Outsourcing & Offshoring Manufacturing in Asia

Hi David,

Thanks for taking the time to speak with me today and share what you learned about outsourcing manufacturing work to Asia, specifically China. Please tell us a little bit about yourself and BaySource, and how you got started?

I was in the consumer products industry and I’m going back to before the year 2000. We owned some brands that went to the value-price-point category and we needed to develop the new brands, new packaging and we were over a hundred-million-dollar company, but we had very limited expertise in our purchasing and procurement department.

Really China was just coming on board. It was really all the Fortune 500 companies that had the resources to send people to China. We didn’t. So we struggled getting some packaging done the right way. We were challenged with that, and it dawned on me that there was no enterprise set up for serving small and medium size businesses. To help them navigate China, to become a bridge to doing business in China and you know having a trusted resource to mitigate the usual anxiety, which are costs and quality.

And so, around 2004 I put a business plan together to kind of take a look at how we can serve small-middle sized companies in the United States having a trusted bridge to China setting up offices over there, and I kind of felt the opportunities would be enormous. That is how I got started. I left that position to start what is BaySource now. That was 2005.

Wow. Okay. That is a good history you have there, so when someone’s considering offshoring their manufacturing to either China or other Asian countries, what are the things they should consider?

They have to consider the potential volume of the product they are looking to source. And, more importantly than that, they need to understand how much of their cost of goods labor makes up in term of the total landed costs. So,  if labor is not at least around 25% of your cost of goods, it generally doesn’t make sense to go to China because until you start adding labor vis-à-vis secondary processes, manual processes, finishing, handwork, anything with labor…assembly, that’s when it makes sense for China. And, they should also look at their design. Are they making or designing products, which keep costs, whether involving labor or not…are they keeping the costs of their products to the minimum when designing their products?

All right, very good, so things kind of need to be designed for China and have a good fit for Asian manufacturing.

Not even designed for China. I am just talking in general, you know? Whenever you’re designing or creating or developing a new product, you want to design a product that is going to be suitable to the market you’re serving or you’re selling in, right? That you are not going to out-cost yourself based on either what is currently available or where the costs are going to out-weigh the value.

Sure! Right! Thanks for the clarification there. So, what are some other advantages beside costs to offshoring the manufacturing?

The other advantages we see, mostly now for offshore manufacturing is that there is infrastructure in place, particularly in China. So, China’s benefited from a steep learning curve in the past 15 years. Their efficiencies are up. There’s infrastructure in place, plant property and equipment. The municipalities infrastructures are there, highway systems, rail, obviously shipping.

So really startup costs are a huge advantage, when offshoring because you don’t have to invest in assets: equipment, plants, facilities, people, training, all of that kind of overhead.

Well, they really have built quite a system over there and I can really see that if you had the volume to warrant it, they can really turn out a lot very quickly for you.

What about some of the pitfalls or disadvantages of outsourcing your manufacturing?

Sure. So, what I like to say is whether you’re making a product in Chicago or China, the product has to be managed: the life cycle, the development, the quality. You have to manage new product development, and so the obvious disadvantages are time and distance. Not to mention the built-in disadvantages which are communication and translation, so a lot of details can get lost in translation.

Another disadvantage is that the Chinese are often making products that they have no idea what the applications for those products are. They’re making just literal widgets based on drawings, designs, specifications, but don’t always necessarily know what these product are being used for in the U.S. So there isn’t that proactive nature for somebody at the factory level to say: Hey! We can make this product a little bit better or wouldn’t it work better if we did this?

Whereas, you know, locally there is probably more common knowledge built-in around: Hey why are they doing it this way? If they made it this way, we could fit it in a box better or it would be more efficient or it would show up on the shelves better or something like that.  You’re not going to get that sort of proactive participation when you are offshoring.

So I guess in that example, it’s kind of like you get exactly what you asked for, and not much else, which is very interesting… uncounted costs or advantages, which I think is a pretty interesting aspect there.

As far as, the kind of person or business… I mean at what scale or where should a personal or entity be at when they consider their outsourcing manufacturing? Kind of like size, volumes, financial, capability and where should someone really to be at when they start approaching manufacturing in China?

Wherever you are going to manufacture something, you need funding. I don’t mean to state the obvious, but a lot of people don’t take into consideration once that product is developed, once you’ve gone through your first article of inspection, your prototypes, your samples….now you’ve got to place a purchase order. So people have been able to float their ideas, their business, their startup up to a certain point but if you don’t have the right finances and resources in place…to place orders, literally just place the first orders, to cash flow those orders, you’re at a loss there, right?

So, a person or business should consider creating a budget, you know, startup budget, and understanding what their cash flow needs are going to be when they’re manufacturing, I didn’t even mention the tooling and startup costs that need to be built into the equation.

So let’s be a little more pointed about that. I mean minimum order quantity. It would be easier if you said you had an order of 100 or maybe a 1000 of the product but is that realistic when outsourcing to Asia?

Everybody always asks us, so what is your minimum order quantities, but they’re really not our minimum order quantities? They are a factory’s minimum order quantities.

We have a sporting goods client that just placed their first order for a new product. We’ve done several orders for them before but it is a new product for them, and they are going to order 700 of these products, and they are going to order 700 at $40 each. Now, you know now it is a $30,000 order, and that is not a huge order, but their resale on the items, the margin of the resale on that item supports getting into that business, watching that product. The next order will be doubled that or triple that, and also we have found a manufacturer suitable, who is pleased with…..you know who is not stopping at those lower sub 1000 unit orders because they’re a family owned factory, and they have capacity and so they are delighted to help these guys get into the business, because the guys have already proven on other products that they are making, that they’re doing with us. They are proven that they have ability to capture the market. They have already been successful with their other products. There is no one size fits all on the minimum order quantity.

The other thing that I’ll mention to you is that freight…any good business decision maker understands that your freight whether in Chicago or China, freight should not eat into any more than 10% of your costs of good. So a container is a container is a container, so a 40-foot container all-in, let’s just call that $5000. So, if you don’t have $50,000 of value on that container, you really should be looking for something else. Likewise, a 20-foot container is generally…you know with taxes and import fees, tariffs, $3500. So if you do not have $35,000 worth of value on that container, you might want to reconsider.

We should still do “Less Than Container Loads”, LCL but the trade value at cost of the products on those containers support the exercise.

Very good. That’s good metrics and numbers there. For that one example that you gave about that product, can you give a general category of that kind of product as far as you know, was it a soft good, was it engineering intensive, or would something that ….

Yeah, it’s engineering, it’s sports training equipment and it’s got good margin over here, so they will sell it for double what they pay for it, but they have to work in distributor margins and things like that.

For me to say okay that $30,000 order doesn’t make sense even though it is going to cost them $3500 dollars to get it in. The margin on that $30000 of product supports the little bit of overage over that 10% of costs of good.

Very interesting. You mentioned that there was engineering involved with that, so let’s talk about design work. What should be designed offshore? What should not be designed offshore? And what is available in turnkey design services?

We’re seeing more and more Chinese firms pop up to say we’ll do your design and development work, help you get into prototypes, things like that.

Generally, the cost, the managerial cost or the salary of the designer over there, the CAD designers would still be less than over here. However, going back to the original translation issue and application issue, where they can help you design something, but if they don’t know the literal use or the practical everyday use of the product, they are not going to be suited to design nearly as well as the U.S. designer. So, you get what you paid for, right?

And also, when dealing with a designer offshore, just the translation, the back and forth, the product revisions, their understanding of what you’re asking them to do, and how you are asking them to change things. When you start meshing creativity with practical services and design work, it’s definitely an advantage to stay local.

Yes. Very good. Thank you. So, wrapping up! if someone has an idea and they have their finances in place and they’re confident they want to go offshore with their design, their product. What is the next step for them to get started?

So that goes kind of to a question you have, it says: How should a person prepare to outsource their manufacturing? I gave a talk out at a tradeshow in Las Vegas last year, which was essentially how to do business in China. The thesis or the main argument of my discussion was sort of from the garbage in…garbage out. You will be received to the degree that you are prepared, meaning you need to have a…it’s not a business plan but a formal product document, product briefing. A little bit of background about you, the business, you know…. where you are selling to. Not that you have to devolve the whole business plan to the Chinese factory, but you want to put a very professional request of proposal together, because the more thorough and detailed that package of information is, the more creditable you will be with the factory and the greater sense of urgency that they are going to share around helping you with manufacturing your product.

So we talked about a budget. You shouldn’t even be near China, until you’ve done a budget, and what I meant by a budget is sort of a breakeven analysis that if you’ve identified what percentage of the potential market, whether that would be one percent or one tenth of one percent of the market here. And that should extrapolate into top line numbers. And then what your margin needs to be on those numbers to support the business and help you cash flow the business.

So having a budget in place and particularly including those startup costs, those purchase order costs, and then a lot of people don’t even work in the selling and marketing expense. They just think it’s their time but there’s time, there’s travel, the opportunity costs, right? Having a good budget and a sound game plan and a professionally presented package of information around your product.

Very good! So, that last question prompted me to ask something else here. How do you handle IP and licensing issues when you’re working oversea?

So, that is a great question, and you know kind of tongue in cheek I tell people if the Chinese factory or somebody that works in China tells you not to worry about IP…run from that person! That’s just not viable advice.

How we help mitigate that is we work two ways. One, we work with reputable people, reputable suppliers that are owned by decent people, and have worked with Western companies before. So, it is kind of on the coattails of other businesses that have come before them and they have had a good track record with supporting the manufacturing businesses, and not running off with their IP. That’s one way to mitigate it. So if ‘Black & Decker’ has been working with the factory for a while, you know that they’ve audited and scrutinized and challenged that factory’s willingness to protect their IP.

One is really reputation and experience and knowing where to go, having sort of that extra sense in instinct to understand if the factory is reputable or not.

Two is really working with somebody in China that coordinates the manufacturing from a supply chain perspective, and doesn’t necessarily tell the right hand what the left hand is doing.

So, we are making injection molded parts over here. We’re doing our SMT technology and our circuitry over here. We’ve got metal parts and components over here. We select the final assembly point which can usually be one of those factories, but the factories we are going to choose are not the ones that are already participating. Meaning, they’re not vertical, which means they are not manufacturing and marketing companies. They were not already at all the tradeshows in those respective industries over here in U.S, right? So, we work with really pure contract manufactures. We seldom work with companies that are already marketing their own products.

Another thing I’ll tell you that we don’t work with anybody that doesn’t have a patent.

Got it! So, it helps protect you on the US sale side too. That is very handy.

That protects us, and protects them. We just don’t want to work with someone who doesn’t have a patent because we can get well in the process and find out that our customer has no right to launch the product because somebody else has a patent.

Oh interesting. I wasn’t thinking about that originally. David, very good. This is a wealth of information. I appreciate your time and thank you very much.

Yeah! Thank you, Gabriel.