In the last 20 years, we’ve seen a massive wave of manufacturing jobs move to low-labour-cost countries. Now, many companies are beginning to question whether the cost differential offered by distant suppliers compensates for the cost of working with an extended supply chain. These companies find themselves with massive inventories, yet in spite of those inventories they frequently are not able to meet all demand.
It has been difficult for managers to analyse the cost differential mismatch trade-off because mismatch costs are difficult to quantify. The intuition is that the mismatch costs are high, but the managers I discuss with have difficulty believing that overstocks and stockout costs are high enough to wipe out the cost advantage enjoyed by their offshore supplier. Without solid numbers, it’s difficult for managers to incorporate these costs into decision-making.
At the same time, policymakers throughout the developed world have made a commitment to supporting local manufacturing because of the economic benefit that manufacturing brings to a region. Twenty years of offshoring have left entire regions of the US and Europe devastated. The objective at the policy level is to find a path to domestic manufacturing that doesn’t cause companies to lose competitiveness or require that governments provide subsidies.
Our objective has thus been to find a way to quantify the mismatch costs so that decision-makers can see where proximity is sufficiently valuable to warrant paying developed-world salaries. We have turned toward quantitative finance, as the value of proximity can be translated into the value of an option to postpone the order quantity decision so as to work with better information.
Read the full post at Outsource.
Prof. Suzanne de Treville is visiting MIT Sloan from the University of Lausanne.