Making the Case for Reshoring -- Offshore Risks

After years of chasing the lowest cost labor, materials and overhead costs overseas, companies are now recognizing previously unforeseen risks and costs and changing their perspective on what constitutes efficient and wise production practices. Now, the tide seems to be turning in favor of the U.S., where production is more frequently reshored, for goods sold both domestically and to export markets.

Manufacturers should expect this trend to pick up steam through the coming years, according to a recent Boston Consulting Group survey conducted in late February 2012 regarding attitudes around reshoring. Among 106 large U.S. manufacturers surveyed, 70% said sourcing in China is more costly than it looks on paper, and 37% said they plan on bringing production back to the U.S. from China, or are actively considering it.

The case for reshoring is compelling; it helps manufacturers eliminate substandard quality goods produced offshore, avoid theft of IP, cope with supply chain issues and improve their overall competitiveness. With companies realizing the benefits and economics turning in favor of the U.S., and previously lost skilled jobs returning after being lost for decades, what are the other risk factors associated with offshoring that can tip the balance towards reshoring?

Wage Increases

It's no secret that the economies of the developing world are growing at a higher rate than the rest of the world. The accompanying wage pressure, due in part to increased demand for skilled labor, is driving wages up as well -- climbing approximately 15% to 20% annually in China. Soon, the time will come when labor cost are nearly equal, erasing one of the most significant advantages to offshore production.

Companies will also soon see rising rates for engineering and manufacturing draw closer to that of the U.S. According to consultant AlixPartners, manufacturing costs for China will no longer seem like a bargain by 2015, factoring in currency and shipping costs, when they will be equal to the U.S.; India and Mexico are close behind, but the trend is clear.

Labor Issues

Recent and ongoing coverage of the conditions in overseas manufacturing facilities casts a spotlight on an easily ignored aspect of the offshore equation: in-country labor management is left to contend with workers, yet the impact of strikes, dissatisfaction, and calls for better pay and conditions can reverberate well beyond their shores.

Time spent bringing offshore facilities up to acceptable standards, where safety and general working conditions are frequently deplorable, means production suffers in the short term. Potential exposure for supporting or partnering with these companies can be a concern, especially if a domestic manufacturer does not have full access to its offshore partner. Additionally, a manufacturer runs the risk that its reputation, operations and public perception may suffer due to circumstances and events beyond its control.

Risk of Nationalization

Developing economies and those countries with political instability may also pose an operational risk to offshore manufacturers, due to uncertain outcomes and changing attitudes towards foreign companies doing business there. Several South American countries and Mexico are good examples where industry nationalization, tighter restrictions on capital investment and repatriation, and uncertainty regarding their long-term treatment of foreign companies weigh heavily on the decision to keep production offshore.

Intellectual Protection

Today’s manufacturing is heavily reliant upon new ideas, the intangible knowledge capital that fosters tomorrow's products.  The legal use of intellectual property, which includes trusted offshore partners, is constantly under attack by individuals, corporate entities or governments who ignore IP laws and standards. In the absence of worldwide standards for IP protection, companies must make use of patents, trademarks and copyrights, but even with those protections, they are still at risk. Protecting IP abroad and finding remediation can be a costly undertaking, with patent enforcement and injunctive relief slow or lacking, potentially falling short of a fair solution. More troubling are instances of infringement and outright theft of IP of a sensitive nature, potentially exposing the holder to legal or non-compliance risks.  

Speed to Market

Companies are challenged to maintain leaner inventories in today's highly cost-sensitive markets. Speed to market is becoming more critical for innovators and OEM’s who are seeking to capture every competitive edge they can. Yet offshore manufacturing presents unique challenges that strain this new imperative. Markets such as Vietnam offer lower labor costs, but lack the reliable supply chain required for today’s technology-intensive products, including the raw materials, sub-assemblies or the automated or certified manufacturing processes needed to maintain necessary production levels.

Workforce Skill Level

The initial lure of lower labor costs may also hide the fact that labor competency is not always correlated with the available labor pool. With the exception of products that can be produced by low-skilled labor, the value to the manufacturer of labor competency always wins out over low cost. Countries that have realized the benefits of higher manufacturing employment are now facing a skilled labor shortage, due to ever increasing demand for these workers and the inability of their educational and training infrastructure to keep pace. Consider the vastly different skill sets required to assemble a simple consumer product versus those required for advanced composites assembly, CNC equipment, ION implants, or medical devices -- are these more easily obtained overseas?

Material Costs

Conventional wisdom held that China and other countries were the default low-cost option for offshore manufacturing. Now, companies are quickly realizing that reshoring is a competitive option when total costs of manufacturing are factored in. A fundamental component to this equation is the cost of raw materials, which are rising quickly. Base materials including copper, iron, chemicals and plastics have all seen sustained price spikes in the past 18-24 months. The market for critical components such as integrated circuits, LED and display panels has also experienced periodic shortages during critical times. Finally, fuel and energy costs have doubled in some categories since 2008, placing additional pressure on the manufacturing cost equation. Reshoring will not affect the cost of raw materials, but will remove some of the risk that highly competitive materials markets bring.

Regulatory Concerns

Companies are also assessing U.S. government's potential initiatives around creating manufacturing incentives. The government is under pressure to provide non-deficit producing initiatives to make the climate for domestic manufacturing, and reshoring, more attractive. Easing the regulatory burden on manufacturers and simplifying the tax code to provide incentive for capital equipment will provide a clear and predictable outlook for companies that are considering reshoring and those that are currently hesitating or evaluating their options, and also level the playing field where companies are competing with offshore manufacturers.

Present State of Industry

Although manufacturing employment levels have declined for nearly a decade, American manufacturing had its best year ever in 2011, with $600 billion in profits. This measure of success is rooted in a deeper transformation -- American manufacturing is more efficient, productive and automated than ever before. Before the current recession, manufacturers have reengineered, rethought, and reinvented their processes. Clearly, the importance of manufacturing is not discounted in today’s economy, but supported. In the U.S. and other countries like Japan, Germany and Canada, highly skilled jobs are created when high value products are produced, whether they are niche products or simply those that meet demand for the highest grade and quality. Bringing manufacturing back to the U.S. is a wise move for companies seeking access to lean, innovative, efficient and automated processes that will drive their profitability.

U.S. manufacturers have enjoyed the benefits of offshore production for years but now realize that with its advantages come unforeseen risks. Offshoring has not caused the massive U.S. trade deficit and the decline of U.S. manufacturing over the past several decades but nevertheless, has contributed to it. Domestic suppliers have watched as large manufacturers have offshored work and well-paying jobs. Offshoring ultimately contributes to waste and instability. Reshoring strengthens the U.S. economy, is an efficient way to reduce imports, increase exports and regain manufacturing jobs in the United States.

Chris Coghlin is CEO of Coghlin Companies.