Offshore manufacturing touts savings of up to 40% for manufacturers looking to save costs. Many companies have followed China's siren song of lower costs with mixed results. Overall, American companies have cut costs, but the residual effect has been a huge loss of jobs and an erosion of America's manufacturing base. This white paper defines the current state of offshore manufacturing, shows some successes and failures, but most importantly, advises American businesses of a strong, viable stateside alternative, keeping the work and the jobs here in America.

Offshore Manufacturing

American manufacturing is at a crossroads and no one even knows how critical this is. The generation that brought us to this junction may not live to see the devastating results.

We've outsourced everything from pots and pans to dishwashers to large engine parts. Price pressures are tremendous; the distribution channel from retail to manufacturer is brutal. In the business-to-business (B2B) world, it's no less cutthroat. Some say we're creating a new middle class in Asia and strangling our own middle class in America.

Walk into any Wal-Mart in America and you'll see the major impact of offshore manufacturing. Millions of products not made in America line the shelves, featuring low prices slashed even lower. Unemployment followed those jobs that were moved to China, and the ranks of the unemployed have been joined by the owners of failed businesses -- businesses that couldn't compete with China's seduction of low prices, reduced labor cost, and quality that was plenty "good enough" for what we need.

According to a recent study on manufacturing by The Conference Board, the decline in manufacturing jobs in the U.S. and other major nations shows no signs of slowing.

The study states that at least 16 million jobs are created or destroyed each year, in good times and bad. This represents 14% of all U.S. employment. In the current recession, the study shows that manufacturing jobs have been particularly hard hit, dropping 7-8% -- a decline more than three times larger than the 2.2% dip during the two-year period following the recession of 1990-1991.

Dr. Robert McGuckin, author of the study, says, "While job destruction and job creation are part of the regular fabric of economic activity year in and year out, manufacturing is drawing attention because job losses remain high and are not being made up by greater job creation in expansions."

Dr. McGuckin adds that "the key focus of the ongoing debate about job losses should concentrate on improving the reallocation of resources and finding a consensus on how to help workers who have been adversely affected by these intensifying trends."

But workers aren't the only ones who need help. The current economic condition has gone deeper into small to medium-size businesses that are having difficulty sustaining the viselike grip of competitive prices, high labor costs, and the squeeze from meeting the increased costs of government regulations.

Findings from The Conference Board study show that the decline in manufacturing employment growth was well underway in the 1980s. According to the study, job destruction averaged 10.3% while job creation was only 9.1%. The 1.2% difference, according to the report, signaled the continuing and long-run decline in manufacturing jobs.

The shift in jobs represents a major factor in productivity growth, as employees shift from low to high productivity firms and businesses. This shows that new and growing companies replace declining and uncompetitive ones. Many of the productivity gains today are from entirely new enterprises.

CFO magazine recently ran a special section on Offshore Manufacturing and reported that 18% of the survey participants reported that they currently use offshore outsourcing and an additional 10% plan to. This is accompanied by 51% who say that the size of their U.S.-based workforce has decreased by 5% and more over the past three years. Of those currently using offshore outsourcing, 64% indicated that they plan to increase their offshore activities.

According to the report, 59% said they are already sending information technology jobs overseas. In the next category, manufacturing, 36% are sending this work offshore.

The driving factor of cost savings receives mixed reviews, with 22% saying they save over 25% in costs to the other end of the spectrum, with 10% experiencing no savings at all.

Consumer Perceptions

The fickle American consumer continues to drive the economy, so it's interesting to see the dichotomy of thinking relative to offshore manufacturing. In a study done for the Associated Press by Ipsos-Public Affairs, 69% of the consumers surveyed said that they thought outsourcing does more to hurt the economy than to help it. 64% of those surveyed agreed that "Outsourcing is mostly caused by the greed of corporate executives" as compared with 30% who believed the statement "Outsourcing is mostly caused by the need for companies to compete." Over two-thirds said they think sending jobs overseas hurts the U.S. economy.

But even as the American consumer recognizes the pain for corporate America, he is also feeling the pain in his back pocket. So, according to the survey, only 27% check the label to see if an item was made in the U.S. when deciding on what product to buy. 40% said they would purchase the lower-priced product made in another country, even if there was a higher-priced American product available. The American consumer, still driven by price, still drives the economy.

As one CFO survey respondent remarked, "People's concerns about the detrimental effect on the U.S. economy are well founded. First it was the goods sector, now it's the services sector. What will we have left?"

The Good, the Bad, the Ugly

Outsourcing overseas has been a boon to many manufacturers, and a bust to others.

Factors leading manufacturers to an offshore decision are diverse, but almost always start with the need for cost containment due to competitive pressures. Consulting companies touting their offshore manufacturing expertise cite "overall production cost can be reduced by at least 20%, and some as much as 70%."

And, in some cases this is true. Take most Fortune 500 companies, for example. Visit any of their websites and you'll see multiple plant locations. And not only in China -- Mexico is a major destination for offshore manufacturing, as well.

These companies have been successful in bringing down their costs, improving their time to market, and have been a driving force behind a global economy. And, while there are many factors involved in the global economy, offshore manufacturing has been a significant factor.

Recently the CEO of an American manufacturer, who is investigating moving part of his manufacturing to China, returned in amazement. He reported that everywhere he went he saw new construction. "We're funding the growth of China," was his take on the situation.

But even if China develops higher cost structures, a rising middle class, and eventual increased prices, there will always be another country willing to step in and produce our goods more cheaply, says economist Allan Beaulier. And, our free enterprise-based economy will fuel the growth wherever we go.

In the recent, in-depth special section published in CFO magazine, senior editor Roy Harris tells the stories of several companies who have successfully managed offshore manufacturing.

Most companies who are successful with offshore manufacturing go through a process, according to Harris, that begins with the need to understand what parts of their manufacturing can be outsourced. Companies have different sets of criteria, depending on their products. And now, with India's service capabilities, their services and additional functions like administrative jobs in human resources, finance and accounts payable can also be outsourced.

Once a manufacturer has determined which products or components can be outsourced, the startup period can be full of hurdles. There are initial, nonrefundable costs that may vary depending on the value of your orders. Obviously, smaller volumes will not be cost effective for offshore work.

Giving work over to a distant third party is a scary concept for many businesses and can be a major cause of corporate stress. And rightly so, because it's not without its problems. For starters, there's the need for measurement of productivity and quality controls. There are many ways that control can be lost, so manufacturers would do well to develop and implement tight reporting lines and quality control measures.

In addition, on-site tracking is a necessity, says Ravi Aron in the CFO special section on offshore manufacturing. Aron is a professor at the University of Pennsylvania's Wharton School and has studied offshore manufacturing in depth. He has studied the errors and pitfalls and has observed what makes successful projects work.

His strategies for avoiding pitfalls are:

• Design an exit strategy, such as month-to-month contract terms, for the early stages. Allow yourself to back away if goals aren't met.


• Level with employees about U.S. job reductions and cost savings, emphasizing competitiveness and any opportunities for new jobs.


• For processes being relocated offshore -- whether simple or sophisticated -- make sure results, quality, and worker performance can be precisely measured. Then measure them.


• Monitor the work being done for security lapses and performance, preferably by putting some of your own managers on-site.


• Consult international law specialists about the tax and labor laws that apply where you will be operating, particularly if you are setting up an offshore subsidiary. (For example, in India, employees have certain "moral rights" to the property of their companies, unless a contract expressly deletes them.)


• Review U.S. accounting regulations pertaining to offshore operations, such as Statement of Auditing Standards No. 70, "Reports on the Processing of Transactions by Service Organizations."

The Alternative: Onshore or Stateside Manufacturing

Every problem can find multiple solutions. And, while offshore manufacturing has become a growing and viable solution for cost-cutting, there are others.

Take the case of CAT and Flinchbaugh Engineering. CAT, a Fortune 500 equipment manufacturer, had specific equipment parts needs. These parts are large, heavy, and some are unwieldy. So CAT turned to Flinchbaugh Engineering to do the manufacturing. In essence, stateside manufacturing.

The two companies partnered so well that CAT has moved its manufacturing equipment to Flinchbaugh Engineering's York, PA location and has given Flinchbaugh the responsibility of managing the entire production line. The entire CAT line was transferred to Flinchbaugh's facility and is run by Flinchbaugh's employees.

"If people knew about line transfers," asserts president Michael Lehman, "they would realize how much more efficient and effective it would be for them to check out manufacturing options in their own backyard first. It's the offshore vs. onshore debate that's just starting to heat up and a key component is to keep jobs here in the States at the same time that a company can cut costs and be competitive.

"We are able to take the equipment that a company has been using, is about ready to trash, and through our engineering expertise, we are able to revitalize the line and get much more out of it; many more years of productivity." Lehman credits his employees for their experience and expertise in making equipment come back to life.

In addition, Lehman notes that many companies have crippling legacy costs in their labor situations. By transferring the production line for manufacturing components, Lehman states that a company can rid itself of those headaches and still keep jobs here in America.

"Contrary to some initial fears people may have, line transfers are good for jobs because most often people are retrained in a plant that transfers out a line. At the same time, we're able to add jobs here at our plant and keep both sets of jobs here in the states, " adds Lehman.

According to Lehman, the line transfers that work best are those for manufacturing components that are then assembled into OEM equipment or final products. CAT was the first company that transferred a line to Flinchbaugh in 1985. Since then, Flinchbaugh has managed line transfers for numerous other manufacturers, all of whom have realized significant cost reductions.

Flinchbaugh Engineering was started in 1978 and has grown to include complete engineering and machining of component parts for multiple industries. Line transfers are a key part of the company's growth.