Let’s talk for a moment about what I call “Systems Thinking”.
Most people do not think of cause and effect on what I call a “systemic level”. They tend to think in very narrow “chimneys” of thought. What happens in MY department is critical. The ability to see what the effect of an action is on the rest of the company is a rare ability.

Unfortunately, the lack of “Systems Thinking” significantly hobbles us in all walks of life.

Think of the current controversy about producing Ethanol from corn. It seems pretty obvious that making Ethanol from corn is a good thing, right?  Reduce our dependence on fossil fuels, our dependence on foreign sources of those fuels. That can only be good for us, right?

But wait. In order to grow enough corn to fulfill our energy needs, we would have to convert most of the farmland in this country to corn production. Of course, that would make food prices go up, increase our need to transport seed, fertilizer, corn, and all the by-products of corn and ethanol production, and, we would need to develop the infrastructure to support all this. 

In the business world, our leaders frequently jump on the latest bandwagon to champion their brand of Ethanol, of Six Sigma, or Windmills, or whatever sounds good at the moment.

It is exceedingly rare that a thorough analysis, including ALL the ways something can go wrong, what the impacts of those “issues” are, and how to control them, is done.

In engineering, I frequently teach a technique called FMEA (Failure Mode and Effects Analysis).  It is a fairly simple technique, but in practice is rarely used well.

I often hear people saying that they don’t have the time to do the analysis up front, the deadlines are too tight, there aren’t enough resources, the cost is too high, etc.   “We’ll fix it later”.  But, “later” never comes.  It’s always too late and costs too much.

As an executive in an auto supplier, I recall a push to source a product from a local supplier, located about 90 minutes from our plant.  Our cost for the part in question was $1.00.  We purchased the part “Just In Time”, meaning, we kept about 3 days of material on hand to feed our assembly line.  We had great payment terms of Net 60 Days.

Whenever we had engineering changes, or quality issues, we picked up the phone and either the supplier came to us, usually the same day, or, we went to his facility, depending on the issue.

Our Purchasing manager came to me one day, excited that he could source the same part in China for $0.80 each.  That is a big difference when you produce over a million units a year, and represented a savings of $200,000.  At least, it did on the surface.

In subsequent discussions, I learned that the price was $0.80 FOB (Freight On Board) in Hong Kong. We would have to pay for shipping, customs clearance, and insurance to get the parts from Hong Kong to Michigan, which would add approximately $0.05 per part.

We also had to have significant inventory, which meant incurring inventory “carrying costs” related to warehousing.  Not a lot of money, but a few cents per part. 

Next, since shipment from Hong Kong, by sea, took about 6-8 weeks, we had to make sure that we ordered parts at least 12-16 weeks in advance, long before we knew what our customers would be building, so we would have between 16 to 20 weeks of parts in the “pipeline” at any given time, between Hong Kong, on ships, and in our warehouse.  There would be additional inventory at the supplier while they accumulated parts for each shipment.

I asked the Purchasing Manager what would happen if we had a quality problem with the parts, and he said that we would have to argue with the supplier about it.  In all likelihood, though, we would end up eating the cost of the parts.  So, conceivably, we could end up scrapping 20 weeks of parts, or 20,000 parts times 20 weeks – 400,000 parts, at $0.80 each, or $320,000.  That was almost two years of cost savings, worst case.

It also didn’t take into account the impact of engineering changes, for which we were responsible, and the event that we would have to scrap parts because of such a change.

It did not account for the “Cost of Capital”, or the cost of having a few hundred thousand dollars tied up in inventory because we would have to pay cash for the parts before they left Hong Kong, AND, it didn’t account for the significantly higher costs of supporting and supervising the supplier, which now involved sending engineers regularly to China. Instead of an engineer being out of the office for a day to visit the supplier, now he would be gone at least a week, and the travel expenses were significant.

In the end, I lost the argument, and the company decided to buy the parts from China, in spite of the risks and “unaccounted” costs.  The Purchasing Manager was able to convince his boss that the piece price savings were enough.

To this day, I believe that it was a terrible decision, and it certainly demonstrates a lack of Systems Thinking.