Alaska Communications (ACS) dramatically cut warehouse costs and increased service to its construction contractor customers by having the contractors actually run the company’s warehouses. ACS provides wire line services throughout the state of Alaska. Each year it tackles major construction projects to install and maintain telecommunications infrastructure. To provide better service to customers and construction crews, the company has several warehouses throughout the state, two of which experienced highly variable demand, but were staffed full time.
ACS partnered with a contractor to replace ACS warehouse personnel with part time contractor personnel to create a variable workforce (in balance with variable demand) and improve service. The contractor provides personnel as needed to receive and dispense materials at the warehouses to construction crews at (potentially) all hours of the day.
The result was a win for both parties. ACS reduced their labor costs by 75% and gained much-needed flexibility to handle the highly variable load during the construction season. Outsourcing improved service levels, reduced costs, improved agility and boosted capacity. ACS avoided layoffs by not replacing staff members who retired.
The suppliers reaped several benefits from the new arrangement, including better communications with ACS, early notification of new project opportunities, and flexible hours for the warehouse location that better met their needs. This partnership between ACS and its contractor had its rough spots initially, but trust, relationship and strong communication helped both companies increase their capacity and profitability beyond what they could have achieved separately.
Last week NPR reported on an unexpected US manufacturing success story: Georgia Chopsticks, a new company that produces chopsticks for – you guessed it – export to China. When you consider that one third of the world’s population uses chopsticks, it comes as no surprise that there is plenty of room in the market for new producers. Indeed, Georgia Chopsticks plans to ramp up production within the year from two million pairs per day to 10 million per day.
Why Move Production So Far Away From the Consumer?
From a supply chain perspective, we have to ask: why make chopsticks in the southern US, so far from the primary market? In this case the answer is threefold: raw materials, labor, and quality. Clearly China is capable of making chopsticks, but when Georgia Chopsticks’s owner looked for a place to set up his production facility, he found that the small town of Americus, Georgia offered plenty of trees of a type that yields good chopsticks, had a 12% unemployment rate, and while labor is more expensive than it would be in China, the quality is better.
Why It Works in this Case
In this instance, finding raw materials, labor and the potential to produce a high-quality product made it worthwhile to set up production far away from the customer. This is working out because chopsticks are not perishable, demand doesn’t fluctuate, and is it unlikely that chopstick design will change anytime soon. After all, they’ve been around for over three thousand years.
A recent article in The Economist acknowledges an emerging trend toward re-shoring: “…a growing number of multinationals, especially from rich countries, are starting to see the benefits of keeping more of their operations close to home.” Reasons include simplifying supply chains and minimizing risk, cutting transportation costs, and reducing inventory. Let’s take a look at some terms that are coming up in the news, and examine what they really mean for US operations and supply chain.
What is off-shoring?
Before we define off-shoring, let’s look at the difference between off-shoring and outsourcing, because often these two terms are used interchangeably, though their meanings are quite different. Outsourcing has been around for many years. Any company who uses an outside company to process their payroll, for example, is outsourcing that task. Other common examples are janitorial services, landscapers and off-site laundry services used by restaurants.
Off-shoring occurs when a company moves an operations function, like manufacturing of IT services, to an overseas location. Cost and proximity to the customer are the two biggest reasons for off-shoring.
The US has been off-shoring for a long time. When I was a kid, a lot of products were built in Puerto Rico. At that time, quality standards were low for products made in Asia, and a Japanese-made transistor radio was the epitome of cheap.
Going to China
But around 1990 US companies began shifting production to China. When I paid a visit to a manufacturing facility north of Hong Kong in 1993 it was like going to a third world country complete with armed guards at the airport, no paved roads, and a big factory out in the middle of a rice paddy. Cheap labor was the primary reason for off-shoring to Asia in the 90s, but these days some companies move production to China to be closer to their customers: the expanding Chinese middle class.
Where To Next?
Now we’ve added Mexico, India and Eastern Europe to the off-shoring mix, particularly for metal products in the Czech Republic, Hungary, Romania and other former Soviet states. Chinese labor rates are rising, and production is shifting to other areas, like the Philippines and other Southeast Asian countries. Here are four basic considerations for off-shoring (or re-shoring):
Is off-shoring or re-shoring congruent with your strategy? This has to do with the nature of your product, the location of your customers, whether you are a highly innovative organization, and whether your products are slow or fast clock speed.
What is your demand structure? Is it consistent or highly variable? Highly variable demand is very difficult to manage if you have long lead times, regardless of where production is.
How flexible do you need to be? Operations needs to be so flexible that if you can sell a product, you are able to ship it, with high inventory turns and low cost. Highly flexible suppliers and supply chain make it possible.
Look at total cost of ownership, not just part cost. For more on TCO, check out my article on the topic from last year’s eSide Supply Management. Social and environmental considerations are a part of this.
Efficiency is reducing inputs per unit of output. Inputs decrease, output stays flat. Think of cost reduction: we still produce 10 parts, but now it costs us $8 instead of the $10 it used to cost. Efficiency is a one-time, short-run result. Most Lean efforts are focused on efficiency, and I believe this is one of the reasons that Lean usually doesn’t yield long-term results.
Innovation is increasing output while maintaining level input. Your current levels of labor or materials now yield more. A client, a $100 million distributor, is increasing sales by 10 to 20% without spending a nickel more by implementing innovative business processes.
For long-term success, we want innovation, which boosts in sales and improves margins. When innovation starts to happen the results multiply, which means that you get much better traction out of an innovative approach than from pursuing efficiency.
As the recession begins to wane and business picks up, companies are looking at how to most effectively manage their labor. Some are cautious about hiring as they aren’t sure things are really going to stay better, and some now know they can conduct business with fewer employees because of the productivity they gained during the downturn. What strategy is best? How can staffing flexibility be built in?
There are three types of labor resources that can be used; regular employees, temporary employees and overtime. Regular employees are actually cheaper in the long run and usually provide the best quality. Overtime is the most flexible in the short run, but can cause burn-out which can lead to poor quality and low morale. Temporary employees can be a very effective solution with proper management of sources, effective training, and progressive management of the temps.
I have a client that is experiencing a significant positive ramp in their business. From April to October, their output will almost triple. Then, from December to January it will go back down to where it was in April. How do you manage that? If you hire new employees, not only is there a cost for training and a period of fitting in, but then in January you lay them all off. That potentially has a negative impact on morale and the company’s reputation and ability to hire in the future could be severely degraded. The solution was a carefully crafted program of using temporary workers. That also provided a challenge because at the height of activity, the total number of temps actually exceeded the total number of regular employees. How do you manage that?
The solution was actually fairly simple, yet one that most companies would not try. My client assigned a mentor to each temp. The mentor was a regular employee that had a high level of skills, but was not normally a supervisor. This employee was responsible for making sure the temp produced the level of quality and output needed by the company. The mentor was empowered to recommend releasing the temp if they weren’t meeting the necessary standards. Not only did this solve the problem of managing the temps, it also was an opportunity to develop regular employees into potential team leaders. One of those clear win/win situations!
If you talk to your local cost accountant, they will tell you that labor costs (along with materials and supplies) are recorded as variable costs. In reality, they should be treated as fixed costs. Why is that? Because, in the short run, it is not easy to turn this asset into costs that can vary with revenue which is the definition of a variable cost. It is very difficult to lay off people in a low revenue month and then rehire them in a high revenue month. If you try to do that, hiring costs, training costs and cost of quality all increase usually to the degree that they more than offset keeping the people through the downturn.
Many companies will try to furlough people or send them home early in an attempt to turn this fixed cost into a variable cost. While this works in the short run, people will get tired of the lower income and unpredictable work schedule and eventually will look for a new job. This again raises the cost of hiring, training, etc.
The only true variable labor cost is the use of temps and overtime. If your company is in a volatile market, it is best to plan for a level of temps and overtime to create a variable environment.
In the world of manufacturing and distribution, labor costs are usually considered to be a variable cost – that is they vary directly with revenue. In fact, in the short run, direct labor is in reality a fixed cost. While revenue may cycle up and down from month to month, labor generally stays flat. Companies don’t usually lay people off one month and then hire them back the next. So how do you increase the opportunity to reduce costs in down times and yet have the workforce you need for stronger times? The use of temps and overtime is the answer. There are only a few truly variable costs in manufacturing and distribution, and overtime and temps are two of them. I will talk about fixed and variable costs more in future posts.
I have seen companies use temps for as much as 35% of their work force. Many companies prefer not to do that as they believe that temps reduce productivity and quality because of the irregular nature of the resource. In fact, that can be easily managed using several approaches. First, single source your temps. Working with one, or at most two, temp agencies allows you to develop expectations as to the quality and skills you will be getting. Second, have the temp agency pre-train the temps on basic quality and assembly skills. Third, if you provide a positive work environment, even if you release temps, they will want to come back to your company when you need temps again, thus bringing experience with them.
As you can see, with proper management, use of temps can maximize the effectiveness of your variable costs, thus allowing you to manage your labor to significantly increase the profitability of your operations.