Companies today have unprecedented opportunities to move functions to low-cost countries and tap into the capabilities of overseas suppliers. But the plethora of options at their disposal poses difficult challenges. Managers have to determine which links in their supply chain—from materials supply to research and engineering to manufacturing and assembly—are best suited to relocation, and they have to weigh the various risks and benefits presented by different regions and countries. The danger is that the complexity of the decisions can lead to paralysis.

A recent Bain & Company survey reveals that the danger is not just theoretical. We canvassed 138 manufacturing executives in a range of sectors. While more than 80 percent of them believe that cost migration is a high priority in their industry, fewer than two-thirds have launched significant cost-migration initiatives. And even those making major efforts have focused on routine manufacturing and assembly processes. Only 15 percent, for example, are reaping benefits from relocating value-added activities such as research and development.

It's clear that the question for executives is no longer whether to move costs to low-labor-cost countries (LCCs)—that's now a given—but what to move, where to move, and how to move.

What many managers lack, however, is a framework for making these decisions, one that puts the relative benefits and risks of all the myriad options in the proper context and allows executives to make informed decisions that are consistent with corporate strategy.

The cost-migration imperative
We categorized the companies in our sample according to their cost position. Twenty-five percent rated themselves as "cost leaders" in their markets, and 33 percent characterized themselves as "cost laggards," with the remainder falling somewhere in between. When we analyzed their operations, we found that the leaders were well ahead in pursuing cost migration, with more than two-thirds having already moved at least 20 percent of their supply chain costs to LCCs. In contrast, only 13 percent of the laggards had hit the 20 percent mark. The laggards, moreover, confessed to struggling with the practical aspects of overseas moves, while the leaders displayed a great deal of confidence and acumen in drawing on the resources of LCCs.

Consider the case of St. Louis-based Emerson Electric. A $15.6 billion conglomerate that competes in a wide variety of industrial markets around the world, Emerson has been a cost leader for many years. In the mid-1980s, recognizing a surge in global competition across its markets, Emerson embarked on a strategy to methodically and progressively shift sourcing, manufacturing, and engineering from its traditional bases in Western Europe and North America to LCCs. By 2002, LCCs had grown to account for 44 percent of Emerson's total manufacturing labor cost, a fourfold rise from a decade earlier. The company also made shifts of similar magnitude in material costs as well as engineering and development costs.

The success of Emerson's long-term strategy of transferring costs to LCCs is clearly visible in its earnings statement; the company's operating margins have steadily improved in the past decade. Emerson continues to pursue new cost-migration opportunities aggressively. Its ambitious targets include doubling, yet again, the proportion of its material and engineering and development costs located in what it calls "best-cost countries" by 2007.

All the leaders take a systematic approach to cost migration, carefully prioritizing activities and sources based on the prospective gains available. In particular, they recognize that the need to move to LCCs varies dramatically across industries and even individual product categories. Where labor accounts for a high percentage of total costs and transportation costs are relatively low, the cost-migration imperative is strongest. The inverse is also true: maintaining production facilities in high-cost countries can make sense when labor is a minor cost component or transportation costs are high, as in high-value electronics or bulky appliances.

In other words, a decision to migrate costs is not an all-or-nothing proposition; it requires a careful analysis of each product line, focusing on issues such as relative labor costs, logistics costs, customer requirements, and time to market. Once a company has determined which costs to shift to LCCs, success hinges on its ability to determine what particular activities or sources to move, where to move them, and how to make the shift organizationally and operationally. It's in these areas that the cost leaders offer some of their most powerful lessons.

What to move: Think functions, not factories
The labor-cost savings offered by LCCs can be striking, and managers may be tempted to simply shut down an operation in a high-cost country and move it wholesale. But transplanting entire factories is not necessarily the best route, even where significant improvements in cost-competitiveness are critical to survival. The cost of closing down a manufacturing facility in a high-cost country can be considerable—as much as +200,000 per laborer in a country like Germany. Then you have to add in the cost of constructing a new plant in an LCC, plus various hidden "legacy" costs such as those related to disrupting relations with local suppliers. The price of shifting an entire production facility is often so high that it just doesn't make economic sense.

That's why cost leaders think in terms of functions, not factories. They realize that just by shifting certain carefully selected processes or activities, they often can approximate the savings of moving facilities without having to bear the shutdown and start-up costs.

Basic manufacturing processes are only the tip of the iceberg, however. The leaders recognize that the skill levels of LCC workforces are reaching or exceeding those of the developed countries of the West. Several Asian countries, such as Singapore and Taiwan, have in the last few years boasted education levels comparable to or higher than those of the United Kingdom or France. India alone is home to 350 million people who speak English, and it produces 1.5 million tech-savvy college graduates each year.

Companies that understand that "low-wage" no longer translates as "low-skill" take a broad approach to cost migration. They examine specific functions, such as finance or marketing, and components on a case-by-case basis, identifying those ripe for migration and sidestepping those that are not. Boeing, for instance, has a center that does design and technical work in Russia, a country with deep aerospace-engineering skills. Procter & Gamble has its payroll done in Costa Rica. General Electric has built an R&D center in India with a staff of 500, one-third of whom are PhDs. Our research shows that cost leaders are about twice as likely as cost laggards to reap benefits from shifting or adding knowledge-intensive activities such as R&D to LCCs.

In deciding which functions to move, the leaders also carefully take into account opportunities to build new markets in the host country. Emerson, for example, does $900 million worth of manufacturing and sourcing in China. But China is not only a key link in Emerson's global supply chain, it also accounts for more than $1 billion in annual sales of products ranging from industrial motors to network power systems. Emerson uses its operations in LCCs to gain access to and expertise in serving lucrative and rapidly growing new markets. And one of the key reasons GE sources extensively in China is because China represents a vast market for its offerings: a projected $5 billion this year. Like Emerson, GE is now selling more in China than it is sourcing-$1 billion more, in fact.

Where to move: Build a portfolio
China and India have been the leading targets for cost migration-and for good reason. Each offers an attractive combination of low costs, well-developed capabilities, business-friendly regulatory environments, and large domestic markets. But while China and India are the top two destinations cited by both leaders and laggards in our survey, we found that the leaders are far more likely to look beyond those two countries in evaluating LCCs. They recognize that each country has its own risk-and-benefit profile and that these profiles can and will change over time. Indeed, considering that a new facility may have an investment horizon of twenty to thirty years, historical trends and present conditions may be less important than future developments. To hedge their bets and gain greater flexibility, the leaders seek to build a portfolio of LCCs rather than concentrate all their activity in one or two of them. That way, they are better able to ensure security of supply and stable costs over the long run.

A successful portfolio needs to incorporate a range of decision criteria; it can't have just a one-dimensional focus on cheap labor. In China, for instance, companies face political uncertainty and weak enforcement of property rights, risks that could overwhelm the benefits of low labor costs.

To manage such concerns, the cost leaders think of their global supply chain in a way that balances low costs against political and economic risks and proximity to key markets. While China may be the most attractive location for many products on a simple cost-comparison basis, a portfolio approach may mean accepting higher unit costs in other Asian countries, Eastern Europe, or Latin America to protect against currency risks, political risks, or the impact of natural catastrophes. Hungary's labor cost, for example, almost quadruples China's, but because Hungary offers a highly educated workforce and relatively low political risk, it can be a better bet for Western European companies looking to migrate skilled manufacturing.

Of course, production diversity can be taken too far. Many industrial companies struggle with a legacy of fragmentation in their supply chains: subscale plants in dozens of countries, each focused primarily on local assembly. Cost-migration strategies should not be allowed to perpetuate this approach. Decisions about portfolios should be highly disciplined, balancing the risk advantages of diversification with the scale advantages of consolidation. Emerson, for example, concentrates its activities in four major production centers around the world, a portfolio that spans Eastern Europe, Asia, and Latin America but also provides the benefits of concentration.

How to move: Lead from the top
A company's own organizational structure often presents the final hurdle to a successful cost-migration strategy. Here, again, we found a sharp difference between the approaches of leaders and laggards. The laggards tend to leave cost-migration decisions up to individual business units, which has two big drawbacks. First, it encourages incremental decision making rather than a strategic approach to cost management. Second, it prevents companies from reaping savings across business units by pooling sourcing, jointly developing new suppliers, or expanding economies of scale in LCCs.

The cost leaders, in contrast, drive their initiatives from the top down. According to our study, 82 percent of leaders use a companywide or centralized strategy for cost migration. Munich-based Siemens, for example, has announced its intent to shift more internal services and software development to India and other low-cost locations and is setting targets for manufacturing; its Osram division will increase LCC production from 15 percent to 33 percent.

The advantage? A top-down, centralized approach allows companies to use scale to their advantage as they build out their LCC presence, and, perhaps most important, it is often the only way to overcome deep organizational resistance to the redeployment of labor and resources.

Throughout the effort, executives need to guard against underestimating the challenges of such a large-scale initiative. When it comes to cost migration, there are no easy or ready-made answers. Success always requires a major organizational effort and strong leadership. But by taking a methodical, proven approach to making smart what, where, and how decisions, companies will be able to avoid many of the problems that can undermine even the best intentions. And they can sidestep perhaps the greatest roadblock of all: decision paralysis.

Excerpted with permission from "Making the Move to Low-Cost Countries," Supply Chain Strategy, Vol. 1, No. 2, June 2005.

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Till Vestring, based in Singapore, directs Bain & Company's Asia-Pacific Industrial Practice.

Ted Rouse, based in Chicago, directs Bain's Global Industrial Practice.

Uwe Reinert, based in Düsseldorf, directs Bain's European Industrial Practice.

The authors thank Suvir Varma, a Bain partner in Singapore, for assistance with this article. They can be reached at SupplyChain@hbsp.harvard.edu.