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How Real Is Reshoring?

After decades of decline in U.S. manufacturing, a new trend is emerging. Reshoring – the return of globally outsourced manufacturing – may well be the key to revitalizing American industry, and shortening lengthy global supply chains.

For over a century, the United States of America, with its autos from Detroit, textiles from the Carolinas and steel from Pittsburgh, was the world’s biggest manufacturer. The U.S. spawned unrivalled manufacturing giants and household names like General Motors, Ford, Boeing and Levi Strauss. ‘Made in America’ goods were synonymous with quality and invention.

But over the past few decades, U.S. companies steadily started to move, or ”offshore,” their manufacturing units overseas to take advantage of cheap labor in developing countries – most notably China – and the golden age of American industry looked to have come to an end. By the end of 2010, the U.S. had relinquished its manufacturing crown to China, which now supplies one-fifth of the goods consumed worldwide.

Today, as businesses become increasingly and sometimes painfully aware of the challenges of a global supply chain, the argument for offshoring manufacturing is no longer so clear-cut. With factors ranging from rising Chinese wages to higher U.S. productivity, and a groundswell of popular projects from the Made in America Movement to the Reshoring Initiative, the days when offshoring was the default option may be over.

Big names make the move

Several companies have already made the move back home for certain types of activities, such as ECI Biotech for its diagnostic medical instruments, Whirlpool, which will now manufacture its hand mixers in a $200 million plant in Tennessee, and General Electric for its water heaters.

Perhaps most notable is retail giant Wal-Mart, which recently pledged to buy an additional $50 billion worth of domestic products over the next 10 years.

“The economics of manufacturing are changing rapidly,” said Wal-Mart CEO Bill Simon at the 2013 National Retail Federation's annual BIG Show. “In previous decades, investment mainly went to Asia. Wages were low. The price of oil was low. And new factories sprung up out of the ground. But today, some of those investments are nearing the end of their useful lives, and manufacturers are making decisions about where they will invest next. Meanwhile, labor costs in Asia are rising. Oil and transportation costs are high and increasingly uncertain. The equation is changing.” He added that some companies are reaching the tipping point at which manufacturing abroad no longer makes sense for them.1

Even Apple, whose former CEO Steve Jobs once famously told President Obama that, “those jobs aren’t coming back,” has now changed its tune somewhat. “[In 2014] we’re going to bring some production to the U.S.,” Apple’s CEO Tim Cook told Bloomberg Businessweek. “This doesn’t mean that Apple will do it ourselves, but we’ll be working with people and we’ll be investing our money.” Cook also reportedly confirmed that the new Mac would be manufactured in Texas, and would include components made in Illinois and Florida and rely on equipment produced in Kentucky and Michigan.2

Doug Oberhelman, CEO of Caterpillar, which in October 2013 opened a new 850,000 square-foot-facility in Georgia to produce small track-type tractors and mini hydraulic excavators, says his company’s decision to move means improved delivery times as compared to Japan, where production was based previously.3

Mike Quinn, Traditional Trade Global Head at J.P. Morgan, explains the trend: “We’ve seen signs over the last six to 12 months that U.S. companies who source or produce products are becoming increasingly disenchanted with China because of the increased cost base, continued regulatory irregularity and the unavailability of credit. As a result, they continue to seek other sourcing opportunities. The labor cost arbitrage game which manufacturing has been playing for the last 20 years is just about at its end as various economies pick up.”

Cheap as China?

China, once the go-to option for offshoring operations, now doesn’t look as attractive, and it’s not just U.S. companies who think so. A recent Bloomberg report highlights that even Taiwanese manufacturing, which had migrated to mainland China because of the lower labor costs there, is now on its way back home.4

The Boston Consulting Group, in its report “Made in America, Again,” calculates that annual wage and benefit increases of up to 20% at China’s factories will slash its labor-cost advantage over low-cost American states from 55% in 2011 to 39% in 2015.5 When the higher productivity of U.S. workers is taken into account, this could be enough to virtually close the cost gap between the U.S. and China, the report says – a view shared by AlixPartners, which says in a research piece that the U.S. is “on track to achieve cost parity with manufactured imports from China by 2015.”6

While there are still other offshore jurisdictions offering cheap labor – such as Vietnam, which with wages around half those of China, has already seen an influx of sectors such as apparel production – the unreliable delivery, transport delays, long supply chains and often unpredictable quality involved in outsourcing manufacturing to the Far East is leading companies to think twice about where they put their factories.

“Particularly for U.S. companies, the primary driver for offshoring manufacturing was cost – and cost continues to be one of the drivers,” explains Dave Conroy, Regional Trade Executive for North America at J.P. Morgan. “But with the landscape changing around different regions and different countries that have been focal points for offshoring, changes in their economy, the emergence of China’s middle class and a high wealth class, and the strength of the renminbi as a currency, a lot of companies around the world have been given pause.”

Indeed, a Boston Consulting Group survey in April 2012 found more than one-third of U.S.-based manufacturing executives at companies with revenue greater than $1 billion planned to reshore production to the U.S. from China, or are at least considering it.7

But it’s no longer solely about cost. As Conroy points out, companies are now looking at the bigger picture and factoring in the associated cost of offshore manufacturing, inclusive of all the embedded costs around logistics, control, intellectual property, compliance and quality. They are also finding that bringing production closer to the point of sale means their employees can engage more directly with customers and adapt quickly to changes in the market. As Caterpillar vice-president Mary Bell said at the time of the industrial firm’s move to Georgia: “the decision to shift production from Japan to the United States is driven by the proximity to a large base of customers in North America and Europe.”8

“Speed to the market has an inherent monetary value,” adds Quinn, “such as increased revenue because you’re not discounting products that are at the tail end of the season.”

Push and pull

Changing conditions in offshore locations aren’t the only factor driving manufacturing back to the U.S. Rapid advances in shale gas development have led to collapsing gas prices, and this, coupled with the rise in oil prices over the past decade which sent transportation costs soaring, means that it now makes more sense to stay home. In fact, in April 2012, the U.S. National Association of Manufacturers said that additional shale gas development could create 1 million manufacturing jobs by 2025.9 As a result, for sectors ranging from fashion to energy-intensive industries, like chemicals and metal, the United States is an attractive place to be once again.

Nearshore instead of reshore?

However, moving operations back to the U.S. isn’t for everyone. Taxation, in particular, is a pain point, as U.S. nominal corporate tax is higher than in any other country.10 Labor is also a worry; as it’s been a generation since certain types of manufacturing left the U.S., the foundational manufacturing assets aren’t there and it’s not always possible to find management or employees with the right skillsets. Companies are therefore faced with the challenge of attracting – and training – a new generation of factory workers while also protecting their bottom lines.

Another option, then, for companies considering relocating their already offshored operations is ‘nearshoring’ – bringing production closer to their key markets, which for U.S. companies might mean Latin America or Canada.

AlixPartners’ Executives’ Perspectives on Manufacturing Near-Shoring survey finds that Mexico has emerged as the top choice.11

“Mexico is facing security issues, however this hasn’t prevented corporates investing there,” says Carlos Avila, Trade Head for Mexico at J.P. Morgan. “For example, we are seeing companies from the automotive sector building plants in Mexico. It’s a country that it is growing and the growth expectations are big.” It’s not just carmakers who are finding Mexico an attractive option. Since the country’s sweeping energy reform, the oil and gas sector also looks set to become a hotspot for U.S. investment.

Moving to Mexico, which was once a favored spot for many U.S.-based manufacturers and has the available labor pool, also makes sense to the bottom line: manufacturing wages, adjusted for Mexico’s superior worker productivity, are tipped to be 30% lower than in China by 2015.12 Furthermore, the country’s raft of free trade agreements positions it as a hub for products for export.

“Investment in infrastructure such as roads in Mexico has been very high over the last five to six years, which helps suppliers. It’s cheaper and faster to ship from Mexico to the U.S. than from China to the U.S. and that gives Mexico a competitive advantage against China,” adds Avila.

Mexico also beats out Far East competition in terms of proximity to customers, reduced cultural and linguistic barriers, the strength of intellectual property protection and transport costs. In an unlikely twist, manufacturing in Mexico could also be good for the U.S. economy: according to Boston Consulting Group,13 Mexican factories use four times as many American-made components as their Chinese counterparts.

Shorter lead times, better supply chain control and better communication are some of the benefits of nearshoring, according to respondents of law firm Grant Thornton’s Supply Chain Insights survey.14

Avila adds that Mexico is open in terms of raising finance. “Companies can go to the commercial banking sector to access finance, they can go to the capital markets and there are also non-bank institutions that are also getting into the market.”

“Manufacturers are looking at cost of goods sold and working capital as drivers,” says JP Morgan’s Conroy. “They’re looking for better visibility, operational visibility and cost between themselves and their customers.”

There is already some evidence that trade along the Mexico-U.S. route is increasing: “JP Morgan started with a supply chain finance team in Mexico around three years ago, and it has been growing steadily at 30 percent every year since then. We are seeing both Mexican suppliers as well as foreign suppliers for U.S. corporates. There has also been an increase within our supply chain finance programs of Mexican suppliers to foreign entities based in the U.S. and that is a signal to me how the trend is taking hold across the board,” says Avila.

A real trend?

It’s clear that rethinking offshoring offers many benefits. Can high-profile moves back home by household names generate enough momentum for this trend to move downstream?

“If a big company says it will grow U.S. sourcing, that creates an impetus for some of their key suppliers who do not sit in the U.S. to look at establishing capacity,” says Conroy.

As a case in point, Foxconn, the China-based manufacturer of Apple’s iPhone, is reported to be considering expanding operations in the U.S. to meet demand for U.S.-made components.15

“It’s hard to say whether or not this is a snowballing trend at this point,” says Conroy, “but given the kinds of companies that are focused on this as a priority, it is certainly becoming a serious development and a serious movement in the industry.”

Despite media attention, so far there is only anecdotal evidence pointing to a resurgence in U.S. manufacturing, and the trend has yet to make a dent in the statistics. However, J.P. Morgan’s Quinn is optimistic: “It’s a difficult indicator to hang your hat on, but we see far fewer import letter-of-credit transactions. This reflects the move to open account, and we see a general decline in offshore sourcing.” He qualifies this though by highlighting that companies may be sourcing from agents in the U.S. who have overseas manufacturing, which would be disruptive to that indicator.

“It’s not a crystal clear change. It’s anecdotal, but we’re seeing isolated incidences that may become more of a trend over the next few years assuming that suppliers, manufacturers, and large buyers are able to leverage capital markets in the U.S. to raise money, and find the resources they need to produce the products,” he adds.

One thing is clear: while there are clear economic benefits to bringing manufacturing back closer to home, there are still significant barriers. As AlixPartners points out, “any sourcing change has a switching cost that must be overcome. There are capital hurdles, including tooling and transition costs, savings sensitivity and/or uncertainty, such as with the exchange rate outlook, and the occasional need for approval from customers or regulatory agencies.”16

“As suppliers look to establish new manufacturing hubs or locations, they need more financing upfront on a pre-shipment or purchase order basis for work in progress, for establishment of manufacturing capability,” says Conroy, who adds that companies who take the leap can benefit from the cost of capital and the payment process efficiency associated with reshoring as well as invoicing efficiencies and workflow efficiencies.

Some manufacturing operations, to echo Steve Jobs, really are “never coming back,” such as those with a high labor content that are destined for Asian markets or make sense from a scale perspective. However, as President Obama publically commits to making America a magnet for jobs and manufacturing, manufacturing jobs have increased by almost half a million over the past three years, after a decade of decline. The tide appears to be turning: a recent Deloitte poll of more than 900 predominantly U.S.-based executives and managers found that 39% believe their company is likely to deploy its next manufacturing operation in the United States, compared with only 16% who cited China as the likely destination.17

Today, as companies from blue-chip giants to small enterprises consider where they should establish manufacturing, they are increasingly looking less at labor costs and more through a holistic lens that blends cost concerns with the availability of capital, proximity to upstream suppliers or downstream customers, legal frameworks, and connectivity to strategy and design resources. The key question now for the U.S. is whether it is offering the right mix to lure manufacturers back home.

1http://news.walmart.com/executive-viewpoints/a-job-to-do-retails-role-in-an-american-renewal
2http://www.bloomberg.com/news/2012-12-06/apple-to-invest-in-manufacturing-macs-in-u-s-ceo-cook-says.html
3http://www.caterpillar.com/en/news/caterpillarNews/h/caterpillar-celebrates-the-grand-opening-of-bcps-athens-facility.html
4http://www.bloomberg.com/news/2013-06-25/taiwan-s-prodigal-companies-come-home-as-china-labor-costs-rise.html
5http://www.bcg.com/documents/file84471.pdf
6http://www.alixpartners.com/en/WhatWeThink/AllArticles/tabid/635/articleType/ArticleView/articleId/602/2013-Manufacturing-Sourcing-Outlook.aspx#sthash.Hpo6aMk4.dpbs
7http://www.bcg.com/media/PressReleaseDetails.aspx?id=tcm:12-104216
8http://www.prnewswire.com/news-releases/caterpillar-expands-operations-in-united-states-new-factory-near-athens-georgia-expected-to-employ-1400-people-139512648.html
9http://www.pwc.com/en_US/us/industrial-products/assets/pwc-shale-gas-us-manufacturing-renaissance.pdf
10http://www.kpmg.com/global/en/services/tax/tax-tools-and-resources/pages/corporate-tax-rates-table.aspx
11http://www.alixpartners.com/en/LinkClick.aspx?fileticket=Qj7k-IZ4z0M%3D&tabid=947
12http://www.bcg.com/media/PressReleaseDetails.aspx?id=tcm:12-139022
13http://www.bcg.com/media/PressReleaseDetails.aspx?id=tcm:12-139022
14http://www.grantthornton.com/staticfiles/GTCom/CIP/Distribution/Supply Chain Solutions/Supply_Chain_Insights_2012 Survey_1.pdf
15http://www.bloomberg.com/news/2012-12-06/foxconn-plans-american-expansion-as-clients-seek-made-in-u-s-a-.html
16http://www.alixpartners.com/en/Publications/AllArticles/tabid/635/articleType/ArticleView/articleId/602/2013-Manufacturing-Sourcing-Outlook.aspx#sthash.2aFiibyP.dpbs
17http://dupress.com/articles/manufacturing-beyond-china/

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