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A new study ranks the lowest-cost offshore locations for manufacturing – and finds the top spot is right next door.
Kate O'Sullivan, CFO.com | US
February 18, 2010
Until a few years ago, choosing an offshore manufacturing location was fairly straightforward, with finance chiefs and their fellow executives typically focused on a handful of cities in China. But with the volatility in the dollar, fluctuating transportation and commodity costs, and shifting global economic fortunes, the decision has become much more difficult.
"There was huge momentum and almost herd behavior around going to China back in 2005 or 2006," says Stephen Maurer, a managing director at AlixPartners and co-author of the consulting firm's new study of manufacturing costs in low-cost locations. "China was more competitive than other low-cost countries and had more infrastructure. Now, some of that has changed."
The study factors in such important but occasionally overlooked elements as capital equipment acquisition costs in the offshore location, tax burdens, technical and engineering support costs, and freight rates. The lowest-cost location for U.S. manufacturers in 2009? Mexico, which claimed the top spot in 2008 and has retained its ranking.
"Rising transportation costs and material costs, which hurt China in 2007 and 2008, applied to a much lesser degree in Mexico," says Maurer. "There are really no more transportation costs in Mexico than if you made something in Tennessee." He cites one client that manufactures "big, bulky, cheap plastic stuff" in China that found its shipping costs skyrocketing from 15% to 40% of the total product cost. "They were thinking that suddenly their low-cost strategy wasn't too low-cost anymore," says Maurer.
What's more, as the prices of commodities rose prior to the recession, the amount of time products spent in transit had an increasingly significant impact on companies' inventory carrying costs, making the lengthy trip from China that much more expensive. Commodity costs and shipping rates have since moderated with the slowing of the global economy, but finance chiefs have realized the risks those costs pose to global supply chains and are reevaluating some of their offshore sites as a result.
The decision to relocate an existing offshore operation is not one to make quickly, however, even in the face of rapid changes in cost structure. Switching costs can include teaching proprietary processes to a new offshore partner and buying new equipment, in addition to the time and resources involved in scouting a new location. Some countries also have specific technical expertise that makes them the best choices for certain complex, high-value items, says Maurer. Airplane parts, for example, are better off made in India, Russia, or China, countries with extensive engineering talent, than they would be in Vietnam, which is newer to the offshoring game and lacks some of the technical and management reserves found elsewhere.
Rather than pulling up stakes hastily, CFOs should consider their goals in the market where they are manufacturing, says Maurer. Are they in China simply for the cost savings, and do they ship everything back to the United States to sell? Or are they hoping to serve China's large, growing economy? If the strategy is the former, perhaps it is time for a move. But if it's the latter, it's likely worth sticking around.
Companies new to offshoring should aim to build more flexibility into their supply chain from the outset, recommends Maurer. Instead of operating one or several large facilities in one country, they should consider establishing smaller operations in a handful of locations. While managing multiple sites adds complexity to a company's operations, it also hedges risk.
"If someone wants to go for the absolute lowest-cost option, they might build a bunch of company-owned factories in Vietnam," says Maurer. "But that might not be the lowest-cost option next year." Instead, a company might want to consider simultaneously locating in Vietnam, India, and Mexico, for example. "If the rupee strengthens, you can shift some work to Vietnam. If transportation costs go crazy, you can move some more work to Mexico," says Maurer. Such far-flung facilities allow a company to adjust its supply chain in response to cost swings without starting from scratch in a new locale. They also mitigate other hazards associated with a single location, from political risk to natural disasters to dramatic wage inflation.
With manufacturing volumes down 20% to 40% from their peaks in 2008, Maurer says his clients are carefully considering their plants' locations. Despite all the tactical belt-tightening they've done over the past two years, "many clients realize they're still not anywhere near where they need to be," says Maurer. "We are not going to bounce back to peak levels of consumption anytime soon, and most manufacturers can't wait five years. It's time to make those structural changes."