As the US closes the cost gap with other locations, nearshoring decisions remain complex
According to the AlixPartners Manufacturing-Sourcing Outlook, the United States has reached parity with Mexico as a preferred nearshoring location.¹ Thirty-seven percent of respondents said their preferred nearshoring location would be the US—the same percentage that said Mexico. This continues a trend seen over the past two years (figure 1) of the US closing the gap with Mexico.
Additionally, the US appears to be on track to achieve cost parity with China by 2015. However, it does not mean nearshoring to the US or Mexico is right for all companies; AlixPartners’ analysis shows that actual cost competitiveness varies greatly by product type and several other factors.
To Nearshore or Not to Nearshore?
The decision regarding whether or not to nearshore is growing increasingly important. Eighty-four percent of respondents said the decision to nearshore is very important or somewhat important, up from just over half (53%) last year. A full 100% say the importance of making nearshoring decisions is the same or higher than last year. Why? Forty-nine percent see nearshoring as an opportunity for their companies to serve US demand requirements. Of those companies, a third are pursuing it now—or have already done so within the past three years; another 57% have plans to nearshore within one to three years.
Cost is, as ever, a main driver: 58% of the executives surveyed said they have reduced or expect to reduce total landed costs by 5 to 20% as a result of nearshoring. Those cost savings are expected to come from a wide variety of sources, with the most-attractive potential advantages being lower freight costs and improved speed-to-market/lower inventory or intransit costs (figure 2).
Factors to Consider
But it’s not always that simple. Although respondents see the US as a more-cost-competitive source for manufacturing today, applying that thinking with a broad brush across products could be a mistake, according to AlixPartners’ analysis.
In our economic analysis of the costs of nearshoring versus offshoring, we took an in-depth look at three different product types: fabricated parts (machined or stamped parts as well as molded-plastic and precision medical equipment), assemblies (including complex electromechanical devices and autowelded assemblies), and consumer products (including personal care products and packaging). We focused on four countries—the US, Mexico, China, and India—and discovered that, for the three product types analyzed, each of the three low-cost countries (LCCs) still has lower total landed costs relative to those in the US (figure 3).
Several factors are in play. In 2009, exchange rates and a drop in ocean freight and materials costs made all major LCCs much more competitive. Now, as those factors stabilize and return to more sustainable economic levels, the cost of importing has started to creep back up to prerecession levels. However, ocean freight rates have remained far below prerecession levels, having spiked during 2005–08 as demand and fuel prices rose. In late 2008, shipping costs fell precipitously because of lower fuel prices and reduced demand. Despite a slight recovery in late 2009, rates dropped yet again, and as of July 2012 (the latest month for which data was available), they were once again nearly at their bottom. Therefore, ocean freight rates remain favorable to offshoring in the near term. But if rates increase due to capacity cuts and rising fuel prices—as they are expected to do—the US and Mexico will become more competitive manufacturing locations.
A View of What May Come
In China, major considerations include strengthening exchange rates against the US dollar and internal wage inflation; the latter has been on a steady and steepening incline since 2005. If we assume that historical wage inflation trends will continue and that the Chinese currency strengthens by 5% a year—while other currencies stabilize—and that ocean freight rates increase by 5% annually, we can predict that China’s landed cost will approach US cost by 2015. In that scenario, Mexico and India, meanwhile, can be expected to remain very cost competitive.
Other changes are afoot in the manufacturing field, including a rise in the portion of US manufactured goods that are produced domestically. In 2005, 67.6% of the total manufactured goods consumed in the U.S. were made domestically. As of 2011, that portion had risen to 71.9% (figure 4).
With the recession, the total amount of goods consumed dropped—and imports fell faster than domestic production. Since the crash, as the economy has limped back to life, imports have recovered slightly but are still at a lower level than they were in 2005.
Look Twice before You Leap
Even where the economic advantages are clear and risks are low, significant barriers to reshoring or nearshoring do exist. For one, any sourcing change has a switching cost that must be overcome. And there are capital hurdles, including tooling and transition costs, savings sensitivity and/or uncertainty (such as with the exchange rate outlook), and the occasional need for approval from customers or regulatory agencies.
Furthermore, despite China’s landed cost trends, the country maintains a labor and plant/equipment capacity—not to mention a scale—that is unique. It also has an aggressive industrial policy, with emphasis placed on training and incentives for investment. The US, meanwhile, has certain specific constraints that could limit reshoring. When companies first outsourced, they rationalized their production assets—meaning that the plants and equipment that would be required to bring work back to the US would need to be rebuilt. US-based companies, too, are struggling to find skilled domestic manufacturing workers and manufacturing management talent.
In other words, when it comes to moving production, companies should look twice before they leap. Not only do product-cost variables vary widely by product type but several factors such as exchange rates, materials costs, and labor agreements can have dramatic impact on the outcome as well.
1The AlixPartners Manufacturing-Sourcing Outlook analyzed manufacturing sourcing costs, patterns and expectations related to meeting U.S. demand. The Outlook includes data from the AlixPartners Manufacturing-Sourcing Index™, which analyzes a variety of manufactured products and compares the cost to build them in various low-cost countries and transport them to the U.S. versus the cost of manufacturing them in the U.S., tracking several key cost drivers. Those drivers include labor costs, transportation costs, raw-materials costs, inventory costs, capital-equipment costs, overhead costs, duties and exchange rates. The Outlook also included an online survey, conducted in March, of 137 C-level executives from manufacturing-related companies across more than 10 industries. Among the companies represented in the survey, approximately half had annual revenue of $1 billion or more, and all of the respondents said they sourced production across multiple continents.