CHINA FIRST: Wrong Reasons for the Decline of American Manufacturing

Naiveté of the executive and lack of understanding the firm’s cost structure is another less than stellar reason why some products were outsourced to China. In this case, poor make vs buy studies were done which considered only the variable costs of purchasing from China versus manufacturing in the US. What these executives failed to consider was that fixed costs are just that. Of course, one can write down plants and equipment and take the one-time adjustment to earnings and avoid the recurring fixed costs on the income statement. However, which CEO, CFO, or Operations leader volunteered to reduce his or her contribution to fixed cost by reducing their individual compensation commensurately. Fixed costs for assets should be considered as sunk costs. That is not to say, that they should not be considered as part of a future investment decision from a financing standpoint, but they are not ongoing costs per se. The variable costs of operating a factory such as utilities should be considered in the analysis, but not depreciation or lease cost which is more of a financing of the original asset than an ongoing cost that should be assigned to a product based on direct labor content of a product. Of course, in a business, over the long run all costs are variable, as in that one can choose to close the business and eliminate the entire cost of doing business. The problem is that when the decision is made to outsource, rarely is there a complete strategic review of the business including the subsequent impact on product costs if the fixed cost structure is not radically addressed in the same way.