The pros and cons of nearshoring: Moving manufacturing closer to home
MANUFACTURING INSIGHTS |
"Made in America," a slogan once proudly proclaimed by U.S. manufacturers, is making a comeback. Even as the country continues to climb out of recession, manufacturing growth here has created 500,000 U.S.-based jobs during the past three years. One reason for the increase is the growing preference of businesses for bringing manufacturing back to the United States, Mexico and Canada, where it can be nearer to suppliers, engineers and customers. Known as nearshoring – or alternatively as inshoring or onshoring – it offers American companies many economic and logistical advantages. Yet this trend in business proximity can pose some challenges as well.
Several factors are driving this trend. According to the 2013 McGladrey Manufacturing & Distribution Monitor Report, 52 percent of respondents stated that it is important that their manufacturing be physically close to their customers, as expectations for faster time-to-market continue to grow. What's more, 42 percent of manufacturers prefer that their engineers and product developers be closer to the production process.
Costs for land and labor in emerging countries, such as China, are rising, while high U.S. unemployment is relieving pressure on factory owners to increase wages, helping to make U.S. labor costs more globally competitive. Falling domestic energy costs play a role as well. Cheap U.S. natural gas helps power U.S. factories more efficiently and provides inexpensive raw materials for U.S. manufacturers of plastics, tires, certain pharmaceuticals and other petrochemical products.
Overseas logistics costs such as administrative, transportation and inventory functions are rising, too. Remote manufacturing increases risk through factors such as natural disasters, which produced $300 billion in added supply chain costs in 2012. Finally, quality control and protection of intellectual property can be harder to maintain when manufacturing is done overseas.
China – Should I stay or should I go?
As the cost of doing business in China increases, many U.S. companies are nearshoring some of their manufacturing but are not leaving China altogether, largely due to two reasons: First, as China shifts from an export-orientated to a consumer-based economy, it is becoming an ever-more important market for U.S. companies.
Second, it is extremely difficult to dissolve a foreign investment enterprise (FIE). China's liquidation law states that if an FIE does not undertake a proper liquidation, the Chinese government can prosecute its executives and impose heavy penalties. Company leadership also may be permanently barred from country, affecting their future investment opportunities there.
Before shifting from offshoring in China to nearshoring closer to home, companies should confirm that their proposed dissolution meets the Chinese government's criteria:
- The business operation term is expiring and other reasons for dissolution have arisen as prescribed in the company's articles of association.
- Shareholders pass a resolution to dissolve the company.
- The company is affected by a merger or segregation.
- Government authorities cancel the company's business license or China's Supreme People's Court orders it to be dissolved.
Dissolving an FIE is a lengthy process, which generally takes from six to nine months but could take years. During that time, liquidation audits are generally required upon the government's approval of the termination application and again after termination procedures have been completed.
U.S. companies should consider the tax deregistration issues that will arise. Existing tax liabilities, such as the enterprise income tax, value-added tax (VAT), business tax and stamp duties, should be settled. Additionally, the liquidation may result in new liabilities such as individual income tax from employee compensation and a turnover tax for disposal of assets or their return to the United States.
Mexico: a top nearshoring choice, with caveats
In a recent survey, the Executives' Perspectives on Manufacturing Nearshoring, conducted by Alix Parterns, 64 percent of respondents said Mexico was their top choice for nearshoring. Indeed, with the world's 11th largest economy, Mexico offers many nearshoring advantages. It is close to North American markets and offers first-rate port and communications infrastructure. Its regulatory environment allows full foreign investment in most sectors, with no foreign currency restrictions. Competitive corporate tax rates – a flat 30 percent – and exemptions from VAT and import duties in most cases are also an advantage.
Mexico offers challenges as well. Its dependence on the U.S. economy, for example, can greatly affect its own. The country's well-known red tape — extensive paperwork and time-consuming registration and formation processes — can be exasperating. Aggressive tax audits and labor laws can make it difficult for operations. Security, too, is important to consider, although the issue has not seemed to affect U.S. companies' investment in Mexico significantly.
One of the most common issues U.S. manufacturers must consider regarding nearshoring in Mexico is whether to open their own maquiladoras or go through a third party. In general, if a company is looking to nearshore in Mexico for the short term or is new to the country, contracting to a third party could be the best approach. If a company is looking to be there long term, opening their own maquiladora is usually less expensive and simplifies transfer pricing and other issues.
In general, when U.S. companies are considering their nearshoring options, it is best to begin with three general principles:
- Be patient. Things in nearshore countries such as Mexico, or off-shore countries such as China, do not happen as fast as you would expect in the United States.
- Always ask before acting; do not try to look at issues, conditions and laws as you would if you were setting up an operation in the United States.
- Include accounting and legal advisors on your team who are experienced in working with U.S. companies in the regions you are considering.
For additional information on this topic, view our past webcast recording and slides.