As China matures, a host of factors could rebalance the geographical supply chain.

Nearshoring and reshoring are significant topics of discussion in the outsourcing community. Factors that led China to become the world’s workshop are shifting. China’s labor costs have doubled in the past two years and will likely grow another 15% to 20% in 2012. Some OEMs are simply looking to move business to other countries in Asia. Fuel costs and recent natural disasters are key reasons why many are looking closer to home to lower their risk with shorter supply chains. Tighter credit is making inventory buffers more expensive to maintain. All this has led Boston Consulting Group to predict that by 2015 the percentage cost differential between China and some parts of the US will be in the single digits.¹

As few as five years ago, those without an “Asia plan” risked being left behind. Today, OEMs that lack a nearshoring strategy are the ones that risk falling behind. At Spectrum Assembly, we see many companies starting to evaluate the true cost of nearshoring vs. offshoring, particularly with high-mix projects. A Pennsylvania State University study found that most companies took a fairly unsophisticated approach to analyzing offshore sourcing costs.² The key is balancing tangible landed cost against risk factors that are hard to put into dollar amounts. We see several cost and risk factors routinely overlooked in initial cost evaluations. What are the potential cost impacts to evaluate in each of these areas?

Regulatory supply base constraints. Products in highly regulated industries may have very limited supply base options relative to certain components. For example, one of our customers whose products were used in the nuclear industry could use only raw cable that met very rigid industry specifications. The only two suppliers of that type of raw cable were located in the US. An offshore build required shipping raw cable to China, assembling the product and then shipping it back to the US. Add air freight costs to support demand variations of a build-to-order product, and a US build was clearly the most cost-effective option.

Intellectual property theft risk. IP theft is always a risk in certain geographies. Variations in IP laws between countries can make IP violations expensive to prevent. Litigation is expensive wherever you are. Lost market share can be difficult to regain. For products that will be sold in the countries in which they are manufactured, this is simply a cost of doing business. However, if the product will not be sold in that region, the costs of maintaining IP protection in that region should be evaluated.

OEM team time and travel costs. Fit between teams is an important part of a successful outsourcing relationship. The level of product maturity and project complexity dictate how much time sourcing, engineering and contractor teams need to spend together. The cost of deploying teams at a distance, extended work hours to support multiple time zone teleconferences and potential language or communications issues should be considered in a total cost evaluation. Another driver is preference for the convenience of a local supplier when significant engineering interface is required.

Quality concerns. Most OEMs audit to ensure an offshore contractor has acceptable levels of quality. Contractors in these regions are used to substituting wherever they can to reduce cost or keep lines running, and on-the-fly AVL changes are common. If the contractor isn’t watched, unauthorized substitutions may be inadvertently made. This can create significant issues for companies in regulated industries such as medical equipment or in any mission-critical product that requires third-party design approval or registration. Quality issues can creep in over time, particularly in high-mix projects. As a labor market matures, personnel turnover increases. This in turn drives learning curve quality issues as replacement personnel are hired and trained. A factory in China can experience turnover of upwards of 80% season to season. The standard training strategy with a high turnover workforce is to train them well on a specific task with few product options. Comparatively, onshore companies focus on developing low turnover workforces through pay-for-skills programs, and lower labor costs by using fewer employees to perform a wider variety of tasks. As an example, over 50% of our production operators have been with Spectrum Assembly more than a decade.

Alignment with contractor’s business model. Two dynamics are changing the model in Asia. First, internal demand is causing China to go up market. Simple jobs are being no bid in favor of more challenging work with more value-add. Second, the recent disasters in Japan and Thailand drove offshore contractors to implement disaster recovery plans and prioritize work for their most important customers. The OEMs whose production was delayed in favor of contractors’ larger customers are now looking for partnerships with contractors who see them as a fundamental part of their business strategy.

Expedited shipping costs driven by demand variations. Another challenge is that demand is hard to forecast. Most top distributors will say that in North America the mean average deviation (MAD) on a 30-day horizon is not much better than 50%. As a result, OEMs with higher mix product lines have greater schedule flexibility if they assemble locally with an onshore contractor and a Lean supply base philosophy where variations can be addressed fairly easily. With an offshore pipeline, variations may trigger air freighted shipments. One or two overseas premium air shipments can completely cancel out any labor savings.

Resource opportunity costs. The first benefit that most OEMs look for to justify an outsourcing project is the variable cost savings embodied in landed price. When offshore and onshore pricing is near parity, resource opportunity costs need to be carefully analyzed. For example, longer pipelines driven by sea shipments increase the potential inability to meet varying customer demand. Onshore suppliers reduce or eliminate team travel time and usually require less oversight than offshore suppliers. Time zones are more compatible to normal working hours. In short, there is a significant savings related to non-value-added time spent on the project when a domestic partner is used. Eliminating that non-value-added time frees those resources. From an inventory perspective, working capital is reduced or can be redeployed in ways that increase a company’s ability to respond to variable demand. From a personnel standpoint, team members can be redeployed to next-generation product development or launching entirely new product lines.

Nearshoring is not right for every product. However, focusing on these cost drivers can help identify products that would benefit from this strategy. All labor markets eventually mature and increase in cost. A strong offshore/nearshore total cost analysis process is critical in ensuring that sourcing teams make the most cost-effective decisions.

References

1. H. L. Sirkin, M. Zinser and D. Hohner, “Made in America, Again. Why Manufacturing Will Return to the US,” Boston Consulting Group, August 2011, p. 3.
2. R. Young, P. Swan, E. Thomchick and K. Ruamsook, “Extending Landed Cost Models To Improve Offshore Sourcing Decisions,” International Journal of Physical Distribution & Logistics Management, vol. 39, no. 4, 2009 p. 320.

Wally Johnson is vice president, sales and marketing, at Spectrum Assembly Inc. (saicorp.com); This email address is being protected from spambots. You need JavaScript enabled to view it..