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Evaluating decisions on offshoring and reshoring

MANUFACTURING INSIGHTS  | 

Not long ago, China was the undisputed go-to location for American manufacturers seeking a low-cost alternative for production operations. Now, however, an increasing number of business leaders are opting to return business to the U.S. or to keep foreign manufacturing closer to home.

In a recent survey of manufacturing executives, the Boston Consulting Group found that 37 percent of U.S. firms with current China production plants have either brought that work back to American soil or are strongly considering such a move. While rising labor costs were the top reason, 70 percent of survey respondents concluded that production operations in China turned out to be more expensive than originally planned.

Still, in a world where American manufacturers are under constant pressure to lean out costs and bulk up profits, there are distinct reasons why China may become less desirable as an offshoring location. These include:

  • Total cost. According to data compiled by The Hackett Group, a strategic business advisory firm, the total landed cost for a manufacturing operation in China in 2005 was 31 percent less than a comparable production setting in the U.S. By 2010, that gap had shrunk to 23 percent. Based on rising wages, higher shipping costs and other considerations, Hackett forecasts that differential will fall to just 16 percent by 2013.
  • Product quality and intellectual property risk. In a survey of 130 global companies by Boston-based AMR Research, respondents named China as the top contributor for nine of 15 listed risks. These included supplier risk, product quality failure risk and intellectual property infringement. In regard to quality, China expert Marshall Meyer at the University of Pennsylvania's Wharton School of Business says the issue is not one-sided. For example, he believes many U.S. manufacturers underestimated the support Chinese production operations would need to meet acceptable quality benchmarks – particularly for goods in non-regulated industries. Conversely, he noted that Chinese contract manufacturers often have multiple subcontract tiers, which make quality control harder to manage. And, while there's little doubt that intellectual property theft is common in China, Meyer says the lack of a national court system makes it hard for Beijing to systematically crack down on the practice.
  • Nearshoring. While there's been a great deal of media coverage of some U.S. manufacturers bringing work back from China and other distant offshore locations (reshoring), less has been written about the concept of nearshoring. In short, this practice involves outsourcing production to relatively close non-U.S. locations (such as Mexico, Canada or Central America), which cuts freight costs, shortens delivery timelines and makes it easier to maintain oversight of product engineering and quality. While China's average production wage of $1.65 to $1.85 per hour is a bit lower than Mexico's $1.85 to $2.25 per hour range, wages in the latter nation are growing at a far slower rate.

Barring substantial changes in U.S. tax and regulatory policies, it's likely that some form of production outsourcing will continue. In the Fall 2011 McGladrey Monitor, nearly 70 percent of large manufacturers reported having at least some production operations in a non-U.S. location. Even among manufacturers with annual revenues under $25 million, 21 percent said they made goods outside of the U.S.

Without question, decisions on moving or keeping a production location are complex. Here are some quick considerations to keep in mind:

Do a full circle assessment. Thoughts of offshoring or reshoring a manufacturing operation are often sparked by a single cause, which is why it's important to broaden any evaluation to include shutdown and startup expenses, as well as a comparison of total landed costs. In addition, discussions of any prospective move should also include the potential effects on product quality, customer support, supplier availability and overall business growth.

Evaluate market goals. There's an important distinction between choosing a foreign location to produce goods, versus choosing that same location to produce and sell those same products to international markets. In the Fall 2011 Monitor report, companies with $500 million or more in annual revenue sold the vast majority of their foreign production in non-U.S. locations, typically close to the international customer base. On the other hand, companies with revenues between $25 to $100 million were split on the issue, with 37 percent of foreign production sold internationally and 33 percent intended primarily for shipment back for sale in U.S. markets. Bottom-line: Companies should strategically balance cost-effective production with opportunities to sell in nearby markets.

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