January 25, 2016 Procurement

About fifteen years ago companies were massively relocating their production and assembly work overseas to take advantage of low labour costs, especially in countries like China and India.

However, these same companies realized over time that offshoring also came with its own risks and costs.

Today, some prominent manufacturers are bringing work back home, prompting other companies from around the world to rethink the benefits of reshoring and its long-term implications.

Many manufacturing organizations moved their operations to China based on the assumption that the country provided tremendous cost advantages. This was true 10 or 15 years ago, but not anymore.

According to the Boston Consulting Group (BCG) Global Manufacturing Cost-Competitiveness Index, the difference in manufacturing costs between China and the United States has become negligible. As a matter of fact, for every dollar required to manufacture in the U.S., it costs 96 cents to manufacture in China. And that is before taking other factors into consideration such as the cost of transportation.1

The Index measured changes in direct manufacturing costs from 2004 to 2014 among the world’s top 25 exporting countries, and indicates that old perceptions regarding manufacturing competitiveness no longer hold.

China may still be the world’s largest exporter, but wages have risen 4 times faster than productivity over the past 10 years and higher energy costs for both electricity and natural gas have diminished its long-standing edge.

Hence, the study found that the country with the lowest manufacturing costs is no longer China, but Indonesia, then India, Mexico and Thailand.

But regardless of where production has been outsourced, the cost of offshoring is almost always more than anticipated. Some of the tangible costs that are often underestimated include transportation, expediting, custom duties, warehouse space/costs, salaries for personnel overseas and domestic staff managing overseas suppliers, material handling, procurement staff, inventory carrying, debt, product damage, and potential hidden costs such as occasional trips to Asia.

Intangible costs are just as real. They include the cost of managing offshore suppliers, the cost of corruption, and the possibility of losing intellectual property or damaging customer relationships with late deliveries or poor quality.

Truth be told, assessing a country’s relative competitiveness is a complex task, because it is determined by a number of fluctuating factors. The past ten years have been marked by high volatility. Some countries have seen more than 10 years of 10 to 20% sustained wage growth. Productivity has doubled in many countries while declining in others. Energy costs have increased in many countries, sometimes by up to 200%, and currencies have fluctuated greatly, ranging from -20 to +35% versus the U.S. dollar.2

Under these conditions, trying to identify THE best country to offshore production for the next 10 to 25 years is at best a guesstimate.

From a locational perspective, manufacturers typically have three options: onshoring (within the nation), nearshoring (in a neighbouring country) and offshoring (in a geographically distant country).3

Companies that have brought outsourced personnel and services back to the location from which they were originally offshored—what is effectively called reshoring—include large corporations like General Electric, Motorola, Lenovo, Google, Apple, Boeing, and Ford. However, several studies have confirmed that the reshoring trend is growing.

In 2014 the BCG published its third annual survey of U.S.-based manufacturing executives, which showed that more than half of the respondents were considering bringing production back, thus corroborating the findings from the previous year. In addition, the 2014 study confirmed that these executives were acting on their intentions: the number of respondents who said that their companies were already bringing production back from China to the United States had risen 20% from roughly 13 to 16% the previous year.4

Similarly, a 2013 study by Grant Thornton predicted that over the course of one year, about one-third of U.S. businesses would be moving goods and services back to the United States, and a similar percentage would be reshoring to places closer to home such as Mexico. According to the study, the trend would even hold true for sectors such as IT services and call centres, which have traditionally been largely outsourced abroad.5

In Canada, the reshoring trend may not have gained as much momentum yet. Nevertheless, companies are increasingly realizing the benefits of local manufacturing, especially with the volatility of the Canadian dollar. A 2014 KPMG report indicates that just 14% of Canadian manufacturers plan to source from China, compared to 31% the year before.6

Whether the reshoring trend accelerates or not depends on a number of factors, including the overall state of the economy, but one thing is certain: corporations are no longer just looking at labour costs when they elaborate production strategies.

Although in the past the primary driver for offshoring was labour arbitrage, several studies show that today companies are not interested in lower manufacturing costs alone.

According to a study by the global management consulting firm A.T Kearney, the main reasons manufacturers are bringing production home are delivery time improvement, total cost of ownership, quality improvement, freight cost improvement, wage cost improvement, customer responsiveness, and to a lesser extent image, higher productivity, innovation, and inventory improvement.7

Similarly, respondents to the BCG survey indicated that the top three motivators for reshoring are the needs to shorten the supply chain, reduce shipping costs and provide local control over manufacturing processes, in that order.8

Closer geographical proximity with both customers and suppliers helps reduce shipping costs and delivery times. As a result, manufacturers don’t need to keep large quantities of finished products in stock, which in turn lowers inventory costs. And since local suppliers typically offer longer payment terms than their Chinese counterparts, companies have the added benefit of improved cash flow.

Improved customer responsiveness is another reason manufacturers want to bring production home, or at the very least closer to home. In certain sectors, the ability to turn around a product in days instead of months confers an undisputable competitive advantage. This is particularly important in sectors such as fashion apparel or for technology products where demand varies unexpectedly and production adjustments need to be made quickly.

Similarly, reshoring minimizes the risk of supply chain disruption. Manufacturers can oversee manufacturing processes locally and should the unforeseen happen, they can react much faster than if production was overseas.

From a quality standpoint, the label “Made in America” has always been synonymous with higher quality for sensitive products like food, baby items, or medicines, but the phenomenon is gaining momentum. Companies are becoming increasingly aware that this is what customers want. After conducting its own research and realizing that the country of origin was the second biggest indicator of purchasing preference—right after price—Walmart famously committed in 2013 to buy an extra 250 billion of “made in USA” products over the next ten years.9 The widely advertised announcement certainly benefited the company in terms of brand image, but there was also a strong desire to support the local economy.

More and more businesses see the benefits of maintaining closeness between their R&D department and the manufacturing/assembly line. This approach reinforces collaboration and minimizes the risk of miscommunication due to language barriers. Besides, it makes it much easier to run tests or work on prototypes in iterations. All in all, this translates into even shorter lead times, and can even stimulate creativity and innovation. This has proven to be quite beneficial for complex products.

Some businesses are nonetheless deliberately deciding to either stay local or reshore, even when the benefits are less tangible. Sometimes it is a branding decision, and sometimes it is a long-term commitment to the green movement, since manufacturing eco-friendly products overseas has proven to be more challenging.

Clearly, reshoring is a better decision for industries that are largely influenced by macroeconomic factors such as labour productivity, currency fluctuation, and energy costs. So, companies that are either in computers and electronics, appliances and electrical equipment, primary metals, machinery, furniture, plastics and rubber, paper, or fabricated metals should at least give some thought to the reshoring question.10

Furthermore, organizations located in countries with higher productivity levels are more likely to reshore. In this respect, the large productivity gap between Canada and the U.S. is one of the reasons American companies tend to jump sooner on the reshoring bandwagon than their Canadian counterparts. Manufacturers in the U.S. are typically larger firms and can therefore exploit bigger economies of scale, especially when they have invested in advanced manufacturing technologies such as 3-D printing, robotics, and digital manufacturing.11

To complicate matters further, the reshoring decision needs to be future-proof. As indicated before, one of the key premises behind reshoring is that the benefits of being closer to the customer offset higher labour costs. But that line of reasoning assumes that the goods produced locally are be sold locally.

Meanwhile, emerging markets are growing much faster than domestic markets. General Motors, for example, now sells more cars in China than in any other market.12 So, organizations need to look at their markets globally, otherwise they will simply have the reverse problem in 10 or 20 years.

Whether companies decide to reshore all or part of their product-assembly operations, they should learn from those who have brought work back from abroad.

In this regard, the U.S. Competitiveness Project at Harvard Business School offers precious insight. It shows that reshoring impacts all the levels of the supply chain and that manufacturers need to prepare for challenges that range from rebuilding the supplier ecosystem to hiring and retaining skilled workers, as well as relearning how to manufacture locally.13

These aspects may influence the choice of the reshoring location as well. Should companies reshore to an existing factory or to a new one?

The advantage of using an existing location—as long as it has the necessary capacity—is that manufacturers face fewer logistical challenges such as warehouse space and transportation. Moreover, they can tap into their supplier network, although they need to ensure their suppliers can ramp up as well.

However, when companies need to find a new location with suitable capacity, the location of their suppliers is a crucial factor to consider. With the offshoring movement, many suppliers have followed their customers overseas. As a result, the supplier ecosystem has completely evaporated in certain industries.

Likewise, the shortage of skilled labour has proven to be a tremendous challenge. Finding enough people with the right skills over a relatively short period of time and keeping them motivated to stay requires a lot of preparation. General Electric had a goal of hiring 2 500 new workers for its reshoring project in Kentucky. However, the company had to hire no less than 6 500 workers to yield the required 2 500 employees. When the employee turnover is that high it creates unpredictability in production schedules, which inevitably affects productivity, not to mention the repercussions on recruiting and training costs.

Unfortunately, the lack of skilled workers will only escalate over time as more people reach the retirement age.

There is no easy solution. Some corporations are trying to fill the gap with in-house training, others are recruiting abroad or from local related industries. Many manufacturers are also working collaboratively with community colleges and universities, but it will take years before significant results can be achieved.

Admittedly, automation can fill the labour gap, but only to some extent. This solution tends to work well for companies that don’t need a lot of manufacturing flexibility. However, humans are still more flexible than machines when manufacturers need to produce small quantities of mixed products or adapt to frequent market changes. So, it is often more a question of finding the right mix of manual and automated processes. Besides, it only shifts the recruiting problem, because these manufacturers still need to hire qualified workers to run their expensive machinery.

Another key lesson from the recent reshoring of manufacturing to the U.S. is that companies cannot expect to manufacture products locally the same way they manufactured them overseas. In low-cost countries, the focus was on leveraging cheap labour, but with reshoring the focus is more on adopting lean manufacturing principles.

This often means that manufacturers need to change their mindset around working with suppliers. For years, they have focused almost exclusively on achieving cost efficiencies through low-cost, competitive sourcing. But now they need to work more strategically with their key suppliers to optimize the supply chain. A relationship that entails a much higher level of information sharing and collaboration can go a long way to solve design and production problems.

There is no doubt that big projects like reshoring require a lot of advanced planning and active project management skills. Organizations need to handle myriad of details such as timing existing contracts, maintaining inventory levels throughout the transition, transporting various resources, and enforcing intellectual property rights overseas.14

Nonetheless, the companies that are the best positioned to compete in the future are those that are getting closer to customers, both in emerging markets and in developing countries. And to that end, reshoring is very much a lesson in manufacturing globalization.

When companies initially decided to offshore work from North America or Europe to low-cost developing countries, they made their decision primarily based on low-cost wages. Two decades later they realized that manufacturing costs were only part of the equation.

So far, the reshoring trend has been quite strong in the United States. And although it is likely to continue and even spread to other countries, it will not be across the board. Just like offshoring was not for everybody, reshoring will vary by industry and depend on the degree of reshoring readiness of each company.

Meanwhile, organizations are acutely aware that they don’t control their macroeconomic and industry environments, which is why they increasingly opt for a diversification strategy that requires them to maintain manufacturing operations around the world.

As companies work through the challenges of reshoring, they learn that a collaborative approach with suppliers can lead more lasting competitive advantages than a short-term focus on sourcing the lowest price.

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[1] The Boston Consulting Group August 19, 2014, The BCG global manufacturing cost-competitiveness index, viewed April 22, 2015

[2] Sirkin, H, Zinser, H & Rose, J April 25, 2014, The Shifting economics of global manufacturing, viewed April 22, 2015

[3] Zhang, M 2012 Sher-Wood Hockey sticks: global sourcing, Ivey Publishing

[4] The Boston Consulting Group October, 2014, Made in America, again, viewed April 22, 2015

[5] Grant Thornton, November 19, 2013, Reshoring likely to radically reshape U.S. economy in next year, viewed April 22, 2015

[6] Giguère, L & Matthew, D 2014, Canadian manufacturing outlook 2014, viewed April 27, 2015

[7] Van den Bossche, P, Gupta, P, Gutierrez, H, & Gupta, A February 2014, Solving the reshoring dilemma, viewed April 28, 2015

[8] The Boston Consulting Group October, 2014, Made in America, gain, viewed April 22, 2015

[9] Slavin, C March 24, 2015, Walmart’s made in USA initiative bodes well for U.S. packaging sourcing, viewed April 30, 2015

[10] Van den Bossche, P, Gupta, P, Gutierrez, H, & Gupta, A February 2014, Solving the reshoring dilemma, viewed April 28, 2015

[11] The Boston Consulting Group October 23, 2014, U.S. executives remain bullish on American manufacturing, study finds, viewed May 4, 2015

[12] Campeau, M December 2, 2014, What will the end of cheap Chinese labour mean for Canadians? viewed May 4, 2015 http://business.financialpost....

[13] Shih C. Willy. August 7, 2014, What it takes to reshore manufacturing successfully, MITSloan Management Review, viewed April 22, 2015

[14] Vechiola R May 14, 2014, United States: reshoring is gaining momentum, viewed April 27, 2015


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