Sunday, January 11, 2009

July 2007: Caveat Emptor

The level of imports of all kinds from China and India has dramatically increased in the past decade. This is not news. We have all read the stories of domestic plants being downsized or shut down as production moves off-shore. There are numerous articles regarding the increasing consumption in China of steel, concrete and gasoline. Lately, the press has been rife with reports on product problems, mostly from China regarding defective tires, tainted pet foods and counterfeit poisonous toothpaste.

The question many are asking is how to control quality of the ever increasing number of raw materials, component parts, and finished goods that we are importing. Shoddy, poor quality, goods are one kind of problem but the substitution of diethylene glycol for glycerin in food product is outright dangerous and criminal.

This reminds us of the principle of Caveat Emptor, Buyer Beware. The Latin phrase is used to emphasize that this is an old and valued principle. The problem for consumers today is that they have to know the store, the manufacturer, and trust that both are invoking this principle of Caveat Emptor to the supplier of raw materials, component parts, and finished goods they get from around the world. The supply chains are complicated and long. Products flow from suppliers around the globe. Even raw materials and components sourced from domestic sub-suppliers may have raw materials that are imported from any number of global sources. Caveat Emptor.

In the world of Quality Management, Caveat Emptor often means one thing good Supplier Quality Management. In the case of products coming from Asia where the culture is different, there are serious language barriers, the quality consciousness are at different levels, and government regulations are poorly enforced if they even exist, sound Supplier Quality Management might be good old fashioned Incoming Inspection. While Incoming Inspection is indeed old fashioned, it is not necessarily good. There several reasons for this:

1. Incoming Inspection is costly. In the US, many companies have eliminated or severely cut back on this activity. Rather than filter out bad quality, the movement has been to select or develop suppliers that have sound repeatable Quality Management Systems and can certify the Quality of the goods they produce and ship. The onus is on the producing company not the customer company. It makes no economic sense to invest in human capital to detect and filter out poor quality AFTER it is produced and shipped. It is more economical to produce good Quality in the first place.

2. Incoming Inspection is not effective. Even 100% inspection is not effective. There are measurement errors inherent in any system that would allow defects to slip through. If sampling plans are used, as they should, to provide a reasonable filter at a lesser cost, the older Quality manuals speak about two kinds of risk. First is the Producer's Risk, this is the probability that a good lot will be rejected. Second is the Consumer's Risk that a bad lot or shipment will be accepted. These risks are inherent in Incoming Inspection and simply mean that bad product can be passed through.

3. If a lot or shipment is rejected, what is the disposition of the materials? If a lot of material from half way around the world is rejected, the customer company must decide what to do with the materials, components, or finished goods. Shipping it back half way around the globe i.e. rejecting and returning the goods is usually not economical. Thus the goods must be sorted, re-worked or disposed of again at considerable expense. If one does not have factories or warehouses, the problem of disposition is further complicated and even more costly.
There is a Quality principle called QCD (Quality, Cost, and Delivery) that emerged from the Japanese Quality movement. The basic idea is that consumers judge products on these three dimensions and make a purchasing decision. Quality can be elementary. Does the product work and do what it was intended to do in a reliable way? Quality could also refer to production innovation. Does the product provide a new feature or function that customers would value. Consider the innovation of the iPod over the Walkman that allowed consumers to carry all their music around with them all the time and never have to change a tape or disk.

The same applies to Delivery. It could be as simple as availability. Is the product on the shelf in the stores? For mail order or home delivery, it refers to the reliability and on-time delivery of the goods as promised. But on a more sophisticated level, it is how fast a company can churn out new innovative products thus defining and potentially owning the market.

Cost is the cost or purchase, the price of the product or service. For more complicated goods like machines, e.g. automobiles, Cost could be the cost of ownership or the life cycle cost of the item. This would include purchase price plus all maintenance, operational, and repair costs.
In terms of QCD, if two products are equal in two of the three dimensions, the one that outperforms the other in the third dimension should be the choice of rational consumers and eventually gain market leadership.

In out-sourcing and off-shoring of materials, components and finished goods, companies are looking to save money. They are trying either to gain an advantage if they are first to do so or simply to remain competitive in terms of C – Cost. The labor costs are very low in China, India and other countries. Industries are chasing low C labor around the world. As China becomes saturated and some say it is happening faster than we think, companies will chase low C labor to Vietnam, Africa and elsewhere.

The savings in C are not only in labor. It is surprising how little labor directly affects the cost of many goods. In mature consumer products with higher levels of automation, the labor component might only be 2-4% of the cost of goods. Savings of 50-90% in labor costs are very real but maybe not compelling enough. Additional savings in taxes and regulatory expenses, Environmental, Health, and Safety, over doing business in the highly regulated and taxed markets of North America and Europe may indeed tip the scale.

With savings in C comes trade-offs. The first and most obvious is in terms of D – Delivery Time. In out-sourcing something that was produced in North America to China, replenishment time to Distribution Centers or customer companies will jump from days/weeks to weeks/months. This trade-off is obvious and part of the sourcing calculations. It will take longer to ship the goods in and inventory will go up. The savings are still substantial enough to justify the decision.

Yet, the decisions are not often robust. With time, there are other transportation Costs that could affect the C – D balance. A study done justifying outsourcing based on a fuel cost of X might not be so advantageous at a fuel cost of 1.5-2.0 X. If the demand for transportation from Asia to North America changes the supply and demand balance to the favor of the ocean carriers, rates might substantially increase further eroding savings.

The trade-off that is often under the radar when the decision to out-source is made is Q – Quality. This could be Quality of the product or Quality of the service. Customer companies can easily and wrongly assume that the Quality culture and systems that they have with domestic suppliers, internal or external, will transfer off-shore if simply stipulated clearly in the contract.

This problem may not exist in the early stages of out-sourcing. But as the Supply and Demand equation tilts in favor of the Supply i.e. there is more demand than supply can keep up with, there is less incentive for the suppliers to build in and assure Quality. It comes down to the integrity of the management of these suppliers. When Demand outpaces Supply, there can be a tendency for unqualified, unscrupulous or dishonest parties to enter the business. Quality can suffer due to incompetence and dramatic growth in the case of the unqualified. It can become criminal in the hands of the unscrupulous and dishonest. The criminal compromise of Quality was no doubt in play in melamine laced wheat gluten that killed pets in North America and also in the substitution of diethylene glycol for glycerin in both toothpastes and medicines.

How do customer companies ensure Quality in their incoming materials, components and finished goods? It would be best if the tried and true methods of supplier development, management and certification could be employed. This would be the most economic solution as suppliers would have to demonstrate having a quality system and that they are able to manage to it. Quality would thus be built in at the source and goods would arrive certified and fit for use.

If this is not possible due to the supplier not being capable of such a level of management, older methods must be used implemented e.g. Incoming Inspection. This risk is on the customer companies. They have to manage it for the sake of their market share and to prevent lawsuits when the problems are so severe that safety and health are at risk.

Incoming Inspection requires the customer companies to dedicate resources to detect and determine the Quality level that is already built into the goods. Most companies in North America have minimized this function over the past twenty years. Thus, the additional cost is quite real and quite unexpected. It is further complicated by the reality that they may not even have the space in their plants or distribution centers (if indeed they still have any) for the level of inspection and subsequent sorting and rework that will be needed.

There might be a third party opportunity to provide this service in China, India or wherever to detect poor Quality and reject lots before it is shipped. But, if local companies are employed to do such there is still a risk. More and more companies are finding it necessary to place their own personal in the producing plants as co-plant managers or co-production/quality managers to ensure things are being done properly at the source. Placing full time employees from North America and Europe in the producing countries to manage inspection at the source of production would further erode the savings of the out-sourcing.

In the 1950s and 1960s, basically post World War II, there was a flurry of products coming from Japan. There was a standing joke about these imports. The joke was the Made in Japan equaled cheap, unreliable, and shoddy goods. At the time many of the goods deserved to be associated with bad quality. There was even an urban legend of a Japanese town being renamed Usa so goods exported from there could bear the MADE IN USA label. The fact is the town of Usa on the island Kyushu was named that long before WWII.

Certainly the story of the Quality ascendancy in Japan, led by the likes of Sony, Toyota, and Mitsubishi are very well documented. The same may well happen in China. Manufacturing companies will mature and the market will shift from the current glut of Demand to something more balanced between Supply and Demand. As a result, the competition between companies will naturally gravitate from a focus solely on C to QCD. Quality of product and service at the best Cost and Delivery will make the difference. There are already reports of from purchasing agents that rating manufacturing facilities by who is in it for the short haul profiteering vs. those investing in R & D and vertical integration.

The August 2007 issue of Business 2.0, a Time Inc. publication, has an article entitled Startup: Rwanda. It features American entrepreneurs investing in this civil war and genocide ravaged country. Now it appears, from the article, to be on the cutting edge of the low cost labor frontier for telecommunications and software.

It may only be a matter of time, and probably less time than most would estimate, before all the labor markets of the world are all engaged and tapped into. When this happens, competition will certainly move from a pure C focus to one of QCD.

As an example of how fast things can move, the writing of this article began because the melamine and diethylene glycol contamination stories were in the press. Since then, stories on Chinese Quality were everywhere in the media and waned before this article was finished.

Lastly, here is a Quality Methodology none of the Quality Guru’s like Deming, Juran, or Ishikawa ever advocated. On July 11, 2007, China executed Zheng Xiayou, 62. He was the head of China's Food and Drug Safety Administration from 1998 to 2005. He was executed for having taken bribes to the tune of $850,000 to approve drugs and products that were of poor Quality to being outright dangerous. People died in both China and Panama due to these tainted or ineffective drugs.

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