For over 20 years, I have worked with the rule of thumb that sending production offshore does not make sense with a labor cost percentage of under 25%.   This means that of your Cost of Goods Sold (COGS), labor is less than ¼ of that cost.  To clarify, if your labor quotient is less than 25% of your COGS, you should not consider outsourcing production overseas.  

That number is probably low, as detailed in the article "Why Having Operations in Close Proximity to Markets Lowers Costs" by John Channing.   But let’s work with the 25% figure.   

A well executed Lean Manufacturing strategy has been shown to consistently reduce a factory’s labor input by 30%.    So, if we were running at a 36% labor quotient prior to Lean, we could expect to reduce this down to 25% with Lean.  So now our tipping point is a 36% labor quotient. 

So, here’s how to make the analysis…   Add up all your direct labor costs (wages, workers comp, benefits, payroll taxes, etc) and divide that into your total COGS.  If the figure is less than 36% and you are not well into Lean production system, then I would not consider foreign outsourcing.   

If your labor quotient is greater than 36%, then you may want to consider it.  Not do it, consider it.  Read John’s article as part of that consideration.

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Jeff Sands is a Director with Dorset Partners LLC, (www.DorsetPartners.com), an advisory firm specializing in corporate turnarounds, financial restructuring, revenue revitalization and profit improvements.    The team at Dorset Partners has guided hundreds of business turnarounds in dozens of industries over the past 35 years.   Much of this knowledge is outlined in the recently published Turnaround Roadmap™ which is available as a Free download on their website.