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Three keys to successful cost migration: determining what capabilities to migrate to low-cost countries, where to put them, and how to execute the migration initiative are the keys to success.

In 2002, Jeffrey Immelt, GE's chairman and CEO, told investors that he planned "to have $5 billion in sourcing from China" by 2005. Back then, Immelt saw the benefits of taking an aggressive approach to moving supply and production to low-cost countries (LCCs). The move would allow GE to save procurement costs on a broad range of items, from raw materials to highly technical finished products, across all of its businesses. Moreover, China represented a vast market for GE's offerings.

These days, GE is not alone. In a recent Bain & Company survey of 138 manufacturing executives, more than 80 percent of respondents believed that migrating costs to LCCs was a top priority. These executives correctly understand that hesitating to make the move would allow their quicker competitors to gain an insurmountable cost advantage. What's more, hesitation can delay companies from establishing a profitable foothold in fast-growing emerging markets.

While the risks of waiting are often clear, the practical hurdles of getting started are not. Companies face three tricky issues as they get moving on cost migration: determining what supply and production capabilities to migrate, where exactly to put them, and how to do it. By having a clear sense of direction up front--before organizational change begins--companies can improve their chances for success. Below we offer three guideposts for the supply chain executives as they help design and implement cost-migration programs.

1. Build the right kind of momentum

So what's the best way to get a cost-migration program in gear? While the impetus to move quickly is strong, our research reveals that cost leaders get up to speed over several years, not in a one-year burst.

Consider Emerson Electric, which is today a $15.6 billion conglomerate and cost leader. Back in the mid-1980s, it explicitly began shifting its sourcing to what it calls "best-cost countries." Next, Emerson began transferring manufacturing to those countries and finally, its engineering capabilities. By 2002, low-cost countries accounted for 44 percent of Emerson's total manufacturing cost.

Like Emerson, companies should start by moving sourcing, not assembly. Much of the embedded labor costs of industrial products lie in labor used to make the components and materials that manufacturers purchase. Aggressively sourcing from LCCs can lead to significant savings--without disrupting a company's workforce. More importantly, sourcing can help companies build a reliable local supply base--something they need to have before they can move assembly operations. Quick wins in sourcing build momentum in the right direction.

2. Don't jump to conclusions about "where"

China and India have been the leading targets for cost migration--and for good reason. Each offers an attractive combination of low costs, well-developed capabilities, business-friendly regulatory environments, and large domestic markets. But while China and India may be the first destinations to spring to mind, companies should begin by evaluating a wide swath of LCCs. Each country has its own strengths and weaknesses that can and will change over time.

Considering that a new facility may have an investment horizon of 20 to 30 years, historical trends and present conditions may be less important than future developments. To hedge their bets and create greater flexibility, cost leaders take a portfolio approach. Rather than concentrating all their activity in one or two countries, they spread their activity out over a mix of LCCs. That way, they're better able to ensure security of supply and stable costs over the long run.

A successful portfolio incorporates a range of decision criteria, balancing low costs against risks and proximity to key markets. China, for instance, may be the most attractive location for many products on a simple cost basis. But companies there face political uncertainty and a lack of enforcement of property rights.

A portfolio approach may mean accepting higher unit costs in other Asian countries, Latin America, or Eastern Europe to protect against currency risks, political risks, or the impact of natural catastrophes.

Of course, production diversity can be taken too far. Many industrial companies struggle with fragmentation in their supply chains: They may have subscale plants in dozens of countries, each focused primarily on local assembly. Cost-migration strategies should not perpetuate this approach. Decisions about portfolios should be highly disciplined, balancing the lower risk that comes with diversification against the scale advantages of consolidation.

3. Start at the top

Finally, be deliberate about how you initiate organizational change. Our research shows that companies planning to shift a substantial part of their cost base to LLCs need to lead the effort from the top down. Indeed, according to our survey, 82 percent of cost leaders use a centralized initiative. The unit-by-unit approach fails to measure up for two reasons. First, in the unit-by-unit approach decision making is incremental rather than strategic. And second, it doesn't allow cost savings to be rolled up by pooling sourcing or expanding economies of scale across business units.

Perhaps most important, a top-down, centralized approach is often the only way to overcome deeply ingrained organizational resistance to the redeployment of labor and sources. From the get-go, executives need to guard against underestimating the challenges of such a large-scale initiative. When it comes to getting started on cost migration, there are no easy or ready-made answers. Success always requires a major organizational effort and strong leadership.

Yet there's no doubt that the rewards of cost migration outweigh the risks. Our research finds that such moves are netting manufacturers in Europe and North America costs savings of 20 to 60 percent. And by understanding the what, where, and how of cost migration, companies can effectively avoid what may be the biggest risk of all: further delay.

Till Vestring, based in Singapore, directs Bain & Company's Asia-Pacific Industrial Practice. Suvir Varma is a Bain partner based in Singapore. Uwe Reinert is a Bain partner based in Dusseldorf, Germany.
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Title Annotation:GLOBAL LINkS
Author:Vestring, Till; Varma, Suvir; Reinert, Uwe
Publication:Supply Chain Management Review
Geographic Code:1USA
Date:Sep 1, 2005
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