Common Sense, Human Nature and the Fundamental Tenets of Business

2014-11-18 08:00:00

By: Charlie Barnhart

(Originally Published on 2-18-2007)

An often used analogy links air-traffic controllers’ use of radar (to direct the flow of airplanes) with how problems or issues in business are prioritized and tracked. Ever hear the expression, “that’s on our radar” or “that must be below the horizon as it hasn’t shown up on the radar yet”? Meaning if something is known it is on the radar and conversely if something is unknown or unexpected it’s off the radar.  So what does radar have to do with common sense, human nature, and the fundamental tenets of business?

It all started in the mid-twentieth century when almost simultaneously the United Kingdom, Germany, and the United States all discovered that dropping small metallic strips from an airplane generated a cloud of echoes that rendered radar information confusing and useless.  In a word, this “electronic-countermeasure” was referred to as Window by the British, Düppel by the Germans, and Chaff by the Americans. Today, in the Outsourcing Navigator Series (ONS), we also use the term Chaff but in the form of an acronym (i.e. CHAF) for: Common sense, Human nature And the Fundamental tenets of business and it is usually under one of these three headings that the misconceptions about outsourcing can be categorized.

Common Sense

For this item let’s use the big fish, little pond - little fish, big pond comparison as it’s the most commonly referenced analogy when discussing the scale of outsourcing requirements and potential supply solutions. Common sense tells us, that to avoid risk and maximize the potential for success when outsourcing, we need to make sure the size of the requirement aligns with the capacity of the supplier. In other words, if we need $4 million worth of outsourcing manufacturing done per year we should consider a supplier who is scale appropriate for this level of work. In the ONS we classify scale appropriate as being somewhere between 5 to 15% of a supplier’s total annual revenue. Therefore a scale appropriate supplier for our $4 million outsourcing project would have annual revenue between $27 and $80 million dollars – or rounded off, $25 to $100 million per year. A hard and fast rule – NO. But certainly a strong starting point from which rational judgment can begin to be applied. So with a little common sense, and a splash of guidance from the ONS, it’s fairly easy to make sure you don’t end-up being either a big fish in a little pond (where there may be inadequate amounts of food and you won’t be able to grow) or a little fish in a big pond (where you’ll have to compete with all the big fish and may end-up getting eaten yourself!)

Yet in approximately 33% of cases labeled as problematic in the ONS, root-cause analysis clearly indicates that inappropriate “scale alignment” was the key factor in outsourcing failure. How did this happen? In most cases it was when common sense got clouded by the Chaff of misguided internal rationalizations (“If we’re a big fish in a smaller pond we’ll get more attention!”) or some form of wishful group-think (“We need multiple tier-one EMS suppliers as our new product is going to be the next big-thing!)

Human Nature

While human nature sounds complicated it’s actually the easiest of the three Chaff issues to explain and I usually do so by sharing the following real-world anecdote:

“An EMS supplier calls their OEM customer to inform them that they’ve been unable to secure a certain part (or a commitment for delivery of a certain part) to meet the requested delivery requirements of the OEM and asks the OEM for help in finding and/or expediting the required material. To whit, the OEM makes a single phone call and immediately secures a commitment from the component supplier to ship the required part as requested.”

All of which results in the author’s phone ringing and an upset OEM client “at their wits end” requesting guidance on how to get their EMS supplier to “start doing the job their getting paid for”, i.e. managing their supply chain and to quit bothering them. Inevitably these calls last about 15 minutes and proceed along the following script:

  • During the first nine minutes the OEM shares their 3 minute story about their underperforming EMS supplier, three times over.
  • During the tenth minute I tell them they need to call their EMS supplier and thank them for keeping them in-the-loop.
  • During the eleventh minute the OEM (usually loudly) asks me if I listened to what they’d said during the first nine minutes of the call.
  • During the twelfth to fourteenth minute I explain that they’re navigating through very dangerous waters with a radar clouded by Chaff and that they need to consider and react based on the human nature aspects of the situation, which includes:
    1. Positively reinforcing their EMS supplier’s behavior (i.e. calling for help), as to do otherwise might mean that the next time there’s a problem they (the OEM) will not hear about it until it’s too late.
    2. Negatively reinforcing their component supplier’s behavior (i.e. withholding resolution until the OEM calls) by informing them that in the future they (the OEM) would appreciate it if they started working more closely with their EMS supplier.
  • During the fifteenth minute the OEM usually grumbles something along the lines of,

“OK, I see your point but I’m not very happy about any of this. We’ll probably end-up doing what you’re suggesting but I’m not happy about any of this – not very happy at all!!!”

Fundamental Tenets of Business

Lastly are the Fundamental Tenets of Business. While there are many business tenets, perhaps the most important relative to outsourcing is: “Margin is the difference between the cost of revenue and selling price AND is applied to all underlying costs equally”. As a tenet (or something accepted as an important truth) the above statement tells us that there are more misconceptions about pricing and the true cost of outsourcing than there are accurate conceptions!

While it would take tens-of-thousands of words to construct a comprehensive list of all the misconceptions, false impressions, and erroneous beliefs floating around relative to the True Cost of Outsourcing, the author’s top-six “myth busting facts” are listed below:

  1. Material mark-up is a contrivance in the quoting process, there is no such thing.
  2. All three elements of COGS are margined at the same percentage no matter how you try to break it out.
  3. It is virtually impossible for OEMs to accurately estimate the non-material elements of COGS (i.e. labor and overhead) without the help of an industry expert.
  4. Profit is the difference between actuals and standards and therefore does not exist until an operational transaction takes place, therefore the term “profit” can never be applied in the quoting process (the term you’re referring to is MARGIN.)
  5. Material, in spite of its placement on the Balance Sheet as an asset, is almost always a liability and therefore needs to be treated as such in the quoting process.
  6. Using geographically remote or complex outsourcing solutions cost more to manage than local, less complex alternatives.

In as few words as possible, “Having great leverage in a business relationship, as OEMs have enjoyed for many years over their EMS service providers, can be a dangerous thing as pressing an advantage is an easy thing to do but can have far reaching negative consequences.”

Bottom Line, when navigating in the outsourcing skyline it’s good to do so without any Chaff floating around from misunderstandings related to Common Sense, Human Nature, and the Fundamental Tenets of Business.

Back to Overview

Copyright 2014 CBA LLC    -    Owned and operated in Hawaii, Gateway to the Pacific