Out, near and reverse sourcing
Trends in sourcing will be a major driver of change for freight movement supply chains.
By Walter Kemmsies
The freight movement supply chain needs to brace itself for more change.
Not only the inbound/outbound balance but also the composition of cargo will change. One of the main indicators of this change will be outsourcing trends.
Over the last 60 years world trade in manufactured goods has grown on average slightly twice as fast as global gross domestic product. This means economic growth isn't the only driver of trade growth. If anything, there is a virtuous feedback cycle whereby trade growth drives economic growth, which in turns results in more trading activity. The catalyst of this cycle is a confluence of structural trends that has increased both the demand for and efficiency of trade. More efficient or lower cost trade allows the world economy to reduce inefficiencies and therefore reach a higher level of output.
The main structural catalysts are shifting demographics, falling trade barriers and transportation infrastructure improvements such as the containerization of trade. These factors induced companies to relocate production facilities to areas with higher demand growth and/or lower labor costs. This trend is referred to as outsourcing or offshoring.
Outsourcing was a major driver of U.S. imported container volume growth over the last decade. Consumption of goods was increasingly met by products made in other countries. This is fairly evident from a few casual observations, such as the 'jobless recovery' of 2001-2007, and North Carolina, long a U.S. furniture manufacturing center, becoming for the first time a net importer of furniture in 2006.
Most outsourcing was and continues to be profit-motivated as opposed to simply focused on cost reduction. Developing economies have younger populations than mature industrialized nations. Younger people are paid less than older people and also spend more of their income on goods than on services. Companies operating in aging developed economies needed to shift their operations to countries with younger populations because those markets were growing faster. It is difficult to sell products produced with expensive developed market labor to workers in emerging markets earning far lower wages. Companies that have moved their production operations offshore to access faster growing markets have also been able to increase their profits by importing their foreign-made goods into the United States. This has been helped by declining transportation costs and increasing reliability of supply chains.
Outsourcing of low-value products such as apparel and disposable plastic utensils began decades ago. This has been extended to higher value goods such as furniture and automobiles and continues on a global scale. Fiat plans to launch the conventional combustion engine version of its 500 model in America later this year. The car will be manufactured by Chrysler in Mexico, with engines supplied from a Michigan plant.
Japanese companies have been making new investments in China even as they continue to retrench and restructure at home. Nissan Motor plans to open a design studio in Beijing in 2011 ' the first Japanese automaker to do so in China. Isetan Mitsukoshi, Japan's largest department store, announced plans to open its fifth department store in China next year, while closing a long-established store in Tokyo. Other Japanese retailers are also planning their first outlets in China.
The Organization for Economic Cooperation and Development forecasts that China's economy will grow by 10.2 percent in 2010 and 9.3 percent in 2011. As population aging accelerates in Japan, it is doubtful real growth there can average even 1 percent. Some foreign companies are also downsizing their operations in Japan while investing elsewhere in Asia. Michelin, the French tire manufacturer, has announced it will close its only factory in the country in July, which employs 380 staff.
Data for domestic output and employment by manufacturing industries indicates this process is not yet complete in the United States either. An examination of employment trends in 17 manufacturing industries whose output is usually transported as maritime freight indicates that since 1990 only three have reduced payrolls by 60 percent to 80 percent. Lagging industries, such as automakers, have only reduced U.S. employment by 15 percent to 40 percent. Only the food manufacturing industry, which seems to be the least vulnerable to outsourcing, has maintained employment close to its 1990 level.
Companies whose products are frequently redesigned may find that outsourcing to Asia makes less sense than to 'near-source' to Mexico, Central America or the Caribbean. Seasonal apparel is a good example. New apparel usually begins to show up on store shelves about six weeks before the next season begins. Frequently redesigned products such as consumer durables could be delivered more cheaply if parts are shipped to Central America or the Caribbean for final assembly.
Products that are intended solely for the U.S. market are also not good candidates for outsourcing to Asia since the costs of a complex supply chain may outweigh the benefits of labor cost savings.
Thus, some of what was outsourced to Asia is likely to be relocated to near-source locations in North and Central America, and possibly the Caribbean. It is possible U.S. industries that have not outsourced a lot so far may do so, but that could conceivably be near-sourced as opposed to outsourced to Asia.
Outsourcing trends must be followed closely because they will be a major driver of change for the freight movement supply chains. Some of that change may not benefit all segments of the transportation industry. If some outsourced production is located in Mexico that would help railroad and trucking company volumes grow, but not port volumes.
Walter Kemmsies is chief economist of Moffatt & Nichol, a marine infrastructure engineering firm. He can be reached at (212) 768-7454 or e-mail, firstname.lastname@example.org.