Asset-light models - trend or industrial information bubble and echo chamber?

Pretext

For years, we at iMB have been noticing an increasing trend that fewer and fewer companies want to keep integrated manufacturing and actually want to maximize outsourcing across the board.

It is felt that 50% of executives would prefer to outsource their own manufacturing, whether we talk to local executives or those in parent companies.

We don't think that's always a good idea!

The reason given by a good ⅔ is that manufacturing is under intense pressure in terms of efficiency and cost reduction.

Immediately, they say that they would therefore prefer to rely on an asset-light model instead, i.e. focus on sales and marketing and outsource the actual assembly and related value-added activities. However, we do not recommend this.

Asset-light models refer to business models that focus on using digital services or outsourcing to minimize capital and labor costs while maximizing efficiency and productivity. Asset-light models are often used to reduce the cost and complexity of business operations, allowing companies to focus on their core competencies and outsource "non-essential" (...) services such as customer service, accounting, and logistics. In the theory enthusiastically put forward, asset-light models can increase companies' flexibility by allowing them to quickly adapt their business strategies to changing market conditions.

This is the context we have been hearing over and over again, and increasingly, since the pandemic. And this is precisely the direction in which a reorganization or transformation should then be driven. (…)

Asset-light models in production can actually harm companies. This is because they risk losing a strategic competitive advantage with massive consequences. The intelligence for transformation projects can be lost. Resilient value chains become a distant prospect.

Weekend production of a supplier of the oil and gas industry, delivery during the night

Looking back: what was outsourcing in its essence?

Around the globe, the word has been with us for decades. Sometimes it is very helpful to revisit what passes our lips so easily.

Outsourcing is a term used to describe the process of contracting a third-party provider to perform certain tasks or services. In the manufacturing industry, it is common practice to outsource certain processes or components of the production process in order to save money and time.

By outsourcing, a company can reduce its overhead costs, increase its efficiency, and focus its resources on its core competencies. Outsourcing can be used in virtually any area of the manufacturing industry. It is common to outsource the production of components or parts, as well as the assembly of finished products. In addition, outsourcing can also be used to outsource design, research and development, and marketing and sales.

Outsourcing is beneficial to manufacturing companies because it allows them to focus on their core competencies and not be burdened with non-essential tasks. It also reduces overhead costs because they no longer have to pay for labor, materials and equipment.

In addition, outsourcing allows companies to access expertise and resources that they may not have in-house.

When outsourcing, it is important to consider not only the cost, but also the quality of the services or products offered. It is also important to build a relationship with the outsourcing provider and ensure that communication between the two parties is clear and consistent.

Overall, outsourcing is a great way for manufacturing companies to increase efficiency and reduce costs without sacrificing quality. By leveraging the expertise and resources available through outsourcing, companies can focus on their core competencies, reduce overhead costs and access the resources they need to succeed in a competitive marketplace.

So much for the general understanding when it comes to outsourcing and subsequently asset-light models.

In a good 18 years of projects of reorganization, restructuring, transformation of business models and post-merger integration projects, we can state on the credit side that outsourcing is not a foreign word in the manufacturing industry in Brazil.

Outsourcing has been part of virtually every industry for decades, but has become increasingly important in recent years, especially at an accelerated pace since the financial crisis. National and international companies are recognizing the many benefits that outsourcing can bring, from cost savings to greater efficiency.

Service station for trucks and industrial utility vehicles

Let's talk about the benefits!

Here are some of the benefits of outsourcing in the manufacturing industry which we have seen in projects time and time again in a wide variety of results.

Cost savings

Time and time again, we have seen sustained results in helping clients reduce costs and increase profitability by outsourcing manufacturing processes. Regional outsourcing to other states or regions within the same state with lower labor and logistics costs can also help reduce overhead costs and improve the bottom line. However, it should be noted here that labor costs should not be considered a priority issue in Brazil, as there is a fundamental shortage of well-skilled labor. Logistics costs in a nation the size of the U.S. minus Alaska are strategic and tactical in nature and should be evaluated as a high priority in all scenarios.

In a few cases, outsourcing also succeeded in reducing material costs. However, this aspect has lost punch since the brutal devaluation of the Real since Q3 2019.

Efficiency

In the past, we have repeatedly been able to robustly identify with clients that outsourcing has increased their efficiency by allowing them to focus on now newly and clearly defined core processes, while other tasks are handled by third-party providers.

In this way, we have been able to ensure that our clients have been able to better manage their resources and achieve greater efficiencies. However, the focus is increasingly on automation and digitization. This is another area where we have seen significant downsides from the disastrous policy of devaluing the real since 2019, with significant repercussions.

The Brazilian Real suffered the highest devaluation among emerging markets decoupling the national economy from global strategic investments.

Access to new technologies

Outsourcing helped in some cases our clients to gain access to new technologies and processes that allowed them to improve the quality of their products and increase their competitiveness.

Outsourcing allows these companies to take advantage of the latest technologies and processes without having to invest in them themselves. This has given Brazilian industry a sustainable comparative advantage, especially during Brazil's boom years with a relatively stable and higher-valued real.

The provably induced devaluation of the real since 2019 has disconnected Brazilian entrepreneurs from the international investment flow, making it difficult for investments in technologies to increase productivity to take place.

Automation and digitization became increasingly unaffordable for Brazilian companies since 2019, as devaluation turned investments into expenses that were not matched by revenues; prices could not be adjusted accordingly.

Increased flexibility

In the past, outsourcing also offered our clients greater flexibility, allowing them to respond quickly as needed. This helped companies better manage their resources and adapt to changing market conditions. This was especially true during the boom years, with a strong real and the social advancement of many Brazilians into the new middle class.

Overall, one would think, outsourcing offers a number of benefits to companies in the manufacturing sector. By outsourcing, companies can reduce costs, increase efficiency, gain access to new technologies, and achieve greater flexibility. Ultimately, these benefits could help our clients increase profitability and remain competitive in the industry.

The attentive reader will note the subjunctive. One cannot ignore the downsides, especially in light of the massive socio-economic tectonic shifts in the Brazilian market. Since about 2015, the process of transferring more and more Brazilians to the new middle class came to a halt. Since about 2017, the process has even visibly declined, which then accelerated significantly from 2019 onwards due to the interest rate policy to massively devalue the real and was further exacerbated by the pandemic. Companies, which can be suppliers collapsed, no longer had capital for investment. In addition, there was the sensitive reduction of the consumer market.

Manufacturing machine base

Let's talk about the downsides!

The Brazilian manufacturing industry has relied on outsourcing for decades to reduce costs and increase efficiency.

However, outsourcing has its own disadvantages, which are becoming increasingly visible and can have a negative impact on the quality of products, employee morale and the overall success of the company.

Especially in recent years, we can clearly see that one of the biggest disadvantages of outsourcing in the manufacturing industry is the potentially poorer quality of products. We could clearly observe this tendency slowly but steadily increasing from around 2015/16.

We perceived the first signs in projects in the Brazilian automotive industry as well as in the packaging industry.

PET bottle blow molding and filling unit

When production is outsourced, there is less control over the quality of the manufactured product. Companies increasingly lost direct control over the production process, resulting in inferior products that did not meet the standards of the assembly companies or system suppliers. Increasingly, we saw clients who saw daily production rejections ranging from 50 to 100%. This was then to be compensated for by increased and often outsourced quality control, especially in the automotive industry. This led to steeply rising process costs, and the complexity of production and its controlling also continued to increase. The character of controlling developed more into a reactive process rather than a fundamentally important tool in the creative transformation of processes and business models.

Another disadvantage of outsourcing is the loss of control over the production process. When production is outsourced, there is no, or a greatly diminished ability to ensure that the company's standards and procedures are followed.

This has resulted in ever-increasing production delays, inferior products, and lack of accountability for the quality of the manufactured product. The typical response: night work, weekend shifts - dramatic cost increases.

In addition, outsourcing can lead to a decline in employee morale. When production is outsourced, employees may feel that their work is not valued or appreciated.

This led to a decline in productivity and a sense of disengagement from the company. With the pandemic, this process has become massively entrenched, especially among well-skilled Brazilian professionals.

And with that said, outsourcing can be costly. It may seem like outsourcing is a cost-effective way to manufacture products, but if not done right, or overdone, it can lead to additional expenses and lost profits.

Production for scrap containers - it isn’t sustainable!

Back to the present - asset-light models

In such situations, we often saw a massive increase in pressure from the international parent companies to outsource the administration and to contract a BPO. As a result, complexity exploded and process mining for a detailed understanding of problem causalities was increasingly lost. The BPO providers were able to name problems, but usually did not have the capacity to perform process mining. As a result, problem solving has become tactical at most; the strategic view has been eliminated.

Organizations need to be extremely careful with asset-light models to ensure that it is cost effective and beneficial to the organization.

A deep self-critical evaluation has to take place!

Conclusion

In summary, while asset-light models in the manufacturing industry can be a beneficial way to reduce costs and increase efficiency, it is important to be aware of the potential significant drawbacks. Companies should carefully evaluate their asset-light model strategy to ensure that it is cost effective and beneficial to the business. This process of evaluation should never be done from the sole perspective of opportunity cost!

The main disadvantage of asset-light models is that they have no control over the quality of the services or products they offer. Without physical assets and infrastructure, companies are unable to monitor the quality of the services or products they provide, which can lead to unsatisfactory customer experiences. In addition, asset-light models are more susceptible to external factors such as supply chain disruptions because they depend on third-party vendors and service providers. Finally, asset-light models often require more capital or debt financing to acquire the services or products needed to operate them.

Just in the last 2-3 years or so, we have seen startling examples of asset-light model projects.

Asset-light models in production-related warehousing: administrative chaos, poorly trained forklift drivers with all the consequences for materials and operational accidents, but sensationally low costs ... .

Asset-light models in administration: the client has been pushed into a BPO system that does not reflect the complexity of value creation, only makes visible the existing problems without being able to help in their true elimination. The client loses the ability to do its own process mining and embarks on a blind flight without an emergency exit.

Effect: Clients lose the possibility to create really strategic scenarios, because only tactically determined actions exist. Creativity in free fall.

elevated frustration potential

All this is diametrically opposed to the pressure to build resilient supply chains and value chains - at least in most cases.

Our general recommendation from now almost two decades of reorganization, business development and transformation:

Seek a redesign of production that takes into account megatrends such as sustainability, regionalization and/or individualization - this creates competitive advantages. Asset-light models can be interesting in extremely standardized productions that are massively geared to economies of scale.