Assessing The Quality Risk of Offshore Manufacturing

Does offshore production pose an added quality risk relative to domestic production? And if so, what factors influence quality risk? The study, “Quality risk in offshore manufacturing: Evidence from the pharmaceutical industry” by John V. Gray and Michal J. Leiblein at the Fisher College of Business at Ohio State, co-authored with Aleda V. Roth at Clemson University’s College of Business and Behavioral Sciences, attempts to answer these questions by examining a series of invariant quality-risk measurement controls.

Companies are hopeful that offshore plants will become lower-cost “clones” of U.S. operations. While many believe this to be a significant cost-cutting strategy, the study proves that quality risk suffers in offshore manufacturing. The research defines quality risk as the propensity of a manufacturing establishment to fail to comply with good manufacturing practices. It is a proxy for the likelihood that a product shipped from a given establishment will not perform as intended due to manufacturing-related issues.

The researchers focused on U.S. pharmaceutical companies with offshore production in Puerto Rico, where 16 of the top 20 drugs in the United States were produced at the time of the study. To assess quality risk, the authors used inspection data from the Food and Drug Administration, providing a consistent, unbiased, third-party measure of quality risk in the highly regulated industry. To assess quality risk, they examined 30 matched pairs of U.S. and Puerto Rican pharmaceutical manufacturing facilities. The pairs had the same parent companies and produced similar products.

The researchers measured and controlled factors influencing quality risk in offshore manufacturing, finding: greater potential for expropriation of assets and intellectual property; political, social, and currency instability; issues related to insufficient worker experience and infrastructure; more pronounced cultural issues, language, and communications incompatibilities.

When these factors were measured in depth, they revealed the following:

  • The higher the educational level of the local population from which the plant’s employees are hired, the lower a plant’s quality risk
  • The greater the agglomeration of related plants in the geographic area of the plant, the lower the quality risk of an individual plant in that area
  • The greater the geographic distance between the plant and company headquarters, the higher the quality risk of the plant
  • The greater the cultural distance between the firm’s home country and the offshore plant, the greater the increase of quality risk at the offshore plant

In conclusion, the study warns, “Many top-level executives may be easily blindsided by the numerous perceived upsides of offshoring, and may too easily dismiss the downside operational risks beyond the obvious.”

View the full research here.

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