Starbucks Goes for Vertical Integration to Fuel Growth in China

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A big week of announcements for Starbucks as it continues to emerge from the global economic downturn. It has announced plans to accelerate its store opening programme, with 400 new stores outside the USA alone. And it has also decided, for the first time, to start growing its own coffee beans, as a way of supporting its ambitious growth plans in China.

The cost savings associated with outsourcing overseas (most often to China), while once significant in the short term, is not as great as it once was. Chinese companies' manufacturing successes have created a middle class that now requires higher pay and benefits. Add to that the cost of establishing and managing the contracts with external suppliers, plus the increasing transportation costs and lead times, and the overall cost advantage of outsourced manufacturing has shrunk, or in some cases disappeared.

Core competency issues are strategic decisions. When small volumes of products and components are required, and preparing to manufacture the product in-house would be extremely expensive, it probably does make sense to leave it to the experts. However, if significant volumes would be involved, then it would be worthwhile to at least look at what it would take to do that work in-house.

Lack of technical skills ties in with core competency issues. Whether or not an organization should possess certain skills is a strategic decision. If company leadership decides that those skills are necessary, then they can be developed internally. Indeed, developing manufacturing competency could be just the challenge the bright young engineer with a fresh Master's of Business Administration (MBA) degree needs. And if management is afraid of taking on that risk, then the easy route would be to find someone externally who has the necessary knowledge.

As for lack of capacity, it's easy to say that a production facility can't take on any more work, but often a shop is not actually at maximum capacity. Are there three shifts working, and is all production equipment being used? A "mothballed" production machine may still have value and capacity, which is why it has been kept in storage.

The lean, build-to-order inventory mentality says that the supplier takes on the inventory risk, and that manufacturers should carry little or no inventory. But when a customer order does arrive and there is insufficient stock to fill it, those who go too far in minimizing inventory may end up paying more for the expedited supply of small quantities.

Delegating the technical risk to a supplier appears to absolve the brand owner of responsibility. It gives management someone to blame if a product doesn't live up to the promises made to the customer. But technical risk is part of being creative and standing behind one's product, and the seller should accept that responsibility.

Outsourcing has encouraged companies to keep their staffs lean, but that can be risky. Few companies, for instance, recognize the consequences of failing to have enough staff to enable timely and competent order processing. In addition to poor customer service, these can include the need to assume the risk of late delivery or to expedite shipments. It is clearly worthwhile to locate or train suitable talent to handle this critical function.

Advantages of in-house production
A re-examination of the reasons for outsourcing goes hand-in-hand with careful consideration of the potential benefits of manufacturing in-house. Doing at least some manufacturing work internally has some clear advantages. Those include, but are not limited to, the following: •Control of the processes

•Quality assurance
•Avoidance of unreliable or unsuitable suppliers
•Avoidance of shipping and handling costs of large subassemblies •Protection of proprietary designs
•Potential for new business-unit startup

Control of all aspects of the process of creating subassemblies includes all production costs, scheduling, and engineering...
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