My first column talked about why manufacturing matters most for our country. This month, I want to discuss how chasing cheap prices is not only hollowing out domestic manufacturing but, in many cases, it’s making the companies that offshore less profitable. For decades, consultants and MBAs have told companies to focus on their core competencies—mostly R&D, finance and marketing—and outsource manufacturing offshore. Now, companies are discovering that strategy was often wrong.
Chasing cheap wages in low-cost countries in pursuit of higher profits may actually be killing your bottom line. Consider the impact of hidden costs and risks, such as delays in time to market; carrying costs of larger inventories; decreased innovation due to the separation of engineering and manufacturing; losses from stock-outs; counterfeiting; and poor quality. The latter is no small thing. For example, we’ve all seen how the recent discovery of toxic formaldehyde levels in Chinese-made flooring has severely damaged the Lumber Liquidators brand.
Chasing cheap labor created a mass exodus of U.S. manufacturing beginning in the 1970s. However, according to an Archstone study, as many as 60 percent of companies offshored manufacturing based on miscalculations. Companies used rudimentary cost models, such as wage arbitrage, purchase price variance or landed cost to make the decision to offshore. Off they went, with other companies following them like lemmings, ignoring at least 20 percent of the total cost.
The wage gap used to be so large that most companies made the right decision despite their miscalculations. But with Chinese wages rising at 15 percent per year, it’s time for companies to redo the math, using a tool like the Reshoring Initiative’s Total Cost of Ownership (TCO) Estimator to quantify the costs that are hidden when companies make decisions based mainly on the ex-works price. By using the TCO, manufacturers typically discover that the price gap between domestic and offshore sourcing closes by 15 to 30 percent. In fact, user data suggests that about 25 percent of what is now offshored would be reshored if companies switched from price alone to TCO. Reducing our trade deficit by 25 percent would create 1 million manufacturing jobs!
At a given level and mix of demand for products, the only ways to increase manufacturing are to export more or import less. Reshoring (importing less) is more efficient than exporting more because U.S.-made products are about 30 percent more price-competitive selling against imports in the U.S. than they are competing in overseas markets.
Table 1 shows price comparisons in China and the U.S., assuming constant margins, for a U.S.-made product that is competitive here. The difference arises because exporting adds, on average, at least 15 percent to the total cost of a product exported from either country.
See if you can profitably manufacture or source domestically in the U.S. Start with the offshored product that causes you the most pain (quality, delivery, inventory, intellectual property risk, stock-outs, travel, etc.) and do your own TCO analysis. It’s easy, and we are available to help.
Editor’s note: Harry Moser is the president of the Reshoring Initiative. His column will appear every other month, alternating with Austin Weber’s “On Campus.” Has your company reshored production? Are you thinking about it? We’d like to hear of your success or help you achieve it. With your approval, we would love to report on your successes or opportunities in future issues. Contact firstname.lastname@example.org.