Bloom off China rose

Bloom off China rose Manufacturing giant loses ground as low-cost sourcing option.

By Eric Kulisch

      Soaring fuel prices last year caused many companies to re-evaluate the benefits of sourcing products overseas and having far-flung supply chains.
      A few companies began relocating some plants in Mexico, Central America and even the United States, while others opted to maintain U.S. production sites instead of following through on plans to transfer them to Asia.
      The outsourcing rush over the years was based on the assumption that foreign workers and raw materials were much cheaper than using domestic resources, but many failed to factor in many of the indirect, or hidden, costs.
      A new study by Alix Partners, a Southfield, Mich.-based crisis management consulting firm, finds that the bloom is off the China rose when it comes to that country's perceived cost advantage. And the drip of companies bringing manufacturing back to the Western hemisphere from Asia has turned into a trickle this year.
      Alix Partners evaluated a basket of manufactured components with different labor inputs, and determined that since 2005 Mexico and India have surpassed China as the lowest cost country ' a trend that has markedly accelerated in the past six months. The study also showed that the cost gap between China and the United States has also narrowed. The total landed costs for the various machined parts made in China was just 6 percent lower than the U.S. equivalents ' raising questions about whether maintaining elaborate transportation networks, and contending with quality control concerns and complex customs issues are worth such a small payoff.
      Logistics professionals say China is still king for apparel, toys and many consumer electronic products that are labor intensive, but other types of goods can be made at the same or less cost in other countries.
      A company that effectively negotiated production and transport contracts in 2005 should have been able to receive its goods at 78 percent of the U.S. cost, according to Alix Partners. At the time, China had a 26 percent advantage in labor and a 7 percent advantage in overhead, which were partially offset by an 8 percent differential in freight costs, plus an extra 2 percent cost for duties and 1 percent for larger inventory requirements.

'We're definitely looking at not being so dependent on Asia sourcing.'

John Lebowitz director of global trade management, Dell

      The consulting firm reported that China's 22 percent cost advantage in 2005 eroded to just 6 percent in 2008, due to the appreciation of the Chinese yuan, then-high fuel and shipping costs, elimination of export subsidies, rising labor rates, new environmental mandates on factories, and duty increases due to a spike in commodity prices. The appreciation of the yuan and labor cost inflation were the primary reasons for the 16-point narrowing. The cost for low-value-added stamping and highly automated parts production now is almost the same in China and the United States.
      Heavy, low-value products were impacted the most by rising oil prices because freight costs represent a greater portion of the total delivered cost.
      Meanwhile, the savings for an electric motor assembly decreased from 45 percent to 25 percent.
      Mexico, by contrast, benefited from an extremely favorable change in the exchange rate with the United States, lower transportation costs and its free trade status. The devaluation of the peso also was a key reason that the cost of making goods in Mexico went from 5 percent more expensive than China in 2005 to 20 percent cheaper than China last year.
      The global recession has slowed some of the cost increases in 2009, but the long-term, macroeconomic trends, such as the weakness of the U.S. dollar and rising labor costs in China, are expected to continue, putting pressure on certain sectors that source from the Asian nation.
      Stephen Maurer, head of the firm's lean manufacturing practice, told American Shipper that prices for Chinese manufactured goods haven't increased as much as core economic circumstances would indicate because some suppliers are cutting costs and taking smaller margins for the time being.
   Alix Partners said it has developed a new Manufacturing Outsourcing Cost Index to help international traders analyze fast-changing variables and determine the best-cost country from which to source a particular product, taking into account raw materials, labor, overhead, exchange rates, freight transport, duties and extra inventory to cover 45-day transit times from China on the high end compared to seven-day transit from Mexico.
      The index predicts that while China's position will probably improve in the latter half of this year, as the yuan strengthens and ocean freight rates decline due to moderation of oil prices and a deep drop in trade demand, it will probably not improve enough for China to overtake Mexico and India this year. American manufacturing plants and suppliers still face a significant cost disadvantage in most cases compared to the other nations, although the United States did move up a rank compared to Brazil, the index showed.
      Alix Partners said it intends to expand the index to cover a broader range of products and low-cost countries, such as Vietnam and Indonesia, and develop a European version.
      Maurer said in a news release that companies need to rigorously analyze the savings potential in low-cost countries for each individual component and not assume that one country produces across-the-board outsourcing benefits.
      One-quarter of 59 retailers and consumer product manufacturers surveyed last summer by PricewaterhouseCoopers said they did not know how to quantify any savings from global sourcing, and fewer than half were not confident about product safety and other risks associated with such business practice. Some companies had a reasonable grasp of their customs, transportation and logistics costs, but had more difficulty measuring and tracking compliance costs, the impact of out-of-stocks on lost sales and profit, currency risk, information technology and quality control costs. Only 50 percent of respondents, for example, measured the performance or financial health of their vendors, or out-of-stocks. Three in 10 did not consider tax costs at all when they reviewed their global sourcing programs.
      Dell is getting very good at measuring the health of business partners by using new analytics to evaluate their financial strength, position in the market and potential for future growth before it invests with them, said John Lebowitz, director of global trade management, at a panel discussion in Washington that coincided with the release of an annual report on the logistics industry by the Council of Supply Chain Management Professionals.
      The computer maker gives direct feedback to suppliers 'telling them where we think there are gaps in their business model and if you want to continue doing business with Dell this is where you need to shore it up,' he said.
      PricewaterhouseCoopers said companies need to develop a balanced scorecard approach to operational performance, tax optimization, risk mitigation, business controls and social responsibility instead of measuring each cost element in isolation.
      One-fifth of companies do not regularly evaluate their global sourcing strategy 'and consider the costs and lead time savings from local, on-shore alternatives or potentially the cost savings to be generated from another offshore sourcing country,' the management-consulting firm said.
      International businesses are getting smarter about the variable factors in their supply chain such as regulations, political issues, transportation, and economic changes that can offset cheap labor and raw material savings, logistics industry officials say.
      Dell has heavily sourced supplies and conducted manufacturing in Asia, but is now seriously considering a strategy of regionalizing production sites.
      'We're definitely looking at not being so dependent on Asia sourcing,' Lebowitz said.
      Production of high-end electronics, such as telecom switches and computer servers, is starting to return to the Americas to position supplies close to U.S. customers and reduce the huge cost of repairing and replacing defective equipment, according to a recent article in BusinessWeek.
      The first batch of companies that pull out of China will be ones that never should have moved production there in the first place, Maurer said. Manufacturers of big, bulky, low-value goods that use common manufacturing technology, products with short lead times or ones that require customization or frequent engineering changes are prime candidates to relocate to Mexico or the United States.
      Mexico is best suited for generic production processes such as stamped sheet metal or injection molded plastic that many suppliers can perform, while its northern neighbor is a good option for customized production using proprietary equipment if an existing U.S. facility already has extra capacity.
      'If it's highly automated so there's not much labor involved, then the cost advantage of a low-cost country is not so much,' Maurer said.
      A heavy vehicle manufacturer that helps build vehicles for an Alix Partner client, for example, has to customize a wire harness and install it within a couple of weeks.
      'That level of customization is difficult to support from overseas unless you air freight the harness bag,' Maurer said. Air freight can be at least eight times more expensive than ocean shipments.
      And if a company makes an engineering change to fix a problem or enhance a product then it may have two months of obsolete parts in the supply chain because of the long transit times and extra inventory needed as a buffer for ocean shipping, he noted.
      Relocating manufacturing and distribution centers to the United States to avoid problems associated with offshore production is not as simple as it sounds, cautioned Randall Mullett, vice president of government relations at Con-way Inc., a major trucking and logistics provider based in San Mateo, Calif.
      Land use policies often make it difficult to locate industrial sites near population centers that can provide ready workforce and consumption bases, and there are growing constraints associated with ports, highways, railroads and airports that are not being alleviated by adequate infrastructure investment, he said during a roundtable on freight transportation issues hosted by the RAND Corp. in Washington.
      Companies also must deal with the fact that the entire supplier base for many sectors is now located in Asia and would be difficult to quickly transplant in the United States or elsewhere, experts say. Rebuilding the domestic factories, equipment and labor force will take time.
      Companies that may have considered near-shoring are more cautious about spending money on such transition costs while economic uncertainty continues to prevail, even if it will save them money later, Maurer said.
      Chinese contract manufacturers also have huge scale that does not exist in other countries. Maurer said that companies interested in shifting manufacturing to other regions may have to use multiple suppliers instead of one or break orders into smaller bites so that a new plant can absorb the work. There are no Mexican printers, for example, that can churn out the same volume of books as a Chinese printing plant that employs 10,000 people.
      PricewaterhouseCoopers' survey on global sourcing strategies is available in the 'publications' section of its Web site, at www.pwc.com.