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What is the Real Cost of Purchasing? - A comparison between purchasing offshore and purchasing nearshore

Gustafsson, Johannes LU and Alström, Maria LU (2017) MMTM01 20171
Production and Materials Engineering
Abstract
The product price given when producing offshore is not the entire truth and more companies decide to move their offshore production nearshore (Stentoft et. al, 2016). To measure the actual cost of producing many more parameters than visible costs needs to be taken account for. There are advantages as well as risks with outsourcing and costs can increase with distance such as quality issues, freight prices, increased cost of tied-up capital in transportation and more; the lowest price offer may not be the most cost effective or risk adverse one.
To determine what cost drivers to take into consideration, the data collection will be conducted using a combination between literature studies and data mining at Thule Group through... (More)
The product price given when producing offshore is not the entire truth and more companies decide to move their offshore production nearshore (Stentoft et. al, 2016). To measure the actual cost of producing many more parameters than visible costs needs to be taken account for. There are advantages as well as risks with outsourcing and costs can increase with distance such as quality issues, freight prices, increased cost of tied-up capital in transportation and more; the lowest price offer may not be the most cost effective or risk adverse one.
To determine what cost drivers to take into consideration, the data collection will be conducted using a combination between literature studies and data mining at Thule Group through semi-structured interviews. The interviews will target key persons working within Thule Group. Thule Group works mainly with purchasing finished products or parts to assembly in their production sites. To quantify the cost drivers, two purchased finished products that today are outsourced in China, representing offshore production, have been selected for a case study. This will be compared with an in-house production location in European Union, representing nearshore production. The costs identified are set in relation to the product prices for the two products and presented as mark-ups for each element.
The result shows that duty and freight are the supreme cost drivers for the offshore production location when not as remarkable for the nearshore alternative when having a high market share nearshore. Quality related costs such as having purchasing departments to secure and work with suppliers and claims can be treated as mark-ups but the main cost for quality issues will land within the price of producing the product for either the supplier or for Thule Group if producing in-house. Cost drivers related to delivery performance result in a higher mark-up for the offshore production location than the nearshore due to higher minimum order quantity (MOQ) and lead-time, leading to higher inventory levels. Physical cost of storage and the cost of risk are only a fraction of the financial cost when keeping stock, implying that it is not necessary to calculate on more than the financial cost. To take a decision regarding the inventory levels, the economic optimum between cost of losing sales and the cost of keeping a high stock to prevent this need to be calculated. The cost of lost sales can be calculated but not the cost of negative goodwill. Not to forget is that the intangible costs increase with producing offshore are difficult to predict and calculate for such as; risk of getting obsolete products when keeping higher stocks, converging manufacturing wages, insecurity in exchange rates, increased quality issues and other risks
increasing with distance. A separate case study also shows that duty-free warehouses are to prefer, looking to costs, over traditional warehouses when importing products. The difference between aggregated costs related to the two location options can give the possible difference in production price for the alternatives. (Less)
Popular Abstract
The following study is made to investigate further in the real cost of producing offshore and nearshore. The study is made through literature studies and semi-structured interviews applied on two products today produced in China to be compared with the corresponding costs if produced in-house in Europe. Result show that the final market for the products are having a big impact on the cost because the cost of logistics are the supreme cost carriers beside from the price for the product.
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author
Gustafsson, Johannes LU and Alström, Maria LU
supervisor
organization
course
MMTM01 20171
year
type
H2 - Master's Degree (Two Years)
subject
keywords
cost management, nearshore, offshore, purchasing management, risk management, production
report number
CODEN:LUTMDN/(TMMV-5294)/1-65/2017
language
English
id
8918592
date added to LUP
2017-08-07 09:47:07
date last changed
2017-08-07 09:47:07
@misc{8918592,
  abstract     = {The product price given when producing offshore is not the entire truth and more companies decide to move their offshore production nearshore (Stentoft et. al, 2016). To measure the actual cost of producing many more parameters than visible costs needs to be taken account for. There are advantages as well as risks with outsourcing and costs can increase with distance such as quality issues, freight prices, increased cost of tied-up capital in transportation and more; the lowest price offer may not be the most cost effective or risk adverse one.
To determine what cost drivers to take into consideration, the data collection will be conducted using a combination between literature studies and data mining at Thule Group through semi-structured interviews. The interviews will target key persons working within Thule Group. Thule Group works mainly with purchasing finished products or parts to assembly in their production sites. To quantify the cost drivers, two purchased finished products that today are outsourced in China, representing offshore production, have been selected for a case study. This will be compared with an in-house production location in European Union, representing nearshore production. The costs identified are set in relation to the product prices for the two products and presented as mark-ups for each element.
The result shows that duty and freight are the supreme cost drivers for the offshore production location when not as remarkable for the nearshore alternative when having a high market share nearshore. Quality related costs such as having purchasing departments to secure and work with suppliers and claims can be treated as mark-ups but the main cost for quality issues will land within the price of producing the product for either the supplier or for Thule Group if producing in-house. Cost drivers related to delivery performance result in a higher mark-up for the offshore production location than the nearshore due to higher minimum order quantity (MOQ) and lead-time, leading to higher inventory levels. Physical cost of storage and the cost of risk are only a fraction of the financial cost when keeping stock, implying that it is not necessary to calculate on more than the financial cost. To take a decision regarding the inventory levels, the economic optimum between cost of losing sales and the cost of keeping a high stock to prevent this need to be calculated. The cost of lost sales can be calculated but not the cost of negative goodwill. Not to forget is that the intangible costs increase with producing offshore are difficult to predict and calculate for such as; risk of getting obsolete products when keeping higher stocks, converging manufacturing wages, insecurity in exchange rates, increased quality issues and other risks
increasing with distance. A separate case study also shows that duty-free warehouses are to prefer, looking to costs, over traditional warehouses when importing products. The difference between aggregated costs related to the two location options can give the possible difference in production price for the alternatives.},
  author       = {Gustafsson, Johannes and Alström, Maria},
  keyword      = {cost management,nearshore,offshore,purchasing management,risk management,production},
  language     = {eng},
  note         = {Student Paper},
  title        = {What is the Real Cost of Purchasing? - A comparison between purchasing offshore and purchasing nearshore},
  year         = {2017},
}