The trend to outsource manufacturing began right after China joined the World Trade Organization at the end of 2001, and that is precisely when a large number of U.S. firms took their plants and went overseas, mostly to Asia. They told the press they were having a dickens of a time competing against China’s lower labor costs when quota restrictions (aka trade restrictions) on goods entering the U.S. were phased out on certain products in 2005. Seems they couldn’t hack free trade.
The overseas low-cost, no health-care labor forces had U.S. managers drooling and soon other U.S. industries—such as IT and services—jumped on the outsourcing bandwagon. They hightailed it to India and the Philippines based on the large number of English-speaking, relatively highly skilled workers there.
There was always a concern that companies would outsource engineering. And some—mostly software companies—did.
But after a decade of significant offshoring, the cost savings American firms had chased began to erode. Labor and transportation costs increased, eating into much of the savings manufacturers had previously enjoyed. And many companies uncovered the hidden costs a few consultants warned about. Those costs often outweighed any benefits of manufacturing overseas.
Some of these hidden costs that were not always considered include the increased costs of monitoring and quality control, uncertain protection of intellectual property, and lengthy supply chains. As a result of increasing costs and other factors overseas, some manufacturing has already begun returning to the U.S. This act of returning manufacturing, IT, and service jobs to the U.S., termed “reshoring,” is due to several factors, none of which can be called patriotic or compassionate. Companies are just concerned about their bottom lines.
The Boston Consulting Group (BCG) studied 10 years of data (2001 to 2014) from the 25 countries that account for nearly 90% of the world’s exports of manufactured goods. It wanted to understand the economics driving global sourcing decisions. The group found that manufacturing wages, labor productivity, energy costs, and exchange rates significantly affect manufacturing location decisions. These four factors also improved in terms of cost competitiveness in the U.S. over those 10 years.
· “Increased wages” was the most commonly cited reason for reshoring. Although the U.S. is the lowest-cost manufacturing location of all the developed nations, manufacturing is still cheaper in China. But the cost differential between the two shrunk from 2004 to 2014 as China began requiring that its companies begin granting 13% average annual minimum wage increases in 2011. These wage increases could eliminate any wage advantage China has by 2020, according the report.
· Fluctuating currency values also affect reshoring decisions. The study found that currency fluctuations over the past 10 years have made some locations more favorable than others. For example, when compared against the U.S. dollar, the Chinese yuan increased in value by 35%, while the Indian rupee devalued 26% from 2004 to 2014.
The appreciation of China’s currency not only increases the cost of labor, but it also increases other costs associated with manufacturing operations such as the cost of land, utilities, and exports.
· Labor productivity, which is measured as the gains in output per manufacturing worker, is also commonly cited as a significant factor in total manufacturing costs. Although Chinese labor productivity is increasing, BCG expects it to lag behind wage increases by approximately 40% of current U.S. productivity levels. This means Chinese productivity will soon no longer offset the wage increases to its workers.
· The lower energy costs during that decade, especially in energy-dependent industries such as iron and steel and chemicals, made reshoring a money-saving option for some manufacturers. Large-scale production of shale gas in North America helped cut natural gas prices by 25% to 35% over those 10 years. But overall energy costs in many countries outside of North America are anywhere from 50% to 200% higher than they were in 2004. For the U.S., less expensive natural gas translates into more affordable electricity and lower prices on the raw materials used to make ammonia, hydrogen, methanol, and other materials used in the petrochemical sector. This is a significant cost factor because petrochemicals serve as the base for thousands of industrial and consumer products, including plastics, rubber, paints, fertilizers, detergents, textiles, dyes, and solvents.