Does offshoring still makes sense?

“Just when thousands of manufacturers thought that off- shoring a significant portion of their manufacturing and supply operations has given them competitive parity, the game may be changing again.” [1]

We have read in this week’s articles that factors that once made offshoring activities attractive to companies like Dell and LG have now changed drastically and have eroded many of their savings. Dr. Patrick Dixon, in the above video, also talks about some of the challenges that companies are facing due to high inflation and soaring labor cost in India and China. It is becoming very difficult for the companies to justify for their expensive costs incurred in making offshoring activities efficient as the savings from these activities are decreasing. 

The Way Things Were…

Earlier suppliers in low cost countries like China could offer “perceived” prices 25 to 40% lower than those available onshore mainly because of cheap labor, commodities and favorable exchange rates. Despite some soft issues (Exhibit 1) related to offshoring like quality problems and bottlenecks in logistics networks, most executives were ready to make the trade offs as the magnitude of offshoring saving was much more than the cost of these soft issues. 

The True Offshore Cost....

According to a survey conducted by Archstone Consulting, more than 60% of the manufacturers generally ignore cost elements that can increase their total offshoring cost by more than 20%. For instance - Only 19% of them include customer service cost in their Total Cost Model (Exhibit 4).  Hence, they generally see a distorted picture of the related cost of different manufacturing options by looking at just some of the easily available cost components. 

The Wake-up Call...

However, the steep increase in the prices of offshore labor and commodities every year has made the impact of numerous soft costs painfully obvious to the manufacturers . They have reported significant increase in materials, logistics and transportation cost (Exhibit 2). From 2005 through 2008 alone, transportation charges for ocean freight and the global commodity price index have increased by 135% and 27% respectively. The Chinese Yuan has increased by 18% in value compared to the U.S. Dollar and Chinese manufacturing wages have also increased by 44%. 

Executives are now more concerned about their inability to provide customized services, cost of shipping products for remanufacturing, need for extra warehousing due to offshoring. The combined cost of the changes in global environment and the soft issues has made offshoring activities less appealing to the manufacturers. According to the article by John Ferreira and Len Prokopets from Archstone Consulting, several economists feel that the long-term trend line is pointing towards two developments:

• U.S. and some near manufacturing sources will re-emerge as potential supply markets.
• Local U.S. supply market may regain some of the lost businesses due to offshoring in recent years.

The survey reveals that nearly 90% of the manufacturers are now changing their manufacturing and supply chain strategies. Migration of their operations to U.S. will not only help them in reducing their offshoring cost but will also enable to deal with soft issues effectively like marketing strategies, product development, meeting customer expectations, responsiveness and not just low cost.

However, the biggest challenge is that would these companies be able to find the manufacturing infrastructure, skilled workforce and supplier networks required for their operation in U.S.? Would they be able to re-establish their operation capabilities that had been outsourced? How much time would it take them to rebalance their manufacturing and supply networks after shifting them from offshore to U.S. or near-shore manufacturing sources?

The migration of manufacturing processes offshore has lead to a significant decline in the local manufacturing infrastructure,  technical workforce and maintenance workers in U.S. over the years. Many supply networks have also disappeared. Therefore, re-establishing manufacturing footprint in the U.S. is one of the biggest challenges for the companies. It will take a lot of time, investment and commitment to rebuild everything.

References

[1] http://www.areadevelopment.com/article_pdf/id44472_does-offshoring-still-make-sense.pdf

[2] http://www.businessweek.com/stories/2008-06-18/can-the-u-dot-s-dot-bring-jobs-back-from-china