For U.S. Manufacturing Companies, it May Be Time to Consider On-Shoring

Over the last couple of decades, many U.S. companies have recognized the benefit of significantly lower labor costs by having production located in lower-wage countries such as China or India.

With the cost of labor in many emerging market countries increasing 15%+ per year over recent years and no end in sight to this trend, the labor cost advantage of being overseas is quickly deteriorating, and it may be time for U.S. CEOs to re-analyze the cost benefits of offshore production that is distantly located from the point of customer demand.

For an increasing number of companies (albeit still a small minority of the total number of companies that at one time moved production overseas), there has been a dramatic change to key cost assumptions, and the diminishing overseas labor cost advantage is no longer the key factor driving their location strategies.

One example is companies such as petrochemicals whose production costs are tightly linked to the cost of natural gas, which has dropped by nearly two-thirds in the U.S. since 2007. But more importantly to smaller companies, improvements in automation (both in cost and capability) may allow them to overcome the remaining wage cost gap using the current generation of robotics.

Even when there is no single compelling change to key cost assumptions, there may be a collection of variables whose sum will allow CEOs to conclude that the reduced labor gap no longer justifies having production remote from demand. These variables may likely include:

• Intellectual property protection concerns
• Lengthy and complex logistics pipelines, which increase working capital costs, limit the ability to make rapid product changes, and can carry high costs and risks related to quality problems
• The ongoing complexity of managing remote locations
• The need to re-source key components or raw materials locally or incur the cost to import into a remote location
• Initial incentives provided to locate in the offshore region may be expiring (or have expired)
• Increased shipping costs and duties to move offshore produced products back to the point of demand

PREPPING FOR ONSHORING

For those considering onshoring, careful site selection is critical. Incentives from various sources including state and local governments may help offset some of the initial relocation cost that could hurt the ROI calculation. Some states and localities are getting aggressive in their offerings to attract manufacturers and the good paying jobs they bring with them.

In some cases, states have established free trade zones to increase their attractiveness to lure internationally-focused  businesses. Longer term, to help ensure that the cost/benefit analysis of onshoring will stand the test of time, it will be important that the labor-cost assumptions of onshoring locations are well thought out. An adequate pool of skilled and flexible labor will be critical at start-up and the presence of training infrastructure is key to satisfy future labor requirements.

Unfortunately, there are also a variety of negative variables that need to be considered when looking at onshoring (mostly regulatory driven), and may very well prevent the current trickle of onshoring from becoming a steady flow. These include:

• Corporate tax rates in the U.S.: Recent comments from the administration have focused more on the vague concept of “economic patriotism” than addressing the need for the U.S. to make its corporate tax rates more competitive.
• Electricity costs: Regulations on coal-based electricity production will certainly have a tangible effect on the cost of electricity in the U.S. (+17% by 2020 has been suggested), which will be far more important to most companies than the trend in natural gas prices.
• Organized labor: Recent decisions by various elements of the federal government including the National Labor Relations Board and OSHA, such as the 2013 ruling that now allows union officials to “ride along” with OSHA even when visiting non-unionized facilities, are bothersome and hint at even more concerning future actions.

The benefits of bringing manufacturing facilities back to the U.S. are clear, but there are also challenges. Companies should conduct all necessary research and due diligence in advance to understand the long-term commitment and investment needed, as well as how long it will take to generate a return.