs"), the decision criteria is more difficult but, again, should always be made on total acquisition costs - comparing the cost differences of producing or buying from two supply sources rather than just the existing source. My rule of thumb has always been that if I can get payback on my incremental investment in 2 years or less, and the acquisition cost difference was beneficial or similar, I would make the move to diversify to reduce risks.
If you do a systematic and unbiased review of your product lines following these steps, it will guide you to prioritizing and down-selecting the most impact-full product lines that should be diversified. For businesses with lots of product lines, this can be a daunting task. However, as they say, "Rome wasn't built in a day", so a steady and systematic prioritization will allow you to stay focused on how to best diversify (and replicate) your supply chain.
Before I close, my humorous (I hope!) anecdote for the day: Years ago, when I was at Owens Corning (OC), we owned the rights to the "Pink Panther". Many will remember either the Pink Panther movies or the OC commercials featuring the Pink Panther, promoting OC's pink-colored insulation (which we actually painted on the material in production; it's not natural!).
One of my duties was to manage the supplier in China that produced over 1 million stuffed plush Pink Panthers for us annually; we had a side hustle of selling those Pink Panthers toys to various entities. So I am experienced in plush toys! The date was in 1993 and you can imagine how difficult it was to conduct business, in China, at that time -- I took a bus from Hong Kong, where nobody spoke English, for hours, crossed through 2 borders just to tell the incumbent supplier, in English, which they didn't understand, that we were diversifying our supply sources to a 2nd source... and then return to Hong Kong the same day! Aside from the huge difficulties in doing business with China at that time, I did learn my first lesson about supply chain diversification.
I hope this information is useful to those interested. And again, I encourage you to share this post with others in your network that might find this perspective helpful. I welcome all comments and feedback also. I will be following up with my next week in the coming week that digs a bit more into the "how to" execute a diversification strategy.
---- Tom Weikart, Principal, Desert Sage Advisors