Eric Markowitz | Inc.com staff
Mismanaged supply chain decisions sent manufacturing overseas. But the industry has changed direction.
When Anton Bakker launched his company, Offsite Networks, in 1999, he had no intention of manufacturing overseas. But a few years later, when his company began taking on larger orders, he began looking for cheaper supply alternatives.
That’s when he went to China.
By the early 2000s, Chinese contract manufacturers had become increasingly equipped to handle the type of advanced manufacturing that Offsite was producing—point-of-sale hardware for store loyalty programs, like high-tech printers and scanners. So in 2004, the company, which is based in Norfolk, Virgnia, canceled contracts with domestic suppliers and moved 90 percent of its manufacturing to suppliers based in China, Malaysia, and Tokyo. For the most part, Bakker was satisfied.
“The scale drove us to look for more competitive, cost-effective products,” Bakker says. “I had a difficult time doing that domestically. We found that the products were just not competitive in terms of pricing, and we could find them at less than half the price overseas.”
That narrative—of outsourcing, offshoring, and finding cheaper suppliers overseas—is not a new story.
But then something unexpected happened. In 2011, Offsite Networks moved their manufacturing back to America, finding a domestic supplier, Zentech Manufacturing, based in Baltimore, to carry out the company’s orders.
- See the slideshow: 6 Companies That Came Home
So what changed?
Bakker tells me the company returned for a variety of reasons. It was becoming more affordable to manufacture locally, he says, and American technology had improved rapidly. This meant that labor costs, which had initially driven Bakker to find cheap work overseas, were a smaller percentage of total costs. Meanwhile, an increase in other costs—like shipping, for instance—had increased. In other words, it was cheaper to manufacture locally.
The interesting part is that Bakker is hardly alone. The trend of reshoring—or American companies returning to America—is beginning to gain steam.
Last month, Boston Consulting Group studied the phenomenon. The authors of the study pointed to increases in Chinese wages and shipping costs.
“Things have changed,” Bakker says, noting that the company will do about $10 million in revenue in 2012. “It was painful that we had to go overseas and then come back, but all it kind of worked out,” he says.
Matt Turpin, the founder of Zentech Manufacturing, the Baltimore contract manufacturer that Bakker enlisted to build his company’s product, says he’s seen a growing number of customers that have been burned by outsourcing.
“More and more we’re seeing people complaining about their offshore experiences,” he says. “We’ve had a number of customers recently that were in Asia [come back.]”
So What’s Happening?
Though they’re not often publicized, it’s easy to find examples of more and more companies returning to the United States within the last year. Peerless Industries, a United States-based maker of audio-visual mounting solutions, recently moved back to Illinois. Outdoor Greatroom, which makes outdoor furniture, moved its manufacturing back to Eagan, Minnesota. Otis Elevator Company has returned to South Carolina, Buck Knives came back to Idaho, Karen Kane relocated to Southern California, G.E. opened a new plant in Kentucky, Caterpillar reshored to Texas, and Coleman has moved back to Kansas. The list goes on.
When I ask Harry Moser–founder of The Reshoring Initiative, a group promoting the return of American manufacturing–about the reshoring phenomenon, he laughs.
“You know, that’s the very question President Obama asked me just a few weeks ago,” he says.
Moser was recently invited to take part in Obama’s “insourcing” initiative, which encourages American companies to manufacture locally. Essentially, this is what Moser told Obama: The costs of going overseas have been wildly underestimated, and American firms are beginning to realize that the total cost of going abroad don’t justify offshoring in the first place.
“Looking only at only price, which is what most companies do, all the work would stay offshore,” says Moser. “But if you looked at total cost of ownership, that’s no longer true.”
Of course, outsourcing and offshoring are not dead. Though there’s scant data to illustrate the trend, Moser estimates that even if offshoring is still growing, it’s begun to grow at a slower rate. At the same time, the rate of reshoring is picking up pace.
“If it’s a trickle, it’s a trickle that that’s headed to become a stream,” he says.
Reasons for the Return
Moser believes the main problem of offshoring—and one of the reasons that manufacturing is returning—is because costs of going overseas have been profoundly miscalculated for decades. Supply chain managers have long postulated that lower labor costs abroad, especially in China, have been enough reason to justify outsourcing. But improvements in automation in the last few years mean that labor costs are becoming a much smaller percentage of the overall cost of most products.
“What used to be done in 50 parts is done with one part,” explains Matt Turpin, the president of Zentech. “And the automation within the assembly area has grown by leaps and bounds. It’s light years ahead. So now, when you compare the U.S. to Asia, if your raw materials cost the same, if your cost to buy the automation equipment is the same, if your cost to finance the capital is the same, and your labor is down to 5 minutes or 10 minutes,” well, then, you may as well manufacture here.
Recently, manufacturing analysts have begun to echo Moser’s claims. In one Accenture study last year of 287 manufacturing executives across a variety of industries, the researchers noted a significant underestimation of overseas manufacturing costs.
“Our study found … that many manufacturers who had offshored their operations likely did so without a complete understanding of the ‘total costs,’ and thus, the total cost of offshoring was considerably higher than initially thought,” concluded John Ferreira and Mike Heilala, authors of the report. “Part of the issue is that not all costs of offshoring roll up directly to manufacturing; rather, they impact many areas of the enterprise.”
“This overreliance on direct costs to the exclusion of other legitimate cost factors distorts the business case for offshoring, and likely many decisions to offshore were incorrectly made.”
There’s also, perhaps, a more sinister explanation to the reason for offshoring.
Supply chain managers, who are incentivized to find the cheapest way to manufacture, use a calculation called price variance–the standard accounting metric that reveals the cost-effectiveness of production–to inform their decisions.
The problem with price variance, however, is that it does not take into account many of the ancillary costs and variables–like overhead and corporate strategy development–that Moser believes are necessary to calculate true costs.
“Why do they do that?” says Moser. “For them and the chief executive officer, you can justify a bonus for an individual or the big-time guy for cutting $50 million out of the price by offshoring, whereas if you kept it here and worked hard on being lean and doing it a little better and saving $5 million, it’s harder to justify giving yourself a bonus, and it’s a lot harder to do.
“There’s a … personal incentive bias to take advantage of that price variance mechanism instead of looking at the total cost.”
Then there is China’s currency manipulation, says Bill Waddell, a lean manufacturing expert and a vocal critic of manufacturing policy (or a lack thereof). When Chinese banks artificially reduce the conversion rates from yuan to American dollars, it makes it cheaper for American companies to manufacture overseas, and it gives Chinese manufacturers a better shot at competing.
But the issue affects different U.S. companies in different ways–an artificially lowered yuan benefits large, publicly traded companies that have already invested heavily in Chinese manufacturers, but increases pressure on domestic manufacturers–making it hard to build a business community consensus on the issue.
Though there have been bills proposed to combat currency manipulation, they’ve largely stalled in Congress.
“Within the manufacturing world there are two radically different communities,” Waddell says. “One of them are the big publicly traded companies that you read about and they’re the ones who are the biggest outsources to China. They oppose those bills because they do more manufacturing in China than they do in the U.S.”
Calculating the Total Cost
To understand the total cost of going abroad, Moser and his team have designed Total Cost of Ownership software. It’s essentially a matrix of 36 cost factors. Companies input various factors, and the matrix spits out where it’s cheaper to manufacture here, or abroad. The tool is free and Moser recommends all small business owners try it out.
Among the 36 factors that create the “total cost of ownership,” the algorithm calculates non-traditional ancillary costs, like overhead, corporate strategy and other internal and external business costs. It gets granular, too, trying to quantify what previously had been considered unquantifiable, including items like “the expected percentage price of IP risk” or the “Opportunity cost due to delivery and quality: lost orders, slow response, lost customers, [as a percentage] of price.” In total, there 36 elements that make up the total cost algorithm.
The idea is that these ancillary costs often don’t factor into a typical supply chain calculations, which have systematically undervalued the costs of manufacturing abroad, according to Moser.
Moser analyzed data from 10 recent examples. The results paint a clear picture of how the Total Cost of Ownership module might change an entrepreneur’s perception whether or not to manufacture abroad.
Looking exclusively at the cost of products and labor, which is what many companies do, the U.S. averages 108 percent higher than manufacturing in China in terms of cost. But at total cost of ownership (TCO) levels, the U.S. averages only 12 percent higher. And in 60 percent of the cases, the U.S. total cost of ownership is actuallylower than Chinese total cost of ownership, averaging about 22 percent less than China. In other words, for many companies, Moser believes you can empirically prove it’s actually cheaper to produce products here.
Currently, Moser is working with U.S. Rep. Wolf (R-Virginia), chairman of the House Appropriations Subcommittee, to expand the use of the TCO calculater within the Commerce Department.
“Rather than reinvent the [TCO] software, they’ve come to me,” says Moser.
To change status quo, you must work from inside out
A return to American manufacturing, however, will only be happen if the next generation of supply chain managers and entrepreneurs are less inclined to offshore, Moser says. When we spoke, he was gearing up for speaking engagements with scores of manufacturing groups–from the Institute of Supply Management to an association of Midwest Fasteners to a group of Surface Platers in his adopted home state of Illinois. He’s also meeting with Clemson MBA students.
A big piece of the puzzle, Moser tells me, is educating the MBA students to consider the total costs of going overseas, and looking at the United States as a viable place to manufacture in scale.
“I’d love to see a day when companies report the number of jobs you brought back to America and the millions of dollars worth of improvements in our economy because of the actions you took,” he says.
“If I could get people to put that in their annual reports, we’d be home.”
Eric Markowitz reports on start-ups, entrepreneurs, and issues that affect small businesses. Previously, he worked at Vanity Fair. He lives in New York City. @EricMarkowitz