SCM World 2014 Chief Supply Chain Officer Report: A Conversation with Kevin O’Marah – Part IV

In September, SCM World released its annual Chief Supply Chain Officer Report based on its survey of over 1,000 supply chain executives across all industries and geographies. Supply Chain Nation sat down with Kevin O’Marah, Chief Content Officer for SCM World, to discuss four key findings of the study. In Parts I through III O’Marah explained how companies must embrace uncertainty, approach Big Data analytics and balance the cross purposes of cost versus service objectives in supply chain. In this final post in the series, he addresses the shift away from out-sourcing to vertical integration.

SCN:      Manufacturers report a strong trend toward greater vertical integration vs. out-sourcing production. How will this be operationalized? Does it mean a reversal of the trend to outsource to lower cost countries?

O’Marah:  Yes, it is a reversal of the trend to out-source to lower cost countries. It’s not the absolute end of that trend. The requirement to manufacture at low cost doesn’t go away no matter what you do. However, the notion of a low cost country is very soon going to cease to be a meaningful fact of life.

China, which was the king of low cost, massive scale, and quite high quality gave us the high water mark of low cost manufacturing.  That has come to an end. China’s labor costs have gone up. China’s storage, regulatory, real estate, and risk costs have all gone up. China is still a low cost country for manufacturing, but it is no longer mind-blowingly cheap.

Those who look for a next China will find that there is no next China. I know people who have invested in production in Viet Nam to take advantage of their relatively lower costs. But it’s a small country and cannot handle the scale of what China was able to do. In fact, no one is able to can handle the scale of what China was able to do, and the transparency of wage differential and the expectations of workers around the world basically prohibit anybody from remaining a ‘slave state.’ So whether it is Viet Nam or India or Mexico, the cost differences in labor are going to narrow between high cost countries—United States, Europe—and low cost countries—Viet Nam, India, China, or Mexico.

The shift away from low cost country sourcing includes other benefits—being close to the market is the leading benefit in the research we have done. If I am going to produce for the American market, it makes a lot of sense to be in the U.S., or at least Mexico. If I am going to produce for the European market, it may make sense to make products in Poland or the Czech Republic. And the same applies to any other regional supply chain strategy.

There are also benefits to manufacture close to R&D, engineering and product development centers.  Proximity, even time zone proximity, between the product development organization and the production organization have advantages in terms of dialing in a production process and working through the ramp-to-scale that is necessary in any new product development and launch execution.

Finally, there is a risk benefit of mitigating any sort of ‘all eggs in one basket’ problem with manufacturing in lowest possible cost countries that is addressed by spreading your production assets into multiple geographies. Regionalization of manufacturing is one of the things that is happening and that is pulling production away from massive sites at a lowest possible cost country.

In addition, the question about vertical integration is not just about low cost sourcing, it is also about control. It’s about control of intellectual property. It’s about control of critical and increasingly limited production assets for technologies. It’s about proceeding more quickly within the organization to constantly improve whatever it is you are selling in the marketplace.

The vertical integration benefits are frequently technology driven—I said IP because IP is a key piece of the risk you are exposed to when go with a third party—and the ability to experiment more quickly and learn internally how to get the right assembly sequence, the right machine sequence, how to accomplish the engineering tolerances that are required. This applies to food products as well as aircraft. There is real value in vertical integration.

Some of the strong examples of this come out of industries that are IP and technology intensive, semiconductor being an example. Samsung, one of the most vertically integrated businesses in the world, has from silicon to storefront, total control of huge portions of its production capabilities from microelectronics to devices and ultimately into Samsung Experience stores within Best Buy. That provides skills in tapping its customer and then seeing that back through product design, bill of material definition and sourcing, component manufacturing and even the raw technologies to make it under fabrication. Intel is also reasonably vertically integrated for similar reasons.

Apple, in the same general category, although Foxconn manufactures their products, is virtually integrated in the sense that their personnel, their technology, and increasingly, heavily, equipment that they have bought is what is operating in those Foxconn plants. They also are essentially vertically integrated from silicon to storefront, with control over IP and microelectronics manufacturing technologies that they acquire in the marketplace all the way down to the very well know and very successful Apple stores.

It’s not just high tech. An IP intensive company like Burberry in high-end retail apparel does their own weaving in the high-cost United Kingdom. They don’t just manufacture their stuff in low cost, far away countries and put it on ocean-going containers for weeks on end. They want a quick supply chain, control over quality, and they want to be close to the consumer in their omni-channel experience with Burberry stores as part of the experience of the brand. And they tie that back through sourcing, manufacturing and design—it is all part of what makes Burberry successful.

The trend toward vertical integration has to do with the increasing role of intellectual property in the value of a business, and the urgency at the highest levels of the corporation to control innovation and advancement in technology, branding, formulation, etc. These trends are going to carry on. It will be operationalized by acquisitions and investment in equipment, with huge investments in robotics and automation. Worries will be addressed legally or through business relationships around IP created jointly, such as joint ventures meant to build new technologies. In aerospace, for instance, Raytheon and General Dynamics have worked through this issue. They have operationalized their joint venture for unique technology developed for the Navy, and both parties are satisfied that their shareholders are getting a fair shake.

Whether operationalizing vertical integration through acquisitions, investment of capital or investments in joint IP, the net effect is a supply chain that is far less broken out into bits of core competence capabilities that are arbitrarily pulled together in the open marketplace to deliver product. In other words, outsource everything, which was very hot for a time 20 years ago, has seen its day and is now being replaced by insourcing and the control of IP, control of our most critical capital assets and control of our markets, and I think that trend will continue for a while at least.

SCN:      Thank you, Kevin for all of your insights over this four-blog series.

  2 Comments   Comment

  1. Maria R. Saldivar

    I totally agree with your post and I also think that whatever happened 20 years ago, it’s catching up today. The manufacturing market is getting more expensive today due to the laws and regulations that third world countries are imposing on outsourcing business company’s nowadays. Countries are making money out of all these company’s, which turn to outsourcing for lower cost on labor, that of course, their purpose and goal is to profit out of all this. However, due to the circumstances of not having other resources to survive; I think that it is in the best interest of the governments to let organizations in the manufacturing sector help them in producing jobs, and so be able to sustain themselves. Although, this is not an easy task, and it will probably take many steps to make changes possible, I think is doable.

    Reply
  2. We´re interested in get some information of your systems, we´re a Manufacturer and Direct stores company im Mexico.

    Do you have an agent in Mexico, we´d lie to have some sinformation.

    Thanks.

    Reply

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