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Understanding the critical issues of offshoring and making strategic decisions for bringing production back home

Bachelor Thesis, 2009, 56 Pages

Business economics - Supply, Production, Logistics

Linda Maetschke

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Title:

The process of offshoring and backshoring of manufacturing to and from low wage countries

Subtitle:

Understanding the critical issues of offshoring and making strategic decisions for bringing production back home

Event:

None

Institution / College:

Euromed Management

Author:

Linda Maetschke

Archive No.:

V144193

ISBN (eBook):

978-3-640-54787-6

ISBN (Book):

978-3-640-55180-4

DOI:

10.3239/9783640547876

Category:

Bachelor Thesis

Year:

2009

Pages:

56

Grade:

1,5

Language:

English

Tags:

BackshoringOffshoringManufacturing in low wage countriesAsia

Abstract

Offshore activities do fail, because risks and problems have not sufficiently been anticipated by companies



beforehand, and backshoring transitions are being made in order to readjust and to find a new way of

manufacturing in the most cost efficient and productive way possible. Developing an understanding of the risks

and issues of shifting production to low-wage regions in Asia or Eastern Europe, as well as the elements that

determine a company’s decision of bringing its production back home is the thesis’s main aim. The document is

structured in three parts, whereas the first chapter deals with offshoring, the middle piece with backshoring and

the last part’s case study on ‘Margarete Steiff GmbH’ underlines the thesis’s theoretical parts and applies the

Decision Questionnaire, developed in part two. The thesis is structured in an explanatory manner in order to give

the reader a very broad overview about an up-to-date topic: Offshoring and backshoring of manufacturing to and

from low-wage countries and an approach of improving future backshoring location decisions.

Fulltext (computer-generated)

Page 2

THE PROCESS OF OFFSHORING AND

BACKSHORING OF MANUFACTURING TO AND

FROM LOW-WAGE COUNTRIES

Understanding the critical issues of offshoring and making strategic decisions

for bringing production back home

Bachelor Thesis CESEMED 4



Page 3

April 2009

Linda MAETSCHKE Euromed Marseille School of

Management

Domaine de Luminy BP 921

13-288 Marseille cedex9

France

INDEX

EXECUTIVE SUMMARY... i

INTRODUCTION... iii

1. O FFSHORING AS A STRATEGIC DECISION FOR LOWERING

MANUFACTURING COSTS ... 1

1.1. Definition ... 1

1.2. Evolution of Offshoring... 2

1.3. Drivers and Reasons for Offshoring... 3

1.4. Offshoring Failure Analysis ... 4

1.4.1. Culture ... 5



Page 4

1.4.2. Political Instability... 61.4.3. Legislation... 6

1.4.4. Infrastructure... 7

1.4.5. Supply Chain Management and Transportation Costs... 7

1.4.6. Tariffs and non-tariff costs... 8

1.4.7. Labour and w orkforce management... 9

1.4.8. Overheads and coordination costs ... 9

1.4.9. Unit Labour Costs ...10

1.4.10. Distance and Quality ...10

1.4.11. Intangible reasons...11

1.4.12. Changing environment ...12

1.5. Summary ...14

2. THEB ACKSHORING TRANSITION AS A RELOCATION REACTION

TO A FAILED OFFSHORE PROJECT ... 16

2.1. Definition ...16

2.2. Evolution ...17

2.3. Drivers and Reasons for Backshoring ...18

2.4. Bringing Production back Home Strategically ...21

2.4.1. When to Backshore...21

2.4.2. One-time Transition Costs...21

2.4.3. Strategic Decision-Making...22

2.4.3.1. Product Specifications ...22

2.4.3. 2. Company Specifications ...24

2.4.3. 3. Further Potential at Offshoring Location ...25

2.4.3. 4. Base Case...26

2.4.3. 5. Decision Questionnaire ...27

2.4.4. Strategic Planning ...28



Page 5

2.4.4.1. Project Team...292.4.4. 2. Alert Supplier...29

2.4.4. 3. Plan and Schedule ...29

2.4.4. 4. Quick Reassignment and Recruitment of Employees ...30

2.4.4. 5. Adequate Documentation, Security Policy and Procedures ...30

2.4.4. 6. Set up of Facilities, Plant and Machines (or select Domestic Supplier)...30

2.4.4. 7. Business Continuity...31

2.4.4. 8. Communication Plan ...31

2.4.4. 9. Performance Expectations and Measurements ...31

2.5. Future Outlook ...32

2.6. Summary ...33

3. C ASE STUDY ... 35

3.1. Margarete Steiff GmbH ...35

3.1.1. Company Overview ...35

3.1.2. Products...35

3.1.3. Changes in Collectors behaviour and Retail...35

3.1.4. Going Offshore...36

3.1.5. Problems Offshore ...36

3.1.6. Backshoring Plans and Reasons...38

3.1.7. Analysis of Backshoring Activity ...39

3.2. Summary ...43

B IBLIOGRAPHY ... 44

APPENDIX ... 47





Page 6

EXECUTIVE SUMMARY

Since the beginning of globalisation in the 1970s, offshoring of manufacturing to low -

w age countries has become a relevant topic in order to reduce costs. Businesses w ere able

to low er labour costs and to stay competitive w ithin an environment of f ierce international

rivalry. How ever, offshore engagements have been failing, because the real costs and risks

of sending w ork overseas w ere not fully anticipated.

When adding up expenses for supplementary overheads, coordination and w orkforce

management, low productivity and quality problems as w ell as ever increasing transportation

costs at the offshore plant, the unit labour costs - `the value of labour needed to produce a

unit of a product or a service' (Berger 2005, p. 119) can equal those at home. Inefficiencies

are further created because of political instability, insufficient law enforcement and an

underdeveloped infrastructure at the overseas location. The crucial reality for companies

manufacturing offshore are changing conditions, in particular in terms w ages: In China the

annual real w age grow th betw een 2001 and 2007 has been 12.93 per cent (International

Labour Office 2008, p. 12) and a trained middle manager in the automotive industry speaking

English and Mandarin, w ill earn more in Shanghai than in Wolfsburg or Birmingham (De

Meyer 2008).

Companies reassess their location decision, and bringing production back home is a

natural phenomenon (Carmel 2007). Although reliable data is not available, an estimate of $1

gets backshored for every $10 offshored (Testa 2007) due to the lack of f lexibility and ability

to supply, quality issues, high cost of coordination and the lack of qualif ied personnel (Kinkel

and Maloca 2008, pp. 5-12). One-time transition costs are decisive for the location

reassessment, but even more aspects are included in the Decision Questionnaire: The

specif ications of the product made offshore and the characteristics of the company at home,

the further potential at the offshore location as w ell as the f inancial base line, called the Base

Case (Delaney et al. 2007, pp. 364-5), allow a better understanding of w here a product is

best made offshore or at home. Backing out of a low -w age country needs to be w ell

planned and scheduled for guaranteeing business continuity and a smooth transition

process.

The case study about premium stuffed animal producer `Margarete Steif f ' incorporates



Page 7

i

the issues identif ied w hen producing offshore and the reasons for backshoring. Changes in

collectors' behaviour and retail made Steif f change its strategy. In order to reconquer the

kids' segment w ith a less expensive version of its products, Steif f offshore outsourced to

China in 2003, but announced in mid-2008 to reintegrate its production back under their ow n

roofs in Portugal, Tunisia and Germany w ithin tw o years. Triggered by the loss of f lexibility in

supplying, high turnover that led to quality problems and low eff iciencies combined w ith

lengthy transportation, the toy maker decided to back out of China. Applying the Decision

Questionnaire to the case of Steiff show s the company took the right decision in reintegrating

the production back to its plants.



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ii

INTRODUCTION

As seen in the executive summary, offshore activities do fail, because risks and problems

have not suff iciently been anticipated by companies beforehand, and backshoring transitions

are being made in order to readjust and to find a new w ay of manufacturing in the most cost

eff icient and productive w ay possible.

Developing an understanding of the risks and issues of shifting production to low -w age

regions in Asia or Eastern Europe, as w ell as the elements that determine a company's

decision of bringing its production back home is the thesis's main aim. The document is

structured in three parts, w hereas the first chapter deals w ith offshoring, the middle piece

w ith backshoring and the last part's case study on `Margarete Steiff GmbH' underlines the

thesis's theoretical parts and applies the Decision Questionnaire, developed in part tw o.

The thesis is structured in an explanatory manner in order to give the reader a very broad

overview about an up-to-date topic: Offshoring and backshoring of manufacturing to and frpm

low -w age countries and an approach of improving future backshoring location decisions.



Page 9

iii

1. OFFSHORING AS A STRATEGIC DECISION FOR

LOWERING MANUFACTURING COSTS

`[...] Lower wages, a stable global economy, and rapidly growing local markets.

These factors combined to make nations such as China and Malaysia favoured

manufacturing locations.' (McKinsey 2008, p. 1)



Page 10

1

1.1. Definition

Offshoring is a phenomenon that occurred w ith the emergence of globalisation and can

be defined as international sourcing, w hich refers either to international procurement or

production abroad (Spulber 2007, p. 48), done for dif ferent strategic reasons. Most

commonly, relocations are accomplished in order to gain on cost advantages, especially

labour costs in offshoring business processes to Third World and developing countries.

There are tw o main types of offshoring, as w ell as other hybrid business models:

1. Offshore Branch/ Affiliate (also called Offshore Insourcing or Captives, to produce

abroad but inhouse), w hich means that companies create a w holly ow ned

subsidiary in another country, w here they hire local labour. This approach of

offshoring `by starting its ow n business in a foreign country' (Schniederjans 2005,

p. 5) is also used for entering new markets.

2. Offshore Outsourcing (to produce abroad on a B2B level, independent

contractors), w hich can generally be seen as `the movement of business

processes from inside the organisation to an international service provider'

(Duening 2005, p. 2), to countries like China, India, Eastern Europe or Latin

America. These fragmented companies do outsource business processes that

normally do not belong to their core competencies and w hich other specialised

businesses can accomplish better and more effectively (Kroll 2005).

3. There are other hybrid business models called Build-Operate Transfer (the benefit

of a supplier w ho know s the market, but the advantages of control and financial

benefits of a captive after takeover), Dedicated Center or Synthetic Captive

(similar to outsourcing, except that the offshore supplier gives the customer

greater control over the outside supplier's choice of employees), Virtual Captive or

Assisted Captive (the outsourcing arrangement covers the functions that support

employees but the personnel performing services are employees of the customer)



and Joint Venture (the customer and the offshore supplier jointly create a new

company to provide services to the customer) (Delaney et al. 2007 Volume One,

pp. 27-8).

Combining w ith w ork being done offshore can even happen unconsciously, w hen a U.S.-

based customer hiring a U.S.-based supplier engages in offshore outsourcing if the supplier

has the w ork performed in offshore locations. Many companies have engaged in inadvertent

offshore outsourcing by entering into a contract that does not restrict the location of

performance (Delaney et al. 2007 Volume One, p. 19).

Companies can offshore different parts and processes of their business. The most

common are information technology, softw are R&D, know ledge processes as w ell as

business processes, w hich does include manufacturing. This w ork w ill focus on the process

of relocating manufacturing w hich has beforehand been offshored to the international labour

market and then backshored afterw ards, as this is one of the processes that are most often

relocated.

1.2. Evolution of Offshoring

Suzanne Berger (2005, p. 10, 96) describes in her book that tough international

competition made companies look for new w ays to economise costs. The opening of the

w orld market w as mainly driven by the creation of international trade agreements and zones,

the sinking costs of transportation and communication as w ell as the accessibility of w orkers

in developing countries. Cost of transport dropped by a third betw een 1960 and the

millennium, due to the invention of containers and the creation of third-party logistics provider

(De Meyer 2008).

With these new opportunities, corporations w ould notably seek savings on labour

intensive processes w ithin their business. The new `Lego-Model̀ (Berger 2005, p. 74) w as an

additional driver of bringing production offshore, w hich is characterised as a modular system,

w here corporations `carried out few er and few er of the functions in the production process

w ithin their ow n w alls' (ibid, p. 74).

A shif t took place from products manufactured in-house in totally vertically integrated

companies, to the break open of the production process into modularity. Managers now had

the possibility to decide w here to produce w hat on the international marketplace in order to

get products and services w ith the highest quality for the low est price, because `today's

standard of excellence is not just best-in-class; it's best-in-w orld' (Corbett 2004, p. 4).

Berger gives a short overview about the historical background of offshoring:



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2

The first jobs relocated overseas in the 1970s were in industries requiring relatively low levels

of skil l : toys, clothing, shoes, printed circuit board assembly. By the 1980s, the increasing level of

skills that could be found in a number of low-wage Southeast Asian and East Asian countries, l ike

Taiwan, Malaysia, and South Korea, made it possible to set up more complex manufacturing

operations, like the hard-disk-drive industry in Singapore. (Berger 2005, p. 117)

The phenomenon of sourcing or producing abroad is therefore nothing new , w hat `has

caught everyone by surprise since the 1990s is the speed at w hich offshoring has taken hold'

(Scase 2007, p. 6).

1.3. Drivers and Reasons for Offshoring

One main driver of the process of modularity and the break up of the production process

w as competition w ithin a marketplace becoming more and more internationally resulting in

f iercer rivalry. Competition requires that today's organisations reduce costs and improve

quality to gain a competitive advantage (American Productivity & Quality Center 1997, p. 6).

This is the w ay companies try to survive, w hereas, offshoring is seen as a strategic decision

of achieving this superiority.

Going abroad in order to gain a competitive advantage has four different motivations:

1. Market entry into a foreign market,

2. Induced offshoring (follow ing ones' clients, notably in B2B relations),

3. Access to resources that are scarce and exhausted at home,

4. Low ering the cost of production (Berger 2005, p. 113).

Less important factors are tax advantages and subsidies as w ell as access to innovative

clusters and know ledge that make foreign production destinations more attractive. The

aforementioned reasons can also be in combination w ith each other, for example companies

seeking market entry to a low -w age country and at the same time benefiting from moderate



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3

costs of production. Often a w hole bundle of motives are influential for offshoring decisions.

The new EU-members especially in Eastern Europe and Asian countries are the most

popular target regions for cost driven offshoring activities. Offshoring for market and

customer reasons are mainly `targeted at Northern America and Asia, w hereas Western

Europe seems to be attractive for compensating for capacity bottlenecks or as source for

new technologies' (Dachs et al. 2006, p. 1)

When offshoring for cost reasons, the predominant interest of managers to produce

abroad besides low environmental standards, cheap rents and energy prices as w ell as tax

advantages, not surprisingly, are f inding w orkers at inexpensive w ages w ith limited social

benefits. Even in capital-intensive and highly automated industries such as the automotive

sector, corporations opt for relocation, although labour costs represent an insignificant

component of overall costs.

1.4. Offshoring Failure Analysis

Offshoring decisions made for market entry, follow ing clients and to obtain access to

scarce resources are less likely to fail, than offshoring implemented for low ering the costs of

production. This has been proven by a Fraunhofer Institute study of offshoring operations of

German organisations by Kinkel and Lay (2004). They concluded that cost driven production

offshoring has a higher risk of failing and even a negative quantitative impact on employment

at the home location (Kinkel and Lay 2004, pp. 9-10). Offshoring motivations other than for

cost savings tend to fail less often and do not have a negative impact on employment at

home.

A fundamental before considering relocating, is to reflect on the real costs of producing

abroad and not only to see inexpensive labour costs as a separate factor. There is a

deficiency in the analysis of the real overall costs, previous to the offshoring decision.

As described in James E. Austin's book (1990), this analysis needs to include:

o Economic Factors (labour, capital, infrastructure, technology and natural

resources)



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4

o Political Factors (instability, ideology, institutions, international links)

o Cultural Issues (social structure & dynamics, human nature, time & space,

religion, gender roles, language)

o Demographic Evolution (population grow th, age structure, urbanisation,

migration, health status)

Daniel F. Spulber (2007, pp. 6 - 8) def ined in his book a more modern approach on the

costs of doing business across international borders. He calls the four types of trade barriers

`the four Ts':

o Transaction costs (dif ferent cultures, different business practises, different

languages, unknow n markets)

o Tariffs and non-tariff costs (government trade barriers, economic nationalism,

subsidies, tariffs and quotas at borders)

o Transportation costs (freight, complicated logistics and supply chains, respond to

market)

o Time costs (longer cycle times w ith supply chains geographically dispersed,

adapting to new environment, slow er reaction time)

Below , the most common aspects I identif ied w hile looking at case studies and articles of

w hy offshoring engagements failed and w hat risks should be examined the most thoroughly

are further examined. As you can see in the graphic (f igure 1) I developed, the most

important factors that inf luence the failure of an offshoring engagement are being

summarised. The reasons are listed w ithout order, because for every company, depending

on size, products and processes, the w eight of each reason might be different.

Afterw ards, each aspect is elaborated further in order gain a more specific insight and

understanding w hy offshoring to low -w age countries fails.

Figure 1



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5

1.4.1. Culture

When analysing cultural factors for the failure of offshoring decisions in the first place, it

needs to be mentioned that already communication betw een tw o persons from dif ferent

cultures is more likely to fail than information exchange betw een people from the same

culture, because the recipient w ill interpret and understand the sender's message differently

due to another w ay of thinking and seeing reality. Language problems w ill reinforce this

condition, in spite of English being applied in business situations as a common language for

communication. Many ideas and concepts are not simply translatable from one language to

another and little face to face communication reinforces this problem, because nonverbal

messages get lost (Phatak 1983, p. 133)

Cultural differences, including aspects like pow er distance, individualism, masculinity and

uncertainty avoidance as described and analysed by Hofstede, have dif ferent dimensions in

dif ferent countries around the globe and have an enormous negative impact if not recognised

in management.

Employees on the other side of the globe have a different aw areness for quality issues,

urgency and the w ay business should be conducted. Many offshore engagements fail simply



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6

because of these cultural components.

1.4.2. Political Instability

To act on the assumption that political stability is as common as in the Western w orld, is

a big mistake. The analysis of the political reality is as important as the calculation of the cost

of labour. A repressive government hinders fruitful economic development in a dramatic w ay.

Bribery, corrupt officials and hold-ups are part of everyday life in other parts of the w orld,

w hich makes political stability become a valuable asset for making business. How ever,

although the possibility of a w ar break-out is the w orst case scenario, but not impossible in

countries w ith rebellious movements and extreme poverty of some of its population.

A recent example is the death of 2,473 people in India in 2008 from acts of terrorism.

Executives have been kidnapped or killed and `some multinationals have temporarily flow n

out their top expat execs out of India' (Lakshman 2008, p. 24), because of new w aves of

terrorism. This unstable environment means unexpected business interruptions for some

companies offshore.

1.4.3. Legislation

In dif ferent countries, different legislations are in force and therefore can have a purely

negative effect on doing business w ith an offshoring engagement, w hen not considered

beforehand.

A country like China does protect intellectual property (copy rights) differently as this is

the case in Europe and Northern America, w hereas sensitive information becomes even

more vulnerable w hen being exposed to this environment. Therefore, in particular innovative

and new products being manufactured in these countries w ill more likely become copied,

than w hen being produced at home. Even if most of the countries do have law s for protecting

intellectual property and businesses in general, the crucial component is the enforcement of

law and the support of the government in doing so. Not only the existence, but the

application of law has an enormous value for the success of offshoring activities.



When it comes to HR practises abroad, certainly, these do not resemble the ones in

industrially higher developed countries. Duening (2005, p. 200) discusses, that plenty of

foreign countries still haven't created `law s governing matters such as w orkplace

discrimination, sexual harassment, or privacy' (ibid, p. 200), w hich can easily be respected

w hen setting up a companies' ow n facilities abroad, but w ill become a major issue w hen it

comes to contracting. Sw eat shop and child labour practises common in certain countries

can severely ruin a good reputation of a brand, w hich is one of the most important intangible

assets.

1.4.4. Infrastructure

Even though taxes are low and property for setting up a plant is easily and for a small

amount of money accessible, this often doesn't include the costs, w hich need to be invested

w hen the infrastructure is not as sophisticated as at home. The gas and electricity grid,

highw ay and railroad netw orks, telephone service, police, and other public services are often

poor and unreliable. In some countries, roads simply do not exist or are in such a bad

condition, that companies do need to build their ow n roads for the transportation of their

manufactured goods as w ell as to supply their plant.

For the supply of electricity, pow er lines need to be set up at the cost of the organisation,

even current generators to be installed, because interruption of production are often due to

pow er breakdow ns or shortages in developing countries (Berger 2005, p. 125).

1.4.5. Supply Chain Management and Transportation Costs

When producing abroad and not in the home market anymore, a more sophisticated

supply chain management needs to be established, since the supply of the plant and the

delivery of f inished goods beyond international borders requires a more mature planning.

Consequently, this adds up to the costs.

It needs to be considered, that long distance supply chains are more vulnerable and

exact time schedules are more diff icult to foresee w hen seafreight is the w ay of transporting

goods to Europe or America. Not only is the time an important component of supply chains,

but also an immature infrastructure as above mentioned. When a big w hole in the middle of

the road makes it almost impossible for the supply truck to reach the plant in time, a reality

check on the infrastructure is needed. The impact of production interruptions, idle times,

penalty paying or overtime, raises the overall costs dramatically.



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7

Other costs occur for buffer stocks, the risk of obsolescence of the products, running out

of stock and the costs to bear, w hen sw ings in demands and evolution in technology can less

f lexible be reacted to (De Meyer, Holw eg 2008).

The International Labour Off ice (2008, p. 7) argues that energy prices have been

increasing by more than a third w ithin tw o years betw een 2005 and 2007 and oil prices

continuing to increase w ith speed and reaching a peak in the middle of 2008, before sliding

back. How ever, increasing demand and scarcity of oil as a resource w ill lead to further

increase in energy prices in the long term. Bulky and heavy products are more vulnerable to

fuel costs (Gandall 2008), as w ell as cheap goods, w here transportation adds up signif icantly

to the final price (Aeppel 2008).

Not only do the transportation costs for shipping the finished goods over the ocean to

their destination have an impact on costs, but increasing oil prices have affected the price

manufacturers pay for raw materials too. The costs for transportation might even be higher

than the actual price for the raw material: Shipping a ton of iron from Brazil to China costs

about $100, w hich is more expensive than the resource itself (McKinsey 2008, p. 1). This

development w ill have an irreversible effect on long distance supply chains, international

trade and offshoring decisions.

1.4.6. Tariffs and non-tariff costs

Even though in the event of globalisation, trade barriers have been going dow n and made

international business easier, various types of tariff and non-tarif f barriers to trade remain

(import quotas, product standards, subsidies, voluntary export restraints, licensing).

Interestingly, importing to developing countries tends to require more signatures and

documents than to developed countries, w hich is an important time and f lexibility factor

adding up to the cost of manufacturing abroad (Spulber 2007, pp. 19-20).

Importing goods to OECD high income countries takes an estimated 14 days, w hereas

importing to the Middle East & North Africa, can take up to 43 days (see appendix 1). The

physical infrastructure (port and terminal handling and inland transport) is the reason for one-



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8

quarter of trade delays, w hereas process costs (prearrival document preparation, customs,

inspections) make up for half of the time (The World Bank and the International Finance

Corporation 2006, p.54). Especially for new and innovative consumer goods, these delivery

times might be too long and w ill make the offshoring engagements fail.

1.4.7. Labour and workforce management

The access to inexpensive and skilled w orkers in low -w age countries is one of the major

aspects, w hy organisations decide to offshore parts of their business processes.

Unfortunately, in most cases shif ting w ork from a w orker at home to an employee in an

economically fast developing country is not as easy as it seems, even though w orkers might

be skilled and w ork is basic and requires a minimum of training.

Turnover rates at offshore destinations have become an important issue. Those w orkers

that have the greatest talents, skills and competencies w ill leave f irst, `since they are the

most heavily recruited by the competition' (Testa 2007). Workers w ill change w ork simply for

the reason of getting paid more at another company, even though the dif ference in pay is

minimal. There is a lack of employees w ith previous experience of carrying out product

transitions. The w orkforce is in need of skills that w ould make new -product introduction

smooth (Berger 2005, p. 234). The transfer of know ledge inherent in the human capital is a

critical issue in this high speed economic environment.

Another important aspect is the difference in culture of the employees and management

abroad. This becomes an important issue, if the culture of the home company is one of the

most important factors of success. This can be the case, w hen quality and reactivity are not

seen as important as in the home country, because the cultural background of the offshored

destination does not see these issues as important.

In some countries like India, local employees surprisingly have a relatively high level of

education, hold a high school degree or even a college diploma. How ever, w hen w orking



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w ith less trained and skilled w orkers, productivity and efficiency of the manufacturing process

is more likely to suffer, w hich is often the case in manufacturing. The capacity of reducing

w aste and using resources to the fullest are less developed compared to w orkers in the

Western World (lean production). The ability to see problems and to find solutions for the

elimination of the obstacle is low er than at home. Plus, the w orkforce might not be able to

maintain the equipment as required. The consequences can be long production dow ntimes,

because technical support is not quickly enough available, high w aste of resources and

minimal learning curve effects. All these issues result in low eff iciencies and low productivity

compensating the savings for low cost labour.

1.4.8. Overheads and coordination costs

Most of the companies offshoring have experienced high expenses for overheads and

coordination costs, for managing the manufacturing process abroad, eating up the savings

on labour cost. This includes not only travel expenses for managers in order to update on the

current status of the plant or to help develop the contractor to meet certain standards.

Costs for the expatriation of managers (accommodation, bonuses, f lights) as w ell as their

families w ho w ill accompany them have an enormous impact. Finding appropriate local

managers is a dif f icult undertaking and not all companies are able to hire good employees

that are able to continue the culture of the organisation necessary to create the desired

product. This is especially the case if high quality standards and short delivery times need to

be respected.

On top, w orkforce in developing countries needs more close supervision than in

developed countries and therefore, more supervisors are required, multiplying costs.

1.4.9. Unit Labour Costs

When companies realise, that their offshore engagement or plant hasn't turned out as



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10

promising as expected, they often did not take into account, that the price of labour as adecisive cost factor alone, is not enough an argument for producing abroad.

It is important to have a closer look at the unit labour costs, `the value of labour needed to

produce a unit of a product or a service' (Berger 2005, p. 119), w hich is certainly much

higher in developing countries, as equipment is ancient, efficiency and productivity of the

w orkers are low er, more supervisors are needed and quality is often not comparable. When

more in depth calculations regarding the unit labour cost had been made, few er

organisations w ould have considered offshoring in the f irst place as a real w ay of reducing

costs. Even though w orkers in the USA or Europe are paid significantly more as w orkers in

India, China or the Philippines, the actual labour cost for a unit manufactured are in some

cases even low er in high-w age countries.

Birnbaum (2000, pp. 19-26) gives a plausible example for proving, that labour and

manufacturing costs are w ithout a huge direct impact: The Five-pocket 501 jeans made in

South Korea by a sew er paid $7.50 and hour and an Indonesian w orker paid $0.20 an hour.

Interestingly, the F.O.B. (Free on Board) price w as only 15 per cent higher for the South

Korean made fabric, although their w ages w ere 3,750 per cent higher. He reasons, that total

costs of direct labour amounts to only about 3 to 4 per cent of the price of the product w hen

it's f inally loaded onto the ship, or about 0.75 per cent of the retail price. Therefore, the

impact of labour on costs even in labour-intensive industries is low .

1.4.10. Distance and Quality

The physical distance to the production plant as w ell as to the outsource provider leads to

several disadvantages, w hich have an enormous impact on the success of the global

sourcing. Time in relation w ith distance are the most obvious causes of communication

problems, as the plant or contractor abroad are typically in different time zones. The èvery

day direct contact is limited to the w orking hour overlaps' (Walter, Murray 1982, p. 38-19).

Furthermore travel costs to visit the production site abroad are high and are easily to

directly make out as expenses that compensate savings. The situation w ill be w orsened,



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11

when obtaining a visa for visiting the offshore destination may require w eeks and a lot ofadministrative w ork.

A lack of control and dependence by the client as described in Schniederjans (2005, p.

29) can occur, w hich can lead to a loss of f lexibility in observing and controlling business

actions, final product and contractual problems by the client manager in the home country. In

particular offshore outsourcing engagements carry a certain risk, that the customer's

business, the available technology, and the competitive and regulatory environment may

change dramatically (Delaney et al. 2007 Volume One, p. 17). The w orst case scenario

occurs, w hen the supplier decides not to develop the capabilities the customer w ill need in

the future.

Delivery times in combination w ith long distances are crucial, w hen innovative and new

products are manufactured abroad, that needs to be put on the market very quickly, because

consumers w ant them to buy now . If reactivity as an important success factor is impaired due

to distance and the process of putting goods on the market takes too long, consumers might

sw itch in the meantime to competitors' products.

Quality problems are ranked the No.1 issue of offshoring activities by managers. Quality

control issues are crucial for high standard products, especially w hen detected after being

transported from Asia to Europe or the USA. High costs occur for securing and controlling

quality abroad as w ell as the coordination costs for maintaining product and process quality

(Kinkel et al. 2008, p. 10-11). Low product standards w ill lead to extra follow -up w ork for the

company at home, such as detecting defective items and dealing w ith customer returns,

w hich w ill increase costs and decrease productivity even further.

1.4.11. Intangible reasons

Not only are direct and indirect costs for offshoring engagements and manufacturing

inf luencing failure and success of these, but also intangible factors have an important impact.

Consumers have been developing a certain consciousness about how the products and

services they consume have been produced, sourced and under w hat circumstances.

Manufacturing in low -w age countries like China can damage the reputation for brand

integrity, because consumers are buying a good conscious w ith the product they obtain. The

public is concerned in particular about `tainted and potentially dangerous products' (Katz

2008) manufactured abroad.



On the one hand, a `Made in Germany' or `Made in USA' tag represents an intangible

value, w hich can't be reached w ith a label saying Made in Asia, Africa or Latin-America, as

the countries on these continents are unconsciously referred to low -w age but also low ethical

production methods (child labour, low w ages, punishment) by the consumer. On the other

hand, `Made in ...' of certain countries, stands for quality, that consumer are seeking and

w hich is an important marketing instrument.

Furthermore, w hen offshoring decisions have been made, it had happened that in

particular large companies become imaged negatively by the media. This is mostly the case,

w hen a certain amount of job losses in a region are due to relocation of production of a

company. Not only w ill customers be concerned about loss of jobs in their country, but on the

remaining employees this w ill have an effect on their motivation and consciousness

regarding long-term employment.

Other disadvantages of producing abroad are lost time eff iciencies, longer respond times

to demand, longer delivery times and lead times due to distance. A less common risk, but not

to be ignored is the possibility of the offshoring outsourcing contractor taking over the

business and starting producing, distributing and marketing the products himself.

1.4.12. Changing environment

When talking about developing countries, it is important to take into account that the

economy of offshoring destinations is developing to a more and more sophisticated level in a

fast pace. Offshoring might make sense for a spell of time, but w ages and living standards

w ill constantly rise and might even get to the same level as at home and make the actual

reason for offshoring low ering of production costs invalid. De Meyer (2008) elaborates in

an article, that in China, a w ell trained middle manager in the automotive industry, speaking

English and Mandarin, w ill earn more in Shanghai than in Wolfsburg or in Birmingham, w hich

is due to w age inflation rising up to 25 per cent annually in some regions, like in Bangalore or

Pune. Once more, strengthening currencies as the Yen make offshore manufacturing even

more expensive.

The Global Wage Report (2008) show s, that this is in particular true for China, w here the

average annual real w age grow th betw een 1995 and 2000 has been 9.43 per cent, and

betw een 2001 and 2007 even 12.93 per cent. Wages have been grow ing even faster in the

new millennium, w hich is directly linked to economic grow th (see appendix 2). Globally,

w ages have been grow ing an average of 1.9 per cent betw een 2001-07 (International Labour

Office 2008, p. 12).



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12

Dossani (2008, p. 95) goes even farer in making the assumption, that if w ages in Indiacontinue their annual 12 per cent rise w hile U.S w ages increase at 2 per cent and the

exchange rate stays stable, the gap w ill close in about tw enty years. Of course, this may be

an unrealistic projection, since both supply and demand parameters can change. But it

indicates that sending w ork to India to save on labour costs is valid.

The chart (f igure 2) below taken from the TheMcKinseyQuarterly (September 2008)

underlines how much w ages have been rising, remarkably betw een 2003 and 2008 by

show ing the average annual w age inflation. China and Brazil are the countries w ith the

highest annual w age inf lation in the last 5 years. Furthermore, China still has the low est

average annual w age in $ of the countries show n. The diagram proves the fact that low -w age

countries quickly catch up on w ages.

Figure 2

(McKinsey 2008, p. 2)



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13

The second chart (f igure 2) developed also by McKinsey (September 2008, p. 3), show s

the total landed costs for a midrange server, manufactured in Asia and the United States. In

2003, manufacturing this product in Asia rather than the U.S. contributed a 60 per cent

savings in labour expenses. Labour savings are indexed to $100. By calculating total landed

costs, it is not surprising, that 36 per cent of those labour savings w ere counterbalanced by

freight, shipping-related charges, inventory, product returns, and other expenses. That gave

producing in Asia a $64 landed-cost benefit. Due to today's economic conditions, this

advantage has reversed: After subtracting the increased labour and freight costs, the former

savings of producing offshore have become negative (an extra cost of $16). When

comparing the labour savings ($100 in 2003, $45 now ) w age inflation, increased freight costs

by $21 as w ell as product returns by an additional $4 have caused this evolution because of

higher energy prices.

Figure 3



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14

(McKinsey 2008, p. 4)

1.5. Summary

The first part of the thesis highlights the theoretical background of offshoring and the

reasons w hy offshore engagements fail.

Offshoring of production to developing low -w age countries occurred w ith the emergence

of globalisation (Spulber 2007, p. 48), in order to gain on cost savings. Companies can

offshore in setting up their ow n production facility overseas (offshore branch/ affiliate)

(Schniederjans 2005, p. 5) or by contracting an offshore outsource provider (offshore

outsourcing) (Duening 2005, p. 2). Other hybrid models exist.

International competition, the opening of the w orld market and sinking costs for

transportation as w ell as communication have driven offshoring since the 1970s. The

production process broke open into modularity, w hich w as the end of totally vertically

integrated companies and the beginning of getting the best products w ith highest quality for

the low est price on an international scale (Berger 2005, pp. 10, 96).

Offshore engagement decisions are not only taken for low ering costs of production, but

as w ell for market entry, follow ing clients and access to scarce resources that are exhausted

at home (ibid, p. 113). How ever, the new EU-member countries, Eastern Europe and Asia

are most popular target regions for cost driven activities (Dachs et al. 2006, p.1) , w hich tend

to fail more often than offshoring decisions made for other reasons (Kinkel and Lay 2004, pp.

9-10).

Overall, companies do not reflect on the real costs of producing abroad. Cultural

problems, political instability and insufficient legislation play a big role; w hen communication

problems lead to business interruptions, economic development is hindered by a repressive

government or the protection of intellectual property is not enforced. An underdeveloped

infrastructure makes it diff icult to supply the plant and high energy prices have a negative



Page 24

15

impact on transportation costs and the final product. Tarif f and non-tariff costs have to be

considered, for example w hen importing goods takes up to a month because of complicated

processes at borders (Spulber 2007, pp. 6-8). Labour and w orkforce management in

developing countries is more demanding, because of high turnover rates, low productivity

and eff iciency as w ell as dif ferences in culture. Overheads and coordination costs add up,

w hen expenses for expatriation of managers, travel costs and close supervision of the

overseas w orkforce are taken into consideration. What companies need to look at are the

unit labour costs `the value of labour needed to produce a unit of a product or a service'

(Berger 2005, p. 119), w hich are certainly much higher in developing countries. The distance

to the offshore manufacturing plant becomes a disadvantage considering different time

zones, lack of control and f lexibility (Schniederjans 2005, p. 29).

Long delivery times combined w ith quality control problems are the main reasons w hy

offshore engagements fail. Other reasons are the damage of reputation, being imaged

negatively by the media and the sign `Made in China', that consumers refer to as unethical

production methods and job losses in developed countries. Even if the offshore activity is

prof itable, the evolution of the offshore destination is often not taken into consideration w ith

constantly rising w ages, increasing living standards (International Labour Off ice 2008, p. 12)

and depreciation of the currency. Therefore, manufacturing a certain product in a low -w age

country might not be as profitable anymore as it w as a couple of years ago, due to increased

labour and shipping costs (McKinsey 2008, p.3).

2. THEB ACKSHORING TRANSITION AS A RELOCATION

REACTION TO A FAILED OFFSHORE PROJECT



16

Òffshoring is an innovation, organisations experiment. They reassess, stumble,

make mistakes. [Backshoring] is a natural phenomenon of this large economic

change we're going through.' (Carmel 2007)

2.1. Definition

Backshoring is a process after an offshoring decision has been made beforehand, w hich

has either failed or is not as profitable as before anymore. More narrow ly def ined, it is a

location decision, w here the business process or function w ill be brought back home. An

offshoring decision had to be foregone by a backshoring decision.

The business process or function w ill be repatriated completely or partly to the country

w here the head quarters are situated (Renz 2005). It needs to be dif ferentiated betw een

direct and indirect backshoring:

1. Direct Backshoring is the process of fully integrating the process and function that

has been offshored beforehand into the ow n production.

2. Indirect Backshoring is the process of backshoring a process of function for

concentration at the home location. This is the case, w hen local suppliers are

preferred and contracted for sourcing. Integration into the ow n production does

not take place.

Typical for carried out backshoring decisions are 3 phases over a period of time.

1. The first phase is the phase of relocating processes and functions abroad.

2. The second period of producing and manufacturing offshore.

3. Finally, the third period of backshoring to the home country (Renz 2005).

Renz describes in his diploma thesis (2005) the first phase as making a location decision,

w hich is marked by relocation to low -w age countries. Then the phase of producing abroad is

reached. This second phase ends, w hen the in phase one taken location decision w ill be

rethought, reassessed and finally modif ied. The last phase is presented by relocating back

home, w hereas a new international location decision w ill not be taken in favour of the home

country. Capacities w ill be directly or indirectly shifted back.



Page 25

2.2. Evolution

A backshoring decision can only be taken if an offshoring decision along w ith a period of

manufacturing and production abroad has foregone. Therefore backshoring is a

phenomenon that occurred after offshoring appeared.

Mouhoud (2007, pp. 42-43) identif ies in his book four characteristic w aves of industrial

backshoring that appeared in the last 30 years:

The first wave appeared at the beginning of the 1980s, w hen companies like National

Semi Conductor Corp., Motorola and General Motors relocated back to the USA their

production and assembly units, w hich had been offshored to Indonesia, Singapore, Malaysia

or Hong Kong. The reason for this is the automatisation of production, so that unit costs have

become as competitive in the United States as in the countries offshored (ibid, p. 42).

The second wave is characterised by German companies relocating in the first half of the

1980s w ithin the electronics industry. AEG for example has backshored production of its

electronic devices and consumer electronics from Mexico and the Philippines and Bosch

brought production home of its video cameras and electronic devices from Taiw an, Mexico,

Venezuela and Guatemala (ibid, p. 42).

The third wave comprises European organisations in the 1990s in the electronics,

computer and textile and leather garment industry. The author mentions French companies

like Nathan, Bull, Dassault Automatismes, ADDX and SAGEM as w ell as the w atches (Ope,

Lannion), glasses (Essilor), clothing (Caroll, Naf Naf), shoes (Kickers, Kélian) and office

furniture (FRCharett) industries (ibid, p. 42).

The fourth wave of backshoring in the years 2000 responded to the increase of offshoring

activities of service and rationalisation w ithin organisations because of market constraints

and stockholder's prof it distribution. Quality problems of relocalised services and

manufacturing w ere risking letting companies lose their competitive advantages and made

them shif t production back home. In the manufacturing industry, Philips backshored in 2003

its units beforehand relocated to Spain and rationalises its organisation in concentrating

production in its big production plants in France and Germany. The same happened w ith

Nokia, that closed its plant in Spain in order to consolidate business units back in its home



Page 26

17

country Finland (ibid, p. 43).

2.3. Drivers and Reasons for Backshoring

Backshoring as a definition is used, w hen an offshoring process has been foregone. The

reasons w hy companies do consider backshoring are mainly, because the offshoring project

has not been as successful as hoped. As cheap labour is the most important reason w hy

companies offshore, this comprises that cost savings have not been as effective as

imagined. Production offshore failed.

Another reason is that the economy and environment of the offshored destination has

undergone a change w ithin the years and cost savings are not as effective anymore, due to

w age inf lation and the rise of transportation costs. Although outsourcing and offshoring

transactions may be dif f icult to reverse because the offshored function and process is diff icult

to rebuild and furthermore, `the transition to a new supplier is risky and requires the

incumbent supplier's cooperation' (Delaney et al. 2007 Volume One, p. 18), backsourcing

and backshoring is a strategy that has w orked for many companies.

Overby (2006) describes in his article, that at the start of an offshore relationship it needs

a big amount of effort in time and resources to get the engagement up and running fluently.

Normally a manager is responsible to look after the offshore activity and taking regular trips

overseas to develop the supplier relation or to make things run smoothly at the captive

abroad. The f irst couple of month, this effort of travelling back and forth w ill w ork out, but

after a couple of years, employees become physically and psychologically tired of

maintaining this relationship called òffshore fatigue' (Overby 2008).

A permanent and continuous re-evaluation and renew al of the process offshore is

required and it is important to maintain that level of attention. Close monitoring is not only

limited to the start-up phase, but needs to be maintained for the w hole period of offshoring. If

companies do not have the capacities (e.g. to expatriate a manager in order to oversee the

relationship onsite) or w illingness to continue the offshore relationship, a backshoring



Page 27

18

strategy should be taken into consideration.

The first part of the thesis highlighted the most important reasons w hy manufacturing

overseas has not succeeded or w hy a changing environment of the abroad destination letting

companies rethink and reassess their offshoring decision (coordination costs, higher unit

labour costs, changing environment etc.). Figure 7 summarises the drivers and conveniences

of w hy companies consider backshoring amongst others as a new strategy for creating

value.

Figure 4



Page 28

19

A study by the Fraunhofer Institute (Kinkel and Maloca 2008) revealed w hat the main

reasons are for companies backshore and how the importance of their motives has changed

from 1999 to 2006. The survey has been conducted on German companies in the Metal and

Electronics industry as w ell as in the manufacturing industry, but is representative for

backshoring reasons in general, because in numerous case studies and articles the same

reasons for sourcing back home again can be found.

First of all, every fourth to sixth offshore decision w ill be reversed and backshored w ithin

the four to f ive years after the decision w as made. As figure 5 indicates, the lack of f lexibility

and the ability to supply as a reason for backshoring has increased sharply since 2003. 72%

of the companies surveyed mentioned this factor as the most decisive in 2006. This is

certainly caused by delivery dif f iculties due to long distances to the manufacturing destination

(ibid, pp. 5-10).

Secondly mentioned are quality problems (61%) of products manufactured abroad, w hich

are essential for backshoring decisions. Great efforts for maintaining quality control and

supervision of the manufacturing plants of products and processes abroad ref lect this

motivation, w hich made the offshore production very costly. Since 1999 this reason has been

evaluated w ith the same importance by the companies interrogated (ibid, pp. 10-11).

High costs of coordination (16%), insufficient infrastructure (15%) and lack of qualif ied

personnel (9%) are the reasons that follow , but have clearly less impact on the backshoring

decision than quality and f lexibility. These motives have lost their importance. The decrease

of costs of coordination might be due to learning effects and a more realistic assessment of

this cost factor, w hereas the impact of infrastructure might be due to improvements w ithin the

offshore destinations (ibid, p. 11).

The decreasing importance of the availability of qualif ied personnel might be due to the

increase of the employee's qualif ication level in low -w age countries. On the other hand, the

lack of highly qualif ied personnel in the home country (e.g. in IT and engineering) could be

the reason, w hy this reason is not as relevant as it w as before w hen it comes to backshoring

decisions (ibid, p. 12).

Even if the qualif ication level of the w orkers is relatively high, as this is the case in the



Page 29

20

new EU member states, `this can often be "outshined" by the implicit expectations resulting

from long years of experience w ith qualif ied personnel at the home location' (Dachs et al.

2006, p. 11) and ending up in disappointment w ith the low quality of the production from

overseas.

Figure 5

Reasons for Backshoring on a time line, example for the German manufacturing sector and

Metal and Electronics industry

(Kinkel 2008, p. 10)

2.4. Bringing Production back Home Strategically



21

2.4.1. When to Backshore

Corbett gives a general explanation w hen companies should stay offshore or rather shore

back:

In the end, organizations should [...] make an ongoing investment of time and talent to learn

how to create and leverage long-term relationships with outside companies-- relationships that

wil l become an integral part of their strategic, tactical, financial, and social fabric. Similarly,

organizations should [...] make the investment needed to learn how to successfully integrate

elements of businesses running at significant distances and under differing cultural and legal

frameworks. It goes without saying, then, that they should not outsource offshore unless they are

prepared to do both. (Corbett 2004, p. 48)

However, before a corporation changes its strategy, it is important to determine the total

cost of each item manufactured overseas. This includes to examine `shif ting trade-offs

betw een cost savings from offshoring (such as low er w ages) and rising logistics charges'

(McKinsey 2008).

When companies w ant to backshore, it is important to not only look at single cost factors,

w hich is also true for offshoring decisions. The importance of speed and f lexibility of supply,

the availability of skilled talented employees and the potential for further productivity gains in

the low -w age country need to be assessed. Another important issue is the one-time

transition costs (e.g. for facilities, employees, machines), w hich add up for the shift f rom

producing abroad to manufacturing at home, especially w hen facilities and machines need to

be set up, refreshed or maintained, employees to be recruited and internal specif ications to

be defined.

2.4.2. One-time Transition Costs

The decision of backshoring or changing the current sourcing strategy in general, alw ays

includes one-time transition costs that might have an impact on the decision process and the

type of backshoring arrangement (direct or indirect). Although one-time transition costs w ill

not be as decisive as other factors, they can be very important depending on the general (in

particular f inancial) situation of the company. Initial costs w ill vary dramatically from one

individual case to another and they are diff icult to establish.

One-time transition costs w ill be higher, w hen production w ill be brought back inhouse,

because facilities and machines have to be set up or repaired, employees to be hired and

processes to be integrated into the internal functions. When contracting domestic suppliers,

the w hole process w ill be simplif ied and w ill have less impact on these costs than bringing



Page 30

production back inhouse. How ever, w hat the right type of backshoring w ill be depends on the

individual evaluation of the situation, environment and business model.

Costs to be considered for integrating the production inhouse:

- Project Team (to engage in the organisation of the transition)

- Set up or maintenance and repair of production plant and machines

- Integration of processes linked w ith manufacturing w ith the other business functions

(HR, Finance, Logistics, Supply Chain Management, Plant Management, Quality

Control etc.)

- Recruitment and reassignment of employees

- Set up and equipping new off ices and facilities for new employees

Costs to be considered for contracting a domestic supplier:

- Project Team (to engage in the organisation of the transition)

- Costs for assessing new contractors and contractual issues (meetings, travel,

communication costs, law yers)

- Harmonisation w ith new supplier (softw are, product and quality requirements)

Costs to be considered if offshore engagement was a captive or a contractor:

- Costs for selling existing plant and machines and laying off offshore w orkers

- Costs for terminating the contract w ith the offshore supplier (e.g. penalties)

2.4.3. Strategic Decision-Making

For making the decision w hat to do about the production offshore, a holistic view and

evaluation is needed, in order to choose the right manufacturing location. There are certain

categories that help to indicate w hether shif ting production back home is a reasonable

decision or w hether keeping manufacturing offshore is the sounder one. The four categories

are Product Specifications, Company Specif ications, Further Potential at offshoring location

and the Base Case (costs for producing home vs. producing offshore).

2.4.3.1. Product Specifications

The specifications of the product w hich is being manufactured offshore are the most



Page 31

22

important w ith regards to the reassessment of the production location because some

products are more suited for offshoring or backshoring than others.

The maturing stage of a product can determine the location decision of the product. If the

good has the characteristics of a Cash Cow or Poor Dog (see Appendix 3 for the BCG-

Matrix) w ithin the product life cycle and only slight improvement potentials w ithin the

maturing process are possible, the production should stay offshore. This is true as-w ell for

items that have been in the market for a long time and tend to be subject to a particular cost

pressure inducing utilisation of additional cost-saving potentials, w hich might only be found at

low -w age countries. If the product is very innovative, new on the market and high in demand,

requiring a sophisticated technological standard combined w ith unpredictable future demand,

domestic production might be the best solution. This is in particular true for offshore

destinations, w here copyrights are not in place and new innovative products can easily be

reproduced and sold.

The complexity of the product is another important issue. Simple and very complex

products (e.g. assembly of very small parts like computer chips) are more suited for

backshoring activities. The f irst can be effectively produced at home w ith highly automated

and standardised production processes. For the complex product, highly qualif ied w orkers

that have build up skills and `several dif ferent service inputs are needed' (Dachs 2006, p. 13),

w hich are more easily and at a higher qualitative level to find at home. In brief, w ell-defined

production tasks w ith a low level of complexity should stay offshore.

Labour intensity of the fabrication process of the product determines location decision

strongly. On one hand, the impact of labour has an inverse proportion: à low er labour

intensity implies a higher probability to offshore parts of production' (ibid, p. 12), because the

limits of cost saving potentials through modernisation and automatisation are being reached.

Labour productivity cannot get any higher at some point, w hich is in particular true for mature

products. Therefore, mature products, but w ith low labour intensity are better off offshore. On

the other hand, very labour-intensive products are better being produced overseas as w ell,

because of the economies to be realised through low w ages.

The impact of transportation on the product is the next factor. The more heavy and bulky

the product is, the more transportation adds up to the costs (Gandall 2008). `The cheaper a



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23

product, the more significant transportation costs are in the f inal price' (Aeppel 2008).

Further, the duration of shipping is remarkably important for some type of products (see

maturing stage), w here speed and f lexibility are essential for selling the item successfully.

The size of the production series can be determining as w ell, if the product is more suited

for producing at home or overseas. Small series of production can be manufactured more

cost effectively at home. This is especially true for customised items and small production

runs that w ill be produced in a limited amount, w hereas large production series of mass

market products are better suited for staying offshore. The reason for this is that domestic

w orkers are more experienced w ith changing the production run and w ith adjusting the

machines for a new production series, w hereas offshore plants and w orkers w ill need a

significant amount of more time to adjust the machinery for a new production runs.

The last important point is the characteristic of separating the production capacities. If the

production is not separable, bringing manufacturing back home w ill be a reasonable choice,

because being obliged of making the w hole product abroad increases risks concerning

quality, control and flexibility. If the production can be separated into parts, staying offshore

might be the w iser decision.

An additional issue is the extent the process relies on the infrastructure. As all

manufacturing activities rely heavily on the local infrastructure (supply and transportation of

raw material and finished goods), this argument is only for completing the list.

2.4.3. 2. Company Specifications

The companies' characteristics play another important role of revaluating and

reassessing the offshoring activity more in-depth in order to make a decision about the best

manufacturing destination in the future

The importance of speed and flexibility for the business model is decisive for analysing

the current offshore production. These characteristics can only be realised w hen producing

at home, because the long distance to the overseas captive or contractor does not allow a

speedy and flexible manufacturing process.



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24

Dachs (et al. 2006, p. 1) described, those larger companies w ith a high share of very old

products in turnover, `hence w ith only slight improvement potentials in the underlying mature

production process', tend to delocalise parts of their production processes more often than

others. Consequently, if the share of old products in turnover is very small, backshoring is the

best solution. The higher the share of old products manufactured offshore, the more cost

savings can be realised. With only a small number of mature products, economies could

become irrelevant and production at home even more attractive.

The size of the company matters, because bigger companies tend to have more

resources available for managing the shift f rom offshore to producing domestically. These

are the f inancial resources for the one-time transition costs (see one-time transition costs),

as w ell as the human resources for managing the shift smoothly. The more profound

experiences regarding changes of strategies and know ledge about outsourcing or integrating

functions and processes back even on an international scale the company has, the more

successful the transition w ill be. In general especially big companies can benefit from this

know ledge.

Certain communication restraints have a heavy impact on the backshoring decision. If the

need for voice contact w ith employees, suppliers customers and business partners at home

is necessary, or w hen the offshored process is interdependent w ith the processes that w ill be

performed during US or Europe business hours, another strategy should be pursued. In

addition, an increased tendency to backshore occurs, w hen necessary documents cannot be

`moved around electronically in suitable time periods or w here resources must be located in

the US or Europe' (Delaney et al. 2007 Volume One, p. 21).

In addition, expenses for Research and Development are an essential indicator for taking

another strategic decision. When R&D expenses are high, this means that the company has

a portfolio w ith many new and highly innovative goods that are better produced at home,

because of legislation issues and developed skills as w ell as competencies necessary for

manufacturing these products.

2.4.3. 3. Further Potential at Offshoring Location



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The status quo and the future potential at the offshoring location is part of the

backshoring decision making process beforehand.

If clustering of the industry has taken place or w ill take place soon at the offshore

destination, then backshoring should not be considered. This is in particular the case, if the

company relies on that cluster and on the closeness to other companies, business partners,

suppliers, clients and others abroad. If clustering is not an issue, then it has more impact on

a backshoring decision.

The question of w hether is any further potential for productivity gains at the offshore

destination should be assessed. When w ages increase, but the productivity and quality stays

the same, then the offshoring activity needs to be questioned. How ever, if there is a positive

evolution regarding productivity and if potential for productivity gain exists, production should

be kept overseas.

What is the situation regarding the availability of skilled employees, to retain w orkers at

the plant and to build up skills, experience and therefore increasing quality? It needs to be

assessed how this issue w ill probably evolve in the future. If employee turnover w ill become

a more serious issue in the future and w ill not evolve positively, production at home makes

more sense in the long run.

The evaluation of the overall continuous evolution and improvement in general of the

offshore activity is essential. This includes the question if the offshore outsourced process

stays static or if the captive does not improve business performance. Technology, skills,

management methods, communication and other factors can be considered for this point.

With benchmarking and comparing certain aspects to other businesses, the overall evolution

and improvement can be measured.

The evolution of the infrastructure, legislation and political stability is another important

aspect of the improvement potential of the external factors of the offshoring location. This

implies that the infrastructure evolves, law s are being created to sustain economic grow th

and protect businesses and their ideas, as w ell as a decrease of bribery and corruption. If

these external factors are evaluated positively, businesses should rather stay offshore.

2.4.3. 4. Base Case



26

When evaluating manufacturing offshore vs. backshore, companies need to establish the

f inancial baseline indicating how much it w ill cost to produce inhouse and providing that

service for itself or to outsource manufacturing to a supplier at home, in order to be able to

evaluate w hat decision makes sense most f inancially.

Establishing the so called Base Case on an ongoing basis has been described in

Delaney (et al. 2007 Volume One, pp. 364-5) and helps to understand the current cost model

and gives a detailed overview of the costs associated w ith providing the service in an

offshored environment and non-offshored environment. The Base Case can be seen as a

tool for assessing more in detail w hich manufacturing model and location is the best one.

The Base Case should include the follow ing costs (can vary depending on the products

and companys' requirements)

- People costs (salaries, taxes and benefits),

- Technology costs,

o Softw are (depreciation, license and maintenance costs

o Equipment (depreciation, lease and maintenance costs)

- Third party service costs (disaster recovery, business continuity services, archiving

services and consultants,

- Facilities costs (depreciation, rental, maintenance, utility costs),

- Corporate overhead costs (payroll, legal and contracts management),

- Travel and training costs,

- Office equipment and supplies (ibid, pp. 364-5)

Furthermore, it is important to estimate, w hich costs had been paid by the offshore

supplier, w hich might get paid by the contractor at home and w hich w ould be paid by oneself,

if production w ould be fully integrated inhouse. Therefore, certain assumptions have to be

made to complete the Base Case depending on how the backshoring activity w ill be

integrated back home:

- Personnel that has not been fully dedicated to manufacturing abroad being brought

back home.

- Costs for items and services that are shared across multiple processes and functions.

- Projections and assumptions about future volume requirements for the process to be

backshored.

- Resources needed to effectively manage my process inhouse or outsourced at

home? (ibid, pp. 364-5)



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2.4.3. 5. Decision Questionnaire

The follow ing questionnaire in the form of an Excel table based on the strategic decision

making specifications section and is a tool for helping to evaluate the offshore activity. Each

score of a category (Product Specif ications, Company Specifications, Potential at Offshore

Location and the Base Case) has the same w eight on the f inal score, even though some

categories have more or few er questions to be answ ered.

The questions or statements need to be answ ered w ith either YES or NO. For Yes,

number 1 needs to be filled in, for NO, number 2 needs to be f illed in. When using the

original excel spread sheet, for each category, an average score w ill be calculated w ith the

Median method. Therefore the answ ers that w ere most often given (either YES or NO) w ill be

taken into consideration. For the f inal score, the mode of all 4 categories w ill be calculated

and w ill indicate the f inal outcome of that questionnaire. As the final score, either 1 or 2 w ill

appear. Here is w hat the numbers w ill reveal:

- 1 = consider staying offshore , because more arguments speak for staying

overseas

- 2 = consider backshoring, because more arguments speak for bringing

production back home

However, this questionnaire is only for giving directions and help for making the right

decision, therefore an individual and critical view of the situation is still needed in addition.

Product SpecificationsYES = 1

NO = 2

Maturing StageIs the product mature and only slight improvement potentials

w ithin the maturing process are possible? 0

ComplexityThe product is of low to medium complexity and w ell-def ined

tasks can be given. 0

Labour IntensityIs labour intensity of the product either high and/or cost savinglimits due to automatisation w ere reached at home? 0

TransportationDoes transportation have no significant impact on the final priceand speed and f lexibility are not important? 0

Series ofProduction

Is the production series rather big in size and no customisationand/or limited series are manufactured on a regular basis? 0

Separation ofProduction

Is the production separable and can be produced in parts?0

SCORE 0



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Company Specifications

Speed &Flexibility

The lack of speed and f lexibility due to the offshoring activity hasno impact on the company. 0

Share of Old

Products

The share of old products in turnover is relatively high, w ith onlyslight improvement potentials in the underlying mature production

process. 0

Size

The company's size is small to medium and has not sufficient

financial, human resources and experiences for managing a

smooth backshoring shift. 0

Communication

Communication is not restraint by the need for direct voice

contact or the impossibility for moving documents around

electronically in suitable time periods. 0

R&D Expenses Research and Development expenses are relatively low . 0

SCORE 0

Potential at Offshore Location

Clustering Industry clusters have developed offshore or might appear soon.0

ProductivityGains

Productivity has been increased and this trend might continue.0

Skilled

Employees

Skilled employees are available and the retention of w orkers, theincrease of the skill level and therefore quality of the product w ill

increase in the future. 0

Evolution &

Improvement

The offshore activity is evolving and improving constantly. The

offshore process does not stay static. 0

Infrastructure,

Legislation and

Political Stability

Infrastructure, legislation and political stability are evolving

constantly and promoting economic grow th and protecting

businesses overseas. 0

SCORE 0

Base Case

Backshoring After having established the base case, producing offshore is still

less expensive than manufacturing at home. 0

SCORE 0

Result: 1 = Stay Offshore, 2 = consider Backshoring

Final Score 0



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2.4.4. Strategic Planning

When backshoring, companies should set up beforehand a w ell-defined backshoring

plan, in order to have the shift run smoothly and integrate the new process successfully

w ithin the company or to support the shif t from an offshore contractor to a domestic supplier.

In the follow ing, the steps are described w hat has to be taken into consideration once the

decision of bringing production back home has been made. The steps to be taken also

depend on w hat the offshore activity w as like (captive or outsourced) and w hat type of

backshoring strategy w ill be pursued (inhouse or outsourced). Depending on this, the

planning w ill vary on an individual basis. The follow ing content is based on the article

`Backsourcing - JPMorgan and IBM Outsourcing' (Case Study M 2005) and enlarged by

myself.

2.4.4.1. Project Team

Create a project team that w ill be responsible for the shift in order to interrupt internal and

manufacturing processes as little as possible w ithin the company and to allow a successful

backshoring transition, w hich needs to be w ell coordinated. The project team should try to

involve key personnel from Human Resources, Accounting, Procurement, Legal and other, in

order to benefit f rom their competencies and skills for the transition process.

Members of the project team should hold meetings w ith the implementation operations

managers at all levels of the organisation during the transformation period. The purpose of

these meetings is to keep all managers informed of ongoing plans and help bring them into

the decision-making process as much as possible by encouraging them to identify and deal

w ith conflicts that might surface during the design or transition periods (Schniederjans et al.

2005, p. 64).

2.4.4. 2. Alert Supplier

Once the backsourcing strategy is decided upon, the offshore contractor should be



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alerted, in order to maintain a healthy relationship and to promote a cooperative environmentfor handling contractual commitments (Case Study M 2005).

2.4.4. 3. Plan and Schedule

A w ell elaborated transition backsourcing plan and schedule should include clauses to

make sure that àll assets are returned properly and ensure support to the company staff for

a specific time period until the company can reassume full operational control to its

satisfaction' (ibid 2005).

The backshoring plan should include w ell defined expectations (quantitative and

qualitative) and milestones to be reached (e.g. cost reductions, higher productivity,

measurement rations etc.) w ithin a certain time. The plan needs to develop a vision of the

future state of the organisation, because a clear vision helps to reduce risks of not achieving

the objectives set. Review ing of the evolution of the transition plan on a regular basis is

important, because projects being review ed more often are more likely to succeed as

projects not being review ed often and on a regular basis. During the transition, strong top

management support is required. The more top management is committed to the process

and communicates their engagement, the more successful the shift w ill be.

Tw o important dimensions in the transition phase are the most critical for planning: `the

"w ho" and at "w hat time"' (Schniederjans et al. 2005, p. 64). Hierarchy specif ications and w ho

reports to w hat person is necessary to be defined precisely in order to avoid confusion.

2.4.4. 4. Quick Reassignment and Recruitment of Employees

Fast decisions about èmployee reassignment, general management responsibilities and

functions of day-to-day planning, coordinating, staffing, organising and leadership'

(Schniederjans et al. 2005, p. 64) is important. This minimises uncertainty and associated

productivity and motivation concerns. If necessary, new managers and w orkers need to be

recruited, if internal resources are not suff icient. Training might be a necessity for ensuring a

common skill and competency level.



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When backshoring to a domestic outsource provider, companies have been mostsuccessful in achieving fast integration and more cohesive direction of the new ly formed

partnership by assigning employees on a full time basis to òutsourcing tasks or by

employing joint teams and committees to guide the partners, monitor performance, and seek

mutually beneficial resolutions' (American Productivity & Quality Center 1997, p. 50).

2.4.4. 5. Adequate Documentation, Security Policy and Procedures

Documenting operational audits and requirements analysis helps avoid any failure to

meet the expectations and results in the best outsourcing scenario (Case Study M 2005).

To protect important information relevant security procedures need to be set up. This

could mean the documentation of passw ord protection and new softw are installation

procedures, for example. Former personnel `should not be able to access crucial data or

cause system shutdow n' (ibid 2005).

Know ledge transfer from offshore destination to home country should be integrated in the

backsourcing plan, because it might be essential for running the production at the domestic

level smoothly.

2.4.4. 6. Set up of Facilities, Plant and Machines (or select Domestic Supplier)

In order to start producing inhouse off ices, plant and machines need to be set up,

repaired or maintained, depending on the current state and condition of those facilities.

Depending on current production capacities, new machines might need to be bought or

leased.

If the company w ants to outsource domestically, an evaluation of the contractors to be

considered needs to be done. In Schniederjans (et al. 2005, p. 59) an example of rating

tactical provider selection criteria risk factors by country, w hich can be as w ell used for rating

domestic suppliers (see appendix 4). The evaluation should include amongst other things:

necessary production capacity to meet future demand goal, can reduce costs enough to

meet goal, f inancially able to support operations, high production quality and standards,

adequate personnel for job etc., for f inding the right supplier for a long-term relationship.



Other aspects of evaluating a future supplier can and should be taken into consideration

dif fering individually.

2.4.4. 7. Business Continuity

The continuity of the transition action for any unforeseen occurrences during the sw itch

should be w ell planned for and be incorporated as part of the backsourcing plan (Case Study

M 2005), because maintaining stability in production services is important.

Business continuity during transformational change is diff icult, often requiring long hours

and skill-stretching behaviour. Managers and employees might get upset by `frequent

employee meetings and communication w ill be challenged to participate in these areas'

(Duening 2005, p. 153). During that phase, a dif ferent benchmark should be adopted and

only w hen falling below the limit, intervention is required. Giving employees space to

progress and to improve w ithin that new situation is important.

2.4.4. 8. Communication Plan

Open communication, for that all employees are aw are of the change and can react

appropriately is necessary. Keeping employees informed and receptive for transition is part

of the successful transition. The employees should be able and helped to understand w hat is

going on and w hat the goals of the new strategy are via e-mail, intranet, meetings and other

communication tools. What is needed is `communication quantity leavened by honesty' (ibid,

p. 145).

2.4.4. 9. Performance Expectations and Measurements

During the transition phase, measures for monitoring goal achievement must be set up,

w hich function as a quality assurance system (Schniederjans et al. 2005, p. 64), self-

assessment and continuous improvement, being measured on a regular basis. This includes,

setting up dif ferent objectives w hich are valid during the transition process and w hich monitor

performance after the transition has been finished and business runs steadily. Most

reasonable are measuring effectiveness, efficiency, quality, timelines, productivity and

turnover.

These measurements should be quantitative as-w ell as qualitative, w hereas the

qualitative assessment is more diff icult to obtain and w ill become visible in the long run.

How ever, good quantitative measurements w ill have a positive impact on the qualitative

measurements. For example, if the turnover ratio decreases, employees w ill have the

opportunity to build up skills, have a better know ledge of the organisation, production runs

and the products, are able to detect production defects more easily. This kind of

development w ill lead to an overall increase in productivity and quality in the long haul.



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By all means, measurements that are directly linked w ith the areas the company w ants to

improve w ith backshoring its production should be assessed. The quantitative performance

measurement indicators include:

- Finance (total cost performance, cost savings etc.)

- Production (cycle times of machines, percent of defect products, percent of utilisation

of material, percent of late deliveries, time of product in shipment, cost of rush

shipments, percent of scrap and rew ork cost etc.)

- Human Resources (turnover rate, skill level of employees etc.)

- Supply Chain Management (percent on-time deliveries, percent of transportation

costs reduction, stock reduction etc.).

Qualitative performance measurements include customers' satisfaction and employees'

satisfaction, w hich can be obtained w ith the help of surveys.

2.5. Future Outlook

When ref lecting about the future of offshoring and backshoring activities, it is dif f icult to

make a prediction that takes into consideration all factors influencing global sourcing and

production.

On the one hand, backshoring is a process that does happen. `Perhaps one dollar's

w orth of w ork gets backshored for every $10 offshored, according to some experts' (Testa

2007). Maybe numbers are higher, maybe they are low er. Reliable data about offshored jobs

and backshored manufacturing is impossible to obtain and therefore the real trend is open to

speculations. The problems discussed in the first part make backshoring seem the intuitive

decision given increasing energy prices and w age inflation in low -w age countries. The revival

of w estern manufacturing seems to be the most natural future development.

On the other hand, backshoring is not the only solution w hen offshoring has failed. During

the last years, China has been the most popular offshore destination, until India w as called

the New China. Companies simply relocate to another country, w here w ages are still low and



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solve at least the problem of rising w ages. The manufacturing industry already has a close

eye on Africa as the New India for producing cheap mass-market products for consumers

around the w orld. But w hat w ill happen, w hen Africa's low -w age labour has been exploited?

It is only reasonable to think, that `companies are making choices about the best place to do

a given piece of w ork be it offshore, onshore or nearshore' (Thorsen 2008), instead of only

offshoring or backshoring.

My personal opinion is, that in the short run as long as there is a spot on earth, w here

companies are able to produce for less the costs than at home and as long as this activity is

prof itable, organisations w ill continue offshoring. How ever, in the meanw hile, backshoring

transitions w ill become more and more common as strategies. In the long run, domestic

manufacturing w ill become the most popular business model, as the availability for scarce

resources like inexpensive labour and energy w ill deplete.

2.6. Summary

The second part of the thesis deals w ith the theoretical background of backshoring of

manufacturing, the reasons for backing out of low -w age countries as w ell the strategic

decision making and planning the transition process appropriately.

Backshoring is a process after an offshoring engagement has been entered. It is a

location decision, w here the business process or function w ill be repatriated completely or

partly to the home country (Renz 2005).

There w ere four w aves of industrial backshoring w ithin the last 30 years beginning in the

1980s until today, w here the increase of backshoring activities responded to the increase of

offshoring engagements (Mouhoud 2007, pp. 42-43).

The main reasons w hy companies backshore are the little success the offshore

production had, in particular in terms of cost savings. The overseas location has undergone a

change and w age inf lation as w ell as rising transportation costs contributes to this



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development. A constant effort of re-evaluation, high level of attention and close monitoring

combined w ith travelling back and forth leads to offshore fatigue, that make companies

decide to backshore (Overby 2008). A Study by the Fraunhofer Institute reveals that the lack

of f lexibility and the ability to supply, quality issues, high costs of coordination, insuff icient

infrastructure and the lack of qualif ied personnel are the main drivers for shoring back (Kinkel

and Maloca 2008, pp. 10-11).

Therefore, companies do need to invest time and talent on an on-going basis for

maintaining a long-term relationship (Corbett 2004, p. 48).

When making the decision of leaving the low -w age country, one-time transition costs

need to be considered. For evaluating if staying offshore or coming back home, product and

company specifications, further potential at offshore location and the financial base line

(called the Base Case (Delaney et al. 2007, pp. 364-5)) need to be assessed and evaluated

in order to take the best decision for the future manufacturing location. The strategic decision

questionnaire is a tool for assessing the situation and giving guidelines for w hat might be the

best location (either offshore or backshore).

After having decided to integrate production back home, the actual transition process

needs to be planned and scheduled. A project team w ill help w ith tasks and issues like

alerting the supplier, documentation, scheduling, reassignment and recruitment of

employees, business continuity, communication as w ell as setting and monitoring

performance expectations and measurements.

Reliable data is hard to find, but today an estimate of $1 gets backshored for every $10

offshored (Testa 2007). When it becomes less profitable to exploit low -w age offshore

manufacturing locations, backshoring w ill become more meaningful in the future.



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3. CASE STUDY

3.1. Margarete Steiff GmbH



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`We do want to consolidate our work under one roof. Only what we can makeourselves, we can control until the last strand.' (Frechen 2009)

3.1.1. Company Overview

Within the toy industry, Steif f is comparable to w hat sports car producer Porsche is for

the automobile industry (Schmierer 2008) w hen it comes to a positive brand image and

premium products. The German toy company w ith headquarters in Gingen w as founded in

1880 by Margarete Steif f as a store selling felt goods. The company claims that ìt made the

f irst bear w ith moveable arms and legs in 1902' (Wiesmann 2008), created by Margarete's

nephew Robert Steif f.

The historical company has until today remained in private family ow nership and the

annual turnover in 2006 w as estimated at a 42 million employing around 300 people at its

headquarters.

3.1.2. Products

The first Steiff-animal w as an elephant made of felt originally designed as a pin cushion.

Today, the main products of the company are stuffed animals. The w orld-know n trademark is

a gold-plated button ear tag w ith a related yellow ensigma as w ell as a label at the chest,

w hich reveals the date of origin for connoisseurs. A Steiff plush consists of around 35 parts

and w ith an average price of 40 to 70, the toys take up to a year to learn to make, and,

according to Westall àround 80 percent of the w ork is done by hand' (Westall 2008).

Steiff products are know n for premium quality, tradition and prestige as w ell as luxury and

uniqueness, as a significant part of turnover is generated w ith sales to collectors.

3.1.3. Changes in Collectors behaviour and Retail

For 30 years the company has heavily relied upon the business w ith collectors, as this

used to be a comfortable and prof itable niche market (Scheffbuch 2008). Collectors w ould

pay a high price in particular for limited editions, w hich is the reason, w hy Steif f has regularly



revived older items in small amounts. Steif f w as in the fortunate position of creating a higher

demand than supply, w hich has been a very profitable and reliable business.

How ever, w hen Steif f celebrated its 100 th birthday in 2002, turnover decreased rapidly

and limited editions became shelf w armer. The CEO Frechen assumes, that Steif f-collectors

took the anniversary as an opportunity to finalise their collections and to stop the expensive

hobby (Scheffbuch 2008). Even auction houses noticed the end of the Steif f collection boom.

At this point, the company generated barely only half of the turnover than before w ith

collectors.

Steiff w as forced to look into the toy and stuffed animal market from another angle and

noticed, that the retail f ront has changed dramatically. The tendency w ent to cheap soft toys:

90% of the stuffed animals are sold for less than 20 (Scheffbuch). US department stores

once accounted for 30 per cent of toy sales, but today that f igure is just 1 per cent, w hereas

soft toys in the US are now dominated by the discounters as w ell as Wal-Mart, Target and

Toys R Us w hich account for more than 30 per cent of sales (Wiesmann 2008).

3.1.4. Going Offshore

In order to react to the changing business environment, Steif f decided to reconquer kids'

rooms and to get back to the child's segment w ith prices betw een 20-30. Noticeable w ith

less priced versions of its products and w ith changing its production strategy for this

segment. This w as the reason, w hy Steiff created the brand `Cosy Friends', w here a Teddy

Bear had the affordable price of 29. In order to attain this, the company then offshore

outsourced its production to a contractor in China in 2003 for manufacturing the less

expensive brand. In the Chinese factories, mainly labour intensive sew ing w ork w as done.

In the beginning the new business strategy seemed to be doing very w ell, 20% of Steif f 's

turnover w as generated w ith products made in China. Because the price w as low er for the

collectors segment, almost every second item sold by Steiff w as manufactured in China.

3.1.5. Problems Offshore

Steiff experienced w hat a lot of other businesses that w ent offshore had experienced

before: Quality issues, too long transportation w ays, high turnover at the plant and highly

complex w ork that is not suited for offshore manufacturing. In the follow ing paragraphs,

Steif fs' problems in China w ill be looked at more in detail.

Quality issues



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Steiff products stand for high quality and uniqueness, w hich is something that can hardly

be produced at low -w age offshore destinations like China.

Officially the company claims not to have had any quality issues w ith the imported

products from China and that quality problems w ere not the reason w hy they decided to back

out. Steif f communicates, that the company simply has not found enough contractors that

corresponded w ith its high quality requirements and that the only suitable producer did

increase prices. Therefore business w ith China w as not profitable anymore (Scheffbuch

2009).

How ever w hen taking a closer look at the interview s w ith Steif f representatives, quality

problems seemed to play a much more bigger part of their production offshore, because

Steif f says, that they can make best, w hich they make themselves.

Defected items never made it to retail shelves, because they w ere rejected before being

sold. Nonetheless, follow -up w ork in Germany probably decreased savings from producing

offshore drastically. The importance of exact and high quality w ork for Steif f and the

supposable quality issues they had in China can be interpreted through the citation of CEO

Frechen:

A Steiff animal has to look cute, it has to look at you and say, `Take me in your arms and hug

me, I'm there for your, I'm your friend'. If the symmetry is off and if it looks l ike it's been run over

by a car, it's not what we want. People don't pay for that. (Westall 2008)

Workforce Management and High Turnover

`High staff turnover in a fast-grow ing economy meant w orkers did not have long enough

to train' (Westall 2008), w hich became an important concern for Steif f, as seamstresses need

up to a year to learn the ropes of manufacturing the stuffed animals redundant. Workers

w ould have already changed the factory and moved to another company that pays a little bit

more.

As complicated cuts and complex w ork are simply not made for producing w ith an

offshore contractor in a low -w age country, this led to quality issues for Steiff such as `tw isted

legs, bald patches and open seams' (Westall 2008) of its products, because the untrained



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workers w ere not able to produce the required quality Steiff requested.

Long Transportation and Distance

The long distance to the overseas production plant became Steif f 's disadvantage during

the offshore engagement.

On the one hand, Steiff supplied materials from Europe for producing the goods in China,

w hich simply adds up to transportation costs, regarding ever rising energy costs.

On the other hand transportation taking up to 3 months before arriving at the retailers

became a big issue w hen it came to special editions like the stuffed animal `Knut', w hich has

been manufactured because of the hype around the new -born polar bear of the same name

at the Berlin Zoo in 2006. Steif f reported that they had to plan five months betw een ordering

and delivery. Within a short period of time, 80,000 `Knuts' w ere ordered. But w ith long

delivery times, the polar bear arrived at the shops w hen the media circus had slow ed dow n

and Knut w as already grow n up.

The long distance became another issue, w hen òverbooked container ships meant the

company had to buy pricey space in advance, sometimes to find out no shipment w as ready'

(Wiesmann 2008).

Intangible Reasons

Steiff identif ied for themselves another risk for producing in China. Particularly w ithin the

toy industry, products made in China have been called-back by companies because of safety

issues. The reputation of toys made in China has suffered because of major safety scandals

in the last years. The corporation emphasises that Steif f is making only the best for children

and therefore every risk possible has to be avoided (AP 2008). This refers to the good

reputation of a `Made in Germany' product as w ell the trust consumers do have in goods

manufactured in Europe.

High coordination costs and overheads

While producing offshore, Steiff had to send employees from the headquarters to the

production facilities in China in order to maintain quality. The toy maker set very detailed



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standards for its teddies and monitored the production w ith taking material samples

(Schmierer 2008). With having to give seamstresses training in order to bring them to speed,

the costs for low productivity of w orkers w ithin their f irst month w ith the company increasing

costs.

3.1.6. Backshoring Plans and Reasons

In the case of the toy producer, `cheap Asian labour outw eighed by the added diff iculties

many unforeseen of manufacturing there' (Wiesmann 2008) and made them back out of

China. Steiff w anted all production back under its ow n roof, in its existing production plants in

Portugal, Tunisia and Germany. One reason for this is the realisation, that `cheapness meant

an end to uniqueness' (Wiesmann 2008), w hich made Steif f take the step from price back to

quality. A Steif f stuffed animal can be bought now for 30-80. The business now w ants to

follow its ow n values, w hich are prestige, quality and tradition (Kuehnen 2009), w ith now only

producing toys under the brand name of Steiff and stopping its low budget brand.

Five years after having offshored parts of the production to China, Steiff announced it

w ould move back to its existing production facilities, because of not being able to fully

achieve w hat they had planned, especially in terms of quality. It is estimated to reintegrate

the process w ithin 2 years, w hereas at the beginning of 2009 already 30 per cent of the

production has been reduced in China. Steiff 's behaviour proves the statistic of the

Fraunhofer institute that every fourth to sixth company going offshore backs out w ithin four to

f ive years after (Kinkel and Maloca 2008, p. 1).

Although new spaper headlines w ere promising w ith `Steif f brings production back to

Germany', it is important to mention that Steiff w ill not fully rely on Germany as a

manufacturing location in the future. Producing teddies a 100 per cent in Germany, w ould

cost tw ice as much and Steiff argues it w ould not be competitive enough (Scheffbuch 2009).

Sew ing w ill mainly be reintegrated in Portugal and Tunisia, w hereas all items are quality

checked at Giengen in Germany as w ell as the attachment of the golden button in the ear of



Page 48

39

each plush.

3.1.7. Analysis of Backshoring Activity

In this part, the decision questionnaire for evaluating the backshoring decision of Steiff

w ill be applied as far as possible w ith the information available about the company.

Product Specifications

The average Steiff toy like the teddy bear is a mature cash cow product w ith a low market

grow th rate, but w ith a relatively high market share. How ever, some products are Fads (a fad

is a fashion that becomes popular in a culture for a short time) or Stars and on the market

only for a short time, like the polar bear `Knut' or other special editions. Depending on the

segment and product type, Steiff animals are either mature or in the grow th phase w ithin the

product life cycle. Overall, Steif f products are rather at a maturing stage.

Production of Steiff animals is rather complicated due to the sophisticated cuts, the many

parts the items consist of and the very detailed requirements Steif f has for creating a high

quality product.

Labour intensity of the manufacturing process is very high, because 80 per cent of the

w ork is done by hand.

Transportation has a significant impact, in particular because Steif f uses materials from

Europe and transports them to China for further processing. Especially for its Fad products,

f lexibility and speed betw een order and delivery is very important.

Steiff says, that they do not really f it in over there, because typical orders are of around

500 lots and too small to reap good cost savings in factories more accustomed to mass

production (Westall 2008). As China is the perfect place for low price, volume and

standardised products, Steif f 's business model could not harmonise w ith Chinese

manufacturing standards.

The production process is separable and has been produced in several parts. Sew ing

w as done mainly in China, w hereas the f inal quality check and the attachment of the button



Page 49

40

to the ear are done in Germany.


The lack of speed and flexibility due to the production offshore had an impact on the

company. In particular fad products could not be brought to the shelves quickly enough in

order to satisfy demand.

The share of old products in Steiff 's turnover is relatively high. How ever, the company

releases new editions, limited series and Fad products on a regular basis.

Steiff is as a medium sized company doing business in a niche market. The company

belongs to the so called `Mittelstand', w hich are the type of companies that drive the German

economy. Regarding its estimated annual turnover of 42 mio in 2006, the company has

suff icient f inancial resources for managing the transition from moving production back to its

ow n plants in Europe.

The communication betw een the Chinese plant and the German headquarter is not

directly impaired by the long distance. Nonetheless, w hen it comes to maintaining a certain

level of quality w hen new designs and patterns are being produced, the distance and the lack

of direct communication becomes a disadvantage.

R&D expenses seem not to be a big part of Steif fs' expenditures, because the basic idea

a stuffed animal is alw ays kept w ithin the design. Innovative products are not part of

Steif f 's product range. How ever, as there is no published f inancial data about the company, a

reliable answ er about R&D expenses cannot be given. Therefore this question is left out

w hen f illing out the questionnaire.

Potential at Offshore Location

Clustering at the offshore location might not have played a big role for the decision of

manufacturing the teddies abroad, because only sew ing, but no other parts of the production

process have been offshore outsourced, w hich might indicate this.

Productivity gains w ere apparently not gained. Due to high turnover, seamstresses could

not reach the speed they w ould have if they stayed longer w ith the company, so this must

have been an important issue for bringing production back to its ow n plants.

As w orkers needed at least 6 months to learn how to produce high quality stuffed

animals, retention of employees w as one of the biggest issues. Turnover did not decrease



and therefore the overall skill level could not be increased and productivity gains due to

trained and skilled w orkers not be gained.

The offshore activity did not evolve and improve as positively as w ished due to high

turnover. Therefore productivity gains could not be realised in creating a premium and high

quality good.

Infrastructure, Legislation and Political Stability might have influenced the decision of

Steif f to backshore too, but there is no further information found. This question is left out of

the questionnaire.

Base Case

When taking the step of shoring back, Steiff stopped manufacturing its low price brand

`Cosy Friends' and slightly increased the prices for the children's segment. `Cosy Friend'

Teddies w ere betw een 20-30, w hereas the price for the `Steif f ' brand is now set betw een

30-80, due to higher production costs. Overall, Steif f doesn't w ant to increase prices for the

moment.

On the other hand, w hat Steif f w as trying to do producing a very complex and high

premium product that needed to adapt to alw ays changing market demands - w as not

possible in China. They w ere simply not able to get the service they w ere seeking overseas,

and therefore the costs producing in low -w age country China cannot be compared a 100 per

cent.

When making assumptions about the Base Case, producing offshore seemed to be less

expensive for Steif f, but they did not obtain w hat they needed. Producing at its ow n plants in

Europe and North Africa, Steif f could manufacture the good they needed w ith a flexibility and

quality not being attained in China. Of course this has a higher price. In short, manufacturing

in China is less expensive than at home, but not as excellent.

Decision Questionnaire for Steiff

Product Specifications

Maturing StageIs the product mature and only slight improvement potentials

w ithin the maturing process are possible? 1

ComplexityThe product is of low to medium complexity and w ell-def ined tasks

can be given. 2

Labour IntensityIs labour intensity of the product either high and/or cost saving

limits due to automatisation w ere reached at home? 1

TransportationDoes transportation have no significant impact on the final priceand speed and f lexibility are not important? 2

Series of Is the production series rather big in size and no customisation



Page 50

41

Production and/or limited series are manufactured on a regular basis? 2

Separation of

ProductionIs the production separable and can be produced in parts?

1

SCORE 1.5


Speed &

Flexibility

The lack of speed and f lexibility due to the offshoring activity has

no impact on the company. 2

Share of Old

Products

The share of old products in turnover is relatively high, w ith only

slight improvement potentials in the underlying mature production

process. 1

SizeThe company's size is small to medium and has not sufficientfinancial, human resources and experiences for managing a

smooth backshoring shift. 2

CommunicationCommunication is not restraint by the need for direct voice contactor the impossibility for move documents around electronically in

suitable time periods. 2

SCORE 2

Potential at offshore location

Clustering Industry clusters have developed offshore or might appear soon2

Productivity

GainsProductivity has been increased and this trend might continue.

2

Skilled

Employees

Skilled employees are available and the retention of w orkers, the

increase of the skill level and therefore quality of the product w illincrease in the future. 2

Evolution &Improvement

The offshore activity is evolving and improving constantly. Theoffshore process does not stay static. 2

SCORE 2

Base Case

Backshoring After having established the base case, producing offshore is still

less expensive than manufacturing at home. 1

SCORE 1

Result: 1 = Stay Offshore, 2 = consider Backshoring

Final Score 2

The final score on the decision questionnaire is 2, w hich attests that Steiff should shore



Page 51

42

its production back home. The outcome is rather clear. How ever, a detailed assessment and

evaluation of the offshoring situation is very important besides using the decision

questionnaire. Depending on the background, companies should give individual w eight to

certain aspects as corporations, products, situations and decisions are as individual as

people's personalities.

3.2. Summary

The case study is about the German toy manufacturer `Margarete Steif f GmbH', the

reasons and issues w hen they offshored parts of its production to China and the analysis of

its backshoring decision w ith the help of the decision questionnaire.

The toy maker w as founded in 1880 in Gingen, Germany, claiming to have made the f irst

bear w ith moveable arms and legs in 1902 (Wiesmann 2008). The annual turnover in 2006

w as an estimated 40 mio, w ith 300 people employed at the headquarters. Steif f 's high

quality and premium stuffed animal's trademark is the w orld-know n, gold-plated button ear

w ith a related yellow ensign w ith a price range from 40 to 70.

Changes in collectors' behaviour and retail made Steif f change its strategy: In order to

reconquer the kids' segment w ith a less expensive version of its toys, they offshore

outsourced in 2003 to China.

High turnover at the plant, quality problems, too long transportation and highly complex

w ork that w as simply not suited for offshore manufacturing w ere the main issues during its

offshore activity.

The final decision for backing out of China w as triggered by not being able to deliver

polar bear `Knut' in less than three months. In mid-2008, Steiff announced to reintegrate

production under its ow n roofs in Portugal, Tunisia and Germany w ithin 2 years.

An analysis of the new location decision of Steif f, product and company specif ications



Page 52

43

show that shoring production back, in order to improve processes w as the right decision the

company made. For the moment the potential for further improvement overseas is exhausted

and even though the Base Case indicates that producing offshore might be cheaper than at

its production plants in Europe and North Africa, Steiff took the right step in coming back.

Even though the Decision Questionnaire gives a clear result, it is alw ays important to

assess the reasons for backshoring individually.

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45

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Page 55

46

APPENDIX

Appendix 1: Number of days needed to import goods, including prearrival documents, port

and terminal handling, customs and inspections (The World Bank and the International

Finance Corporation 2006, p. 54).

Region Total time (days)

OECD high income 14

East Asia & Pacif ic 28

Latin America & Caribbean 36

Middle East & North Africa 43

Eastern Europe & Central Asia 43

South Asia 47

Sub-Saharan Africa 59

World 39

Appendix 2: GDP per capita grow th and change in real w ages (International Labour Office

2008, p. 14).



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47

Appendix 3: Boston Consulting Group Matrix

Appendix 4: Example of Rating Tactical Provider Selection Criteria Risk Factors by Country

(Schniederjans et al. 2005, p. 59)



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The Process of Off Shoring and Back Shoring of Manufacturing to and From Low Wage Countries _ Understanding the Critical Issues o

Documents

process of offshoring

offshoring location

evolution of offshoring

critical issues of offshoring

offshoring failure analysis

backshoring of manufacturing

backshoring plans

backshoring transitions