Go to Top

Outsourcing actually lowers (!) profits.

In news guaranteed to make Bill Waddell smile, new research from business school professors at Stanford and Wharton (yes, those pointy-headed academics) shows that fashion companies are best off when they manufacture close to home.

As Bill and Kevin have written about often, outsourcing to China -- or any other distant country, for that matter -- lengthens the supply chain, ties up working capital in inventory, and creates all kinds of product liability risks (melamine, anyone?). But for fashion companies, the longer lead times are particularly deadly, because once the new "it" design has been on the street for awhile, it moves quickly to the closeout bin.

By getting goods into shoppers' closets when they are in demand, and
not producing leftover unneeded inventory that will be dumped onto a
sale rack, retailers are more likely to get customers to buy early at
full retail price. The profit margin increase under this combined
scenario is exponential.

And it's the large production batches and the long lead time that's the killer. When you're forecasting demand and producing so far out, you're almost guaranteed to get it wrong:

Using the more traditional outsourcing models requires long production
lead times -- generally six to nine months -- handicapping success
because producers may miss trends or changes in consumer tastes. By
timing production to take place a few weeks before the selling season
rather than half a year or more, a firm can capitalize on more accurate
estimates of demand.

Researchers find that when both rapid production and enhanced design
are done together -- allowing the latest merchandise to get into the
hands of consumers quickly and with little overstock -- a firm's
profits increase by up to twice the sum of the extra profits
that would have been earned from each activity alone.

Retailers increase their profitability, too, because they have a greater likelihood of having inventory of the product their customers want, and they don't have to discount large quantities of merchandise to move it off the floor.

The authors point to the fashion brand Zara, which makes most of its clothing in expensive European and North African factories. Zara can move from design to delivery in just a few weeks. If they outsourced to China, the whole process would take six months or more. The report states that this approach

allows them to anticipate, spot, and take advantage of
consumer needs and trends, and tag production to actual demand. They do
very, very well using this strategy.

I spent about six years in the athletic footwear industry back in the
1990s. Our products weren't on the cutting edge of fashion, but we faced
many of the same pressures. I still remember the pain of having
container loads of shoes with blue stripes en route from China when our
retailers were asking for more of the shoes with the black stripes. Before the shoes even cleared customs, we had to negotiate discounts with our retail customers.

Who knows, Bill -- maybe next Harvard Business School will start publishing research that says respect for people can actually increase profits!

Share Button

One Response to "Outsourcing actually lowers (!) profits."

  • Bill Waddell
    8 June 2010 - 3:23 am

    This is heartening news, Dan, that proves even geniuses can learn. I think you are pushing it a bit with your last line about academia urging respect for people. Let’s not get too carried away here.

    I find it interesting that these insights are billed as “new research” – new to Stanford, perhaps, but hardly new to you and me and the hundreds of thousands of lean proponents across the USA.