Machine Design

Avoiding the commodity mindset trap

A Midwestern manufacturer troubled by outsourcing to low-labor-cost regions flagged for me a recent article in the <i>Wall Street Journal</i>.

Michael Paris
Paris Consultants
Hinsdale, Ill.

Ostensibly, the article was about ways U.S. manufacturers raise prices in commodity markets. I believe it really underscored the fallacy of "the commodity mindset." U.S. manufacturers with this mindset end up competing in global markets based on price alone. This is a losing game. No question that most Asian (and perhaps in the future, African) companies compete far better on price than those in the U.S. A credible study from the National Association of Manufacturers puts the U.S. cost disadvantage at 32%, equivalent to $6/hr in labor.

In essence, the commodity mindset nulls much of the potential value that suppliers bring to customers in the form of creativity, extra engineering and tooling, and support. Yet, these very activities can distinguish innovative, engineered, value-added products from commodities. Common sense says customized and innovative products should command a premium price. And, in fact, these services do add costs. However, companies that fall into the commodity mindset trap may simply tack on a profit margin (40%, say, for overhead) to the estimated costs of extra engineering and materials. This becomes the starting point for negotiating a new price, and the end of the addedvalue calculations. Missing from these calculations are the direct benefits to the customer.

Added value is anything that a reasonable customer should be willing to pay for. This includes such items as manufacturing expertise; quick response; rapid prototyping; and production and application engineering. Basically, added value includes all the tasks customers want to off-load. For example, OEMs in dozens of markets have decided that they only want to design and assemble. Everything in between — subassembly, machining, and fabrication — gets outsourced.

Quantifying these added-value tasks is straightforward. Each requires mostly the time of your engineers and production people, whose costs are well understood. Your fully burdened hourly costs are adequate for estimating customer costs and potential savings. It is even easier to calculate the value of inventory, tooling, and capital investments needed to make customers' products. While these costs are not trivial, they are dwarfed by the goodwill a firm can accrue. If your customer believes you "have his back," he will rely on you more and more.

Recognize that U.S. firms have the advantage when it comes to Lean, continuous-realignment, and value-added initiatives. Cheap-labor competitors are generally uninterested in such things. Having cut the low-labor-cost monster down to size, it's time to take a look at how to build, or rebuild, your business.

Paris Consultants is a management-consulting firm.

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