Wired had an interesting article last month on the backshoring trend lead by many small and medium sized manufacturers (“Made in America: Small Businesses Buck the Offshoring Trend“).
The article makes an excellent point that for many small manufacturers, offshoring may be a costly proposition:
For US firms, the decision to manufacture overseas has long seemed a no-brainer. Labor costs in China and other developing nations have been so cheap that as recently as two or three years ago, anyone who refused to offshore was viewed as a dinosaur, certain to go extinct as bolder companies built the future in Asia. But stamping out products in Guangdong Province is no longer the bargain it once was, and US manufacturing is no longer as expensive. As the labor equation has balanced out, companies—particularly the small to medium-size businesses that make up the innovative guts of America’s technology industry—are taking a long, hard look at the downsides of extending their supply chains to the other side of the planet.
The article points out that direct costs are only a single component. I am about to start teaching this morning an elective class in Operations Strategy. To help organizations make these decisions, we suggest several tools, among them the metrics of Total Landed cost and Total Cost of Ownership. Both of these metrics are aimed at exposing the hidden costs of offshoring and outsourcing, respectively. The first tries to track all the costs (both cost of good sold, as well as supply chain and logistics costs) from the moment the firm purchases the raw material until it ships it to the customer, including all steps in the middle (and including inventory held in different stages). The latter metric tracks the different costs of dealing with different suppliers, including the cost of poor quality, inspection and long lead times. While none of these metrics is perfect, together they try to support the decision making process by making it more quantitative:
Companies are looking to base their decisions on more than just costs,” says Simon Ellis, head of supply-chain strategies practice at IDC Manufacturing Insights, a market research firm. “They’re looking to shorten lead times, to reduce the inventory they have to carry.” …”Manufacturing wages more than doubled in China between 2002 and 2008, and the value of the nation’s currency has risen steadily. It’s now under tremendous international pressure to let the yuan appreciate even more, and the country must cope with worrisome inflation at home (food prices rose by nearly 12 percent last year). And though Chinese workers still earn a fraction of what their American counterparts do, the rising costs of labor there are prompting companies to reevaluate their production strategies.
The article discusses several small and medium sized firms, all have decided to either bring back production to the US or leave it here from the onset. The reasons vary from poor quality to intellectual property. Why is it more acute for small businesses?
If you’re a huge company like Apple, you can get the whole factory to work for you,” says Paul King, founder of Hercules Networks, a New York company that makes charging kiosks for mobile devices. “You can put your own process in place, you can have your own quality control. But without that kind of power, you’re just another customer, and they don’t really care.” King cycled through three Chinese factories from 2008 to 2010 before giving up on offshoring due to persistent manufacturing errors—LCDs that winked out after six months, lights that broke when tapped even gently. The quality woes have disappeared now that Hercules is making its kiosks in the US, King says, and the company is thriving.
What does it mean for offshoring? I think we are going to see more tailored strategies, in which firms keep their production in the US until they become big enough to be able to sustain production oversees. Even then, I believe firms will realize the benefits of keeping production on multiple continents, with the benefits of agility and risk hedging.