Automation vs. Outsourcing
No matter what type of product they make, all manufacturers walk the same fine line and face many of the same burdens. For example, when the path to profitability reaches a T or a Y, management often must make a critical decision: go left and invest in assembly automation technology, or go right and outsource production.
No matter what type of product they make, all manufacturers walk the same fine line and face many of the same burdens today, such as rising health care costs, soaring energy prices and fluctuating raw material supplies. But, when the path to profitability reaches a T or a Y, management must make a critical decision: go left and invest in assembly automation technology or go right and outsource production.
Each strategy has pros and cons that should be carefully weighed. Unfortunately, many companies don’t look before leaping and head down the wrong path too quickly.
Manufacturers typically turn to automation to lower costs, increase yields, decrease cycle times, improve product quality and uniformity, and gain competitiveness. Because short product life cycles are the rule rather than the exception today, most companies want high-speed assembly machines, conveyors, feeders, robots, vision systems and other types of automation that is flexible. Reusable and reconfigurable automation benefits manufacturers because the equipment can be used for more than one product line or more than one assembly process.
Any type of automation project must be competitive in price, provide a positive return on investment and be delivered on time. However, manufacturers are demanding more value from automation equipment today, because they are under intense pressure to compete and control production costs.
As product lifecycles get shorter and shorter, it makes it less practical for some companies to build proprietary assembly lines. Outsourcing production to a third-party contract manufacturer allows original equipment manufacturers (OEMs) to dramatically cut their fixed costs, while freeing up cash to invest in strategic initiatives, such as new product development or marketing. It also lets a company reduce labor costs by shrinking its direct work force.
Most companies that outsource production usually realize better financial ratios, improved cost of goods sold and faster time to market. By limiting their financial risks, manufacturers can derive an immediate cost savings of anywhere from 10 percent to 15 percent.
Unfortunately, there’s no one-size-fits-all “best answer” to the automation vs. outsourcing question. Indeed, the ultimate decision depends on many different factors, including intangibles such as consumer demand, management style, corporate culture and shareholder pressure.
“Just because you don’t outsource something does not mean you have to automate it in order to make improvements,” says Art Smalley, president of the Art of Lean Inc. (Huntington Beach, CA). “There are always certain core components that you just don’t outsource for reasons of technology, competitive advantage and quality. What will change, of course, is the level of automation based upon the region. For instance, manufacturers in Japan and the United States typically use more automation, while there is less automation in areas such as Brazil and Vietnam.”
While outsourcing may help a company reduce costs in the short run, Smalley urges manufacturers to consider alternatives. “Implementing lean principles has enabled many manufacturers to produce more efficiently and profitably at home, and gain a long-term competitive advantage,” he points out.
Unfortunately, some manufacturers realize they’ve made a mistake before it’s too late to turn around. For instance, several high-profile companies that rushed head-first into outsourcing several years ago have recently brought work back in house. In fact, it’s not unheard of to find manufacturers shifting production to the United States from China and other offshore locations.
Tom Kramer, president of Sortimat Technology (Schaumburg, IL), recently encountered two instances of large medical device companies abandoning assembly plants in Mexico due to quality issues with their final assemblies. “The operations were replaced with automation in U.S. manufacturing environments,” says Kramer.
Risks and Rewards
“There are risks to both automation and outsourcing,” warns Smalley. “In one case, you are dealing with a new piece of equipment that might break down a lot until production and maintenance staff can get it running correctly. With outsourcing, quality, lead-time and other indirect costs come into the mix. Little things like communication and time differences can become a big challenge.”
“The risks that automation and offshoring strategies have in common stem from a misunderstanding by manufacturers of the actual costs associated with producing their designs,” adds Nick Dewhurst, executive vice president of Boothroyd Dewhurst Inc. (Wakefield, RI). “Unless you know what the costs of your product are, and where those costs are tied up in design, production and overhead, then you might be barking up the wrong tree using either strategy to stay competitive.”
According to Dewhurst, manufacturers traditionally do a poor job of integrating cost analysis into early product designs. “Many companies [that rush] to outsource manufacturing do not understand that the design of the product determines the final cost,” he explains. “Outsourcing [should not be] the first step in lowering product costs.”
For instance, Dewhurst claims that labor accounts for just 4 percent of product costs vs. 24 percent for overhead and 72 percent for part manufacturing. “Rather than invest capital in automation or incur the hidden costs of offshoring, manufacturers might want to further explore material selection and process choices first,” he suggests. “In addition, they can improve labor costs by reducing assembly complexity in their designs. From our perspective, DFMA analysis is certainly the key to identifying labor and process cost reductions, and for designing parts matched to the feeding and orientation requirements of automated assembly.”
In most cases, arguments can be made for both automation and outsourcing. The best way to take advantage of either is to completely understand your business and the processes involved in it, says Kevin Kozuszek, director of marketing at KUKA Robotics Corp. (Clinton Township, MI). “Generally, automation makes the most sense if you have a task that is expensive in terms of labor or is redundant. Outsourcing makes more sense when your business needs to be somewhat fluid in terms of labor and capital.
“[Manufacturers] need to understand that automation and outsourcing are not at opposite ends of the spectrum,” adds Kozuszek. “Automation is a way to streamline a process. Outsourcing is a business decision to have processes that could be completed by automation removed from a facility, nearly eliminating all of a company’s labor.”
To some people, outsourcing only means one thing: going offshore for cheap manual labor. “In reality, a great deal of outsourcing is done here and is highly automated,” contends Bill Bodine, president of Bodine Assembly and Test Systems (Bridgeport, CT). His company manufactures automated assembly equipment, but also offers contract assembly services. “The benefits and risks really depend on the product type, the sophistication of the assembly process and a host of other variables,” Bodine points out.
Weigh Both Sides
When pondering the automation vs. outsourcing dilemma, there are several factors to consider, such as total cost of ownership vs. purchase price.
“Be careful of underestimating the actual cost of procurement when considering outsourcing,” warns Smalley, a former Toyota Motor Corp. engineer. “Sometimes, companies can save a dime off the purchase price, but in reality they wind up adding more cost in other areas that are not captured in the purchase price, such as inventory holding costs, increased lead time, quality problems, transportation delays and aggravation, as well as more overhead in supply chain management and supplier quality assurance.
A second consideration concerning outsourcing is whether an item is a core technology or not. Sometimes, it’s best to keep certain types of production in-house to protect proprietary technology, processes or quality. “If it is not a core technology or critical item, then outsourcing makes a lot of sense if done correctly,” says Smalley.
“With regards to automation, you have to be sure that automating the process is going to result in a true productivity increase that justifies the cost of the capital,” Smalley points out. “On paper, this is also easy to mistake since the justification process sometimes fails to take into effect the cost of maintenance, spare parts and downtime.”
Also, with automation how do you ensure there is some flexibility in the process? Consumer demand changes and product development comes up with new models all the time. How can you ensure that the capital purchased today will work with other items in the future to provide process flexibility?
Kevin Gingerich, director of marketing services at Bosch Rexroth Corp. (Buchanan, MI), says some other questions to consider include:
- Is the manufacturing process complex or technologically sophisticated, and can it be managed from a distance?
- Can I get the quality and the deliveries that I need?
- Do I have a good transition plan to the outsourced supply chain?
- Can I outsource locally?
That last question is important to remember, because outsourcing doesn’t always mean sending jobs outside the United States. “Contract manufacturing is one of the fastest growing areas in many industries in the U.S., and it may be possible to outsource locally,” Gingerich points out. “If you can find a good partner in the U.S., you can avoid many of the pitfalls associated with outsourcing to organizations that are thousands of miles away.
“Some of these issues are more important than others, but it’s always worth considering several alternate ways of reducing costs to remain competitive,” says Gingerich. “A good way to start is by developing a value stream map to find out exactly where waste is in the process. Often, just taking a good hard look at the way things are currently being done will reveal the best course of action, or several alternate courses of action.
“One of these may, indeed, turn out to be outsourcing,” adds Gingerich. “But, you might also discover that you can squeeze waste out in other ways, and still maintain local control and jobs.”
In addition to cost, quality is another important factor to consider when pondering automation vs. outsourcing. “Quality is without question the most important factor, because customers expect quality now,” argues Gingerich. “So, if you switch to a process that cheapens the end product, or results in manufacturing defects that weren’t there before, you run the risk of damaging your business.”
Unlike many of its competitors, Toyota keeps castings and forgings in-house rather than outsourcing those processes. For instance, Art Smalley worked in an engine facility that made camshafts, crank shafts, connecting rods, cylinder blocks, cylinder heads, pistons and other parts internally. “They were very capital intensive products to make,” he recalls. “But, they are also very important items for quality.”
Many manufacturers overlook automation in favor of quick-fix solutions, such as outsourcing, which appeases analysts and shareholders. Indeed, today’s corporate investment policies typically oppose capital investment in favor of short-term financial reporting.
“Outsourcing moves the high cost of manufacturing operations off the balance sheet,” explains Manoj Kumar, a director of Pittiglio Rabin Todd & McGrath (PRTM, Mountain View, CA), a consulting firm that specializes in operational strategy and supply chain management. “That sends a strong message to Wall Street.” Kumar believes outsourcing is usually a better alternative than investing in automation, because it gives companies the opportunity to use a variable cost model that leads to improved margins and better economies of scale.
“In my opinion, automation produces better results, to the extent that even China is automating, and putting some of their labor out of work,” counters Jim Pinto, an automation consultant based in San Diego. “Automation, not outsourcing, is the primary cause of the ‘jobless recovery’ that’s occurring in American manufacturing.” However, Pinto, who says the purpose of automation is to improve productivity, admits that “investing in automation is risky, if you don’t make the right choices.”
According to Rick Schneider, president and CEO of FANUC Robotics the pressure to automate is both global and relentless. His company recently launched a collaborative initiative called Save Your Factory, which urges North American manufacturers to recognize automation as a more cost effective and profitable alternative to moving production offshore.
“Innovation and automation that produces bottom-line results will mark the difference between life and death for manufacturers in the near future,” claims Schneider. “Automation is absolutely critical now for North American manufacturers to be competitive in the world market because it helps companies reduce costs, increase quality and improve control of their manufacturing operations. Through automation and lean manufacturing operations, North America can be cost-competitive with countries like China.”
Outsourcing to a country with dramatically lower labor costs appears to be a fast solution. “In reality, though, setting up the logistics pathways, the manufacturing systems, quality control mechanisms and other supply chain requirements is much harder when you’re dealing with people who are far away and speak a different language,” says Bosch Rexroth’s Gingerich. “So, to do it right, you really have to be committed to it for the long haul. When viewed this way, automation is often a faster, easier and more permanent fix to profitability problems.”
If automation or outsourcing are viable solutions to cost reduction, then a mature product is the best candidate for either solution. “The best time to consider outsourcing production is when margins have become so thin that even a continued growth in sales will not help you meet the profit targets you need,” contends Gingerich. “This is often the sign of a mature product, with lots of competition. When a product is mature, it’s also more likely that you can forecast demand more carefully-a great prerequisite for automation.”
“Mature products face less of a threat from foreign companies regarding loss of intellectual capital, and their designs may be established enough to warrant investment in dedicated assembly equipment,” adds Nick Dewhurst. “New products are at risk for the very reason that mature products are at less risk. Debugging new automation equipment, ramping up production, solving assembly issues and dealing with lead times are better done right in the company’s local market, wherever that is. Those tasks are difficult to accomplish from another part of the world.”
Production volume and part mix should also play a big role in the decision to automate or outsource. “High production requiring a three-shift operation will quickly justify the cost of automation through asset utilization,” says Brian Kirchner, engineering manager at Vogel Industries (Marine City, MI). “Displacing two operators per shift with a three-shift operation will easily provide $300,000 in annual savings.
“The part mix is always a juggling act, because most automation does not lend itself to process and product variability,” adds Kirchner. “While there are some exceptions, the rule usually holds true.”
Paul Nordin, senior project manager at Sortimat Technology, says high-volume production is ideal for automation. “You’re probably not going to have an easy time outsourcing a 50 million unit per year project,” he explains. “On the other hand, for an application with a large variety of parts and assembly variations with low volume requirements, outsourcing fits.”
According to Nordin, there is a breakeven point for automation. For example, he says manufacturers can usually justify a semiautomatic or fully automatic assembly machine when volume requirements land at around 7 million units a year.
When weighing the pros and cons of automation vs. outsourcing, manufacturers need to consider the effect on total system costs, not just the labor cost component. Most observers believe that today’s market conditions favor outsourcing.
“Today’s marketplace definitely makes it easier to outsource,” says Bill Bodine. “The contract manufacturing industry has developed to a point where virtually any product category has a host of specialists ready to take on the task.” In addition, state-of-the-art communication and logistics support tools, such as e-mail and text messaging, enhance the outsourcing process.
“Outsourcing is one of the hottest trends going,” Gingerich points out. “In general, capital equipment justifications are always pretty straightforward: The return-on-investment calculations, as long as they’re done carefully, will tell you whether new capital equipment is the right way to go.
“In comparison, a powerful trend creates a stronger emotional component to the argumentation,” adds Gingerich. “There’s tons of press, and it seems that if you don’t get on the bandwagon, you’re letting your competition get a leg up. In that environment, outsourcing projects are frequently started at the top of an organization, which sometimes leads to a predetermined result.
“Our experience is that it’s very, very important to consider all possible implications when making changes to a process. The upside to projects that start at the top is that the red tape has been cleared away in advance. So if you have a good plan, you can implement it quickly. This is true for both automation and outsourcing projects.”
According to Dewhurst, it “gets back to the short-sighted thinking that partially may be driven by the investment community. The stock market, and other business incentives, force people to look at what the next quarter’s numbers are going to be and not at longer-term plans.
“Investment in long-term automation projects has a direct impact on next quarter’s numbers,” notes Dewhurst. “In contrast, manufacturers that [outsource production] often have little or no investment in automation and also appear to be reducing labor costs. But, maybe the long-term benefit of that strategy isn’t anywhere near what they imagine.
“So I think that market conditions, such as people being adverse to capital investment primarily due to the impact on short-term gains, really are driving a lot of the offshoring decisions and, potentially, a lot of the automation decisions as well.”
Dewhurst believes that it’s often easier for a publicly traded manufacturer to justify outsourcing, because the capital investment required to build a new plant or install a new automated assembly line in the U.S. is high. “Those long-term expenses seem hard to justify for companies focused primarily on reporting sequentially higher quarterly profits,” he points out.
“But again, the central issue to automation and outsourcing is whether or not manufacturers really understand their product cost drivers,” says Dewhurst. “Many of them hide product development costs in overhead budgets or don’t understand the impact of feature-level decisions on total costs. When those costs are not correctly measured, it is hard to create realistic strategies for improvement. There is an enormous historical disconnect between business accounting and engineering accounting.”
A publicly traded manufacturer is constantly under extreme pressure to show quarterly profits rather than long-term results. “As a result, outsourcing becomes a more attractive option in many cases,” Bodine points out. “Shareholders tend to get nervous with a long-term investment in a world of shorter product life cycles and headlong rushes to push new products to market. Most product life cycles far exceed the initial projections or expectations, but the perception remains unchanged.”
Some observers believe that it is much easier for privately held manufacturers to invest in automation, since there is less external scrutiny on decision making and the payback process. “Private companies, in general, have an easier time when it comes to outsourcing as well,” notes Smalley. “There is just less explaining to do to the outside world in the case of private companies. Public companies have more pressure to perform quarter to quarter, which pushes outsourcing if the cost benefit is obvious.”
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