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 / Fall 2004 / Issue 36(originally published by Booz & Company)


When Offshoring Isn’t a Sure Thing

Like other computer original equipment manufacturers, Apple Computer Inc., a buyer of both chips and steel, limits its manufacturing expenditures by outsourcing some production to contract electronics manufacturers such as Solectron and Sanmina-SCI. By avoiding vertical integration and limiting manufacturing investments to less capital-intensive assembly and testing, Apple generates more than $9 in sales for each $1 in net fixed assets.

Moving closer to the end-user in the consumer electronics value chain, one can see that a retailer is far less capital intensive than a manufacturer. For example, every $1 of net fixed assets of U.S.-based retailer Best Buy, consisting of stores, fixtures, and distribution centers, produces some $11 in sales. Although both Apple and Best Buy have low capital intensity, their respective RPPs are quite different: $70 for Apple versus a mere $8 for Best Buy.

When transportation costs and capital intensity are analyzed together, it is easier to understand why some companies operate close to the customer and others do not. For example, in the high-transportation-cost, capital-intensive steel industry, Ispat Inland’s U.S. plants allow it to remain competitive with steelmakers in lower-wage regions. Less capital-intensive computer manufacturers, such as Apple, have the luxury of choosing to ship high-RPP products from low-wage-rate countries. In fact, Apple faces pressure to do so because labor costs are important to its overall costs.

Lead Time
Apple’s evolving corporate strategy shows how the third factor — market responsiveness — enters into the footprint decision. As Apple emphasizes integrated consumer entertainment solutions, it is expanding its retail channels, including the online iTunes Music Store and more than 75 physical retail stores in such upscale locales as New York City’s Soho district and San Francisco. Moving closer to the consumer forces a company to improve its ability to get goods and services to its customers fast. Even if a company that ships product from across the globe can keep its transport costs in check, the incremental lead time necessary to ship that far can create a supply chain too unresponsive to customer needs.

To quantify the challenge of managing lead time, we employed Little’s Law, an operational construct that measures the length of a company’s “supply pipeline.” Little’s Law, named for Professor John D.C. Little of the MIT Sloan School of Management, states that the length of the pipeline (the “throughput time”) can be calculated by dividing inventory by the rate of sales measured in inventory dollars. The resulting measure provides a perspective on the lead time, measured in days, to convert inventory into revenue. A highly responsive operation has a rapid throughput time, which means it holds little inventory and quickly converts its inputs into customer outputs.

By focusing on assembly and quickly shipping finished product to its customers, Apple maintains a short pipeline with an inventory conversion cycle of only five days. Intel, by contrast, averaged 111 days of throughput time for its pipeline in 2003. A chip produced in one of Intel’s U.S. wafer fabrication facilities may go to Malaysia for packaging, assembly, and testing before shipment to an OEM customer elsewhere in the world. Because Ispat Inland needs to run its production in large batches and maintain a high utilization rate of its capital-intensive manufacturing assets, its throughput time averaged 64 days in 2003. This is similar to Best Buy’s supply pipeline of 61 days.

To fully assess the significance of the three major variables in global operational footprint decisions, it is important to view them relative to each of the other variables, as well as independently. Looking at each of the three variables simultaneously helps explain the global operating footprint for our sample of companies and highlights potential strategic vulnerabilities.

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