Wednesday, September 25, 2013

The Offshore Yo-Yo Risk

The McKinsey article, 'Time to Rethink Off-shoring?" highlights various justifications for reducing certain manufacturing practices abroad because of non-wage related costs.  This is relevant today because in a down economy all costs, landed and wage, are important measures for justifying certain supply chain practices.  Off-shoring has traditionally meant building manufacturing plants outside of the United States because the wage-differentials justified the extra costs.  However, today, with a down economy and rising prices throughout the world this simple supply chain solution must be questioned.

McKinsey's article is extremely significant when viewed in light of the rising 'landed costs.'  McKinsey accurately portrayed these costs, which include transportation, gas, held inventory and freight, as essentially tariffs.  If a government imposed a flat tariff on imported products, manufacturing companies would certainly hesitate in offshoring the development of their products.  Many macroeconomic issues, including political uncertainty and energy resource reallocation have combined to force executives to reconsider offshoring.

There is a risk to this type of analysis however.  Significant resources are required to invest when deciding to offshore many manufacturing practices.  Money is needed to build plants, source materials, educate labor forces and gain political acceptance.  However, the macroeconomic environment we live in ebbs and flows between prosperous times and treacherous downturns.  Manufacturing executives cannot yo-yo between decisions to offshore or re-shore based on the price of a barrel of oil.  Just as oil prices have climbed from $20/barrel to over $100/barrel, so may it drop.  The rise on natural gas production in the US as a result of Shale gas and fracking could easily lead OPEC to decrease the cost of gas.  This would place wage differentials as the main reason to offshore again.  It is, therefore, important to recognize the changing environment we live in and design a supply chain that places significant weight on cost variables that are least likely to change.

This raises significant questions.  What cost variables are likely to stay consistent for the longest amount of time?  And what cost variables are immune from outside influences?  If a manufacturing company can expect costs to vary, then what what point exactly will make them switch to re-shoring in the United States?  Furthermore, what does it do to a brand to re-shore the product?  Will the United States government be receptive to re-shoring or wary of off-shoring at the first hint of lower costs elsewhere?  Finally, what incentives can be given to US companies to encourage them to re-shore and limit their desire to off-shore when certain price indicators turn more favorable?


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