Operations Payoff

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The Art of Off-Shore Buying for Long Term Profitability

Many companies today are outsourcing the purchase of materials, parts and end products overseas believing that they are saving a lot of money. Upon examination, I find that they are comparing the item cost of on-shore suppliers to the item cost of off-shore suppliers. This is often referred to as PPV buying, for Purchase Price Variance. PPV is the difference in cost between what the bill of materials says an item should cost with what the item actually costs. In many cases, especially if there is a large labor component, off-shore sources are significantly less expensive than on shore based on PPV.

Enter the world of Total Cost of Ownership or TCO. TCO includes all of the costs associated with sourcing an item including freight, customs/duties, inventory holding costs, quality, sourcing itself (e.g., trips to Asia), supplier selection and support, etc. TCO can add significantly to the cost of a part, many times more than off-setting the savings achieved on a PPV basis.

I see many companies ignore the TCO element of off-shoring often because the responsibilities for many of those costs are dispersed throughout the company. If Purchasing is not responsible for those costs, they can overlook them when doing the cost trade-off studies for off-shore supply. With labor costs in Asia rising, TCO may suggest that on-shore supply is now actually cheaper. Be sure to look at the Total Cost picture when making off-shore decisions.

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