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Supply Chain Strategy for the C-Suite: The Hidden Costs of Knowledge Transfer in Offshore Operations

Supply Chain Strategy for the C-Suite: The Hidden Costs of Knowledge Transfer in Offshore Operations


The rationale behind off-shoring manufacturing operations is more often than not inextricably linked to the need to improve the bottom line by reducing production costs. Or, put in another way, the need to achieve some sort of competitive advantage through operational efficiency.

Small, medium-sized and large corporations in the US and all over the world have enjoyed the benefits of off-shoring for more than 3 decades now. Advocates of off shoring contend that it has enabled great operational efficiencies by allowing organizations to focus resources on main lines of business, minimize overhead / tooling costs, control manpower and training costs and concentrate energies on management’s core competencies.

When companies in the United States make the decision of moving manufacturing operation outside continental USA they tend to rely heavily on the results from net present value analyzes. Normally these calculations involve forecasting capital investments, expected operational costs, expected income and expected savings and, discounting them to a given rate (cost of capital). If the NPV of the investment is positive, more often than not, companies decide it is a safe bet and move forward with the project.

However, organizations should also give careful consideration and analysis to some not-so-apparent costs that tend to escape NPV analyzes. These costs are frequently referred to as hidden costs. Particularly, companies should be concerned with the hidden costs of knowledge transfer across cultures and its consequent, increasing quality risks involved.

The Role of Culture and Language

In this era of rapid growth, fast communications, short product life cycles and short-lived competitive advantage more and more companies are intentionally selecting offshore suppliers due to low labor costs markets and tax considerations; However, before jumping into setting up offshore operations as a way to achieve high operational efficiencies, companies should consider the role that cultural differences play in the management of quality.

A big consideration worth resolving prior to setting up offshore operations has to do with language as a facilitator in the transference of knowledge process. Will the project require all operations to be carried out in a specific language? Are there any minimal requirement as to language proficiency is concerned?

Several countries and US territories offer an attractive conduit for competitive advantage for many US companies via the establishment of their manufacturing operations offshore. Puerto Rico for example, is a US domestic jurisdiction which has the added tax benefits of operating as a foreign corporation. Puerto Rico has a relatively new industrial biotechnology program geared toward training people for the biotechnology manufacturing industry. Because of this, Puerto Rico is seeing a fair amount of medical device companies selecting the island. It is also seeing a migration from traditional chemical pharmaceutical manufacturing to biotechnology bulk production and biotechnology manufacturing.

It is no secret that quality assurance is crucial for the manufacturing industry. With so much global competition and prevalent shrinking margins, no company can afford to spend time and money on rework. Apart from the obvious costs associated with reworking and fixing quality flaws, loss of reputation is perhaps the highest and costliest consideration for most companies when dealing with quality assurance.

Big Hit on the Pharmaceutical Industry

The pharmaceutical industry is no exception to this rule. For more than 35 years, several pharmaceutical companies have carried out offshore operations in Puerto Rico. In 2001, one of the leading pharmaceutical companies left Puerto Rico manufacturers speechless with the announcement that it would invest $ 250 million to build on the island what could be the world’s largest biotechnology bulk product manufacturing company. Reportedly, the decision was based on quality of workforce and business environment. The new plant was intended to produce a biotechnology product used in the treatment of diabetes.

Apparently, little consideration was given back then to the fundamental role that knowledge transference plays in the management of quality in offshore operations. It should go without saying that the pharmaceutical industry in particular is subject to a number of regulations stipulated by Food and Drug Administration (FDA) and other regulatory authorities. These regulations enforce strict quality standards on pharmaceutical companies to ensure the safety and benefits of the products made by them. Quality management in the industry goes beyond ISO expectations and is much more complex and pervasive in scope necessitating significant investment of time, efforts and resources.

In 2010 the FDA warned this company about manufacturing issues at the plant in Puerto Rico. The problems were associated with the manufacturing of an insulin ingredient, at a facility in Puerto Rico. The agency requested that further evaluation of the matter include an assessment by the company on “the impact to one of their finished drug products.” The agency explained that the drug maker “failed to adequately investigate critical deviations or a failure of a batch to meet its specifications or quality standards” following an inspection in July 2009.

A Similar Case

In a similar case of poor quality management in offshore manufacturing operations, a second pharmaceutical giant’s operations in Puerto Rico cost the company a whopping $ 750 million for troubles associated with the facility. Reportedly, all the systems, the facility, the equipment and the processes were broken. Tainted water was used in manufacturing, production lines were turning out too-potent or not-potent-enough drugs, employees were contaminating products and different medications were packed into the same bottles.

What Studies Show

“Difficulties transferring know-how from US plants in Puerto Rico may be responsible for the high incidence of manufacturing quality problems on the island, according to a new study” says Gareth Macdonald from (1). The study, published in the Journal of Operations Management, revealed that the quality risk is higher for drugs produced in an offshore manufacturing plant compared to those produced by US manufacturers. Also, the study findings suggest that companies run the risk of damaging their reputation due to quality issues by having offshore manufacturing units to reduce expenses.

In the study, conducted by Ohio State University’s Fisher College of Business, researchers found that quality issues were higher for drugs manufactured at a Puerto Rican facility in contrast with a US facility for the same US pharmaceutical firm.

Because of the country’s proximity to the USA and oversight by the FDA, Puerto Rico was considered a safer offshore location unlike other countries. However, its status has been tainted in recent years. Study lead author John Gray said, “The results show how difficult it is to transfer world-class quality control to an offshore plant, even under the best of conditions. We believe the quality differences we found in Puerto Rican plants were driven by challenges in transferring knowledge from headquarters to the plant, due to cultural differences, primarily differences in language and values. “(1)

According to the study, quality was not an issue associated with distance between the plant and the company headquarters, the literacy level of the local population near the plant, or the number of similar drug manufacturing units in the area. Since the study was limited to Puerto Rican plants, the results cannot be extrapolated to other off-shoring locations. However, authors argue that if the differences in quality risk are primarily due to cultural differences, then the risks might actually be less in Puerto Rico compared to elsewhere.

Not all costs or savings can always be forecasted: There will always be hidden costs

As evidenced by the cases above, cultural differences play a significant role in the management of quality in offshore manufacturing operations. For companies such as those in the pharmaceutical industry and other industries that conduct their operations in different countries with varying cultures, adopting a uniform approach to quality management can be challenging; Instead, such companies should benefit from gaining knowledge about the influences of different cultural factors on quality work. With this knowledge, they should be able to adapt their strategies for implementing QM to the cultural context in the different countries where they are active thus minimizing the heavy impacts that culture, language and values ​​impose.


1. Macdonald, G. (2011, September 8). US to Puerto Rico knowledge transfer cause of quality problems, study. Retrieved from


Source by Humberto Coronado

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