When Louisville, Ky.-based GE Appliances rolled out production of its latest hybrid hot water heater last February, the event was viewed as a milestone in the recovery of U.S. manufacturing. It wasn’t just because GE seemed to be making a sizable bet on the revival of U.S. consumer demand during uncertain times. Through 2014, the company will spend about $1 billion to revamp and revitalize its U.S. appliance production, creating 1,300 new jobs in Kentucky, Alabama, Georgia and Indiana. More significant for global supply chain specialists, GE’s new lines of appliances — including high-tech refrigerators and washing machines — will replace the less advanced models that GE had been producing in China and Mexico.
GE is not the only manufacturer that has opted to bring back a sizable number of jobs to the United States. Several CEOs, including Andrew Liveris of Dow Chemical, have declared that they intend to return production lines to the United States. At a time when the word “outsourcing” has become synonymous with “unpatriotic” for some American voters, how many manufacturers are likely to follow in GE’s footsteps? Why are firms placing a huge bet on what some analysts are now calling “re-shoring”? And what factors should global managers take into consideration when they decide whether or not to bring manufacturing lines back to the U.S.?
Hal Sirkin, senior partner and managing director of the Boston Consulting Group, forecasts that during this decade, two million to three million manufacturing jobs will come back to the U.S. “because of the fundamental shift in economics between China and the United States.” In all, this process will provide $100 billion in added economic growth to the U.S. over the decade, he predicts.
Fueling the process, according to Sirkin, will be the rapidly declining divide between Chinese manufacturing wages and those in the U.S. In 2000, U.S. wages were almost 22 times higher than those in China, but by 2015, wages in the U.S. will be only four times higher. Adjusted for productivity, “the differential shrinks even more,” Sirkin notes. In the Yangtze River Delta, the epicenter of China’s skilled manufacturing workforce, “the effective wage rate will be about 61% of U.S. wages in 2015.” At those levels, “it makes sense to return manufacturing of a wide range of goods, with moderate levels of labor content and high logistics costs, to the U.S.”Sirkin argues that because Chinese wages are rising so rapidly, the U.S. will not only win back those jobs, but it will also be able “to retain a lot of the jobs” even after U.S. wage rates rise in the future.
Not everyone is convinced. Marshall L. Fisher, professor of operations and information management at Wharton, says that sort of argument “grossly oversimplifies the global supply chain” by focusing too much on wage rates. “Economists are a little weak when it comes to the operational details that drive companies’ decisions” about sourcing, he adds.
According to Fisher, between 1999 and 2009, China’s competitiveness against the U.S. continued to be largely based on labor cost arbitrage, but Chinese wages have long been rising at a more rapid pace than those in the U.S. During the last 20 years, Chinese wages have grown five- to six-fold, while U.S. wages have grown by about only 50%. Although that has narrowed China’s wage advantage, wages in China’s Pearl Delta assembly complex are still only about 12% of U.S. manufacturing wages.
Over the past several years, an increasing number of U.S. and other global manufacturers have been moving their outsourcing into lower-wage Asian locations, such as inland China, Vietnam, Indonesia and Cambodia, where wages may average about 6% of those in the U.S. Even manufacturers based in higher-cost Asian locations, such as Taiwan, have moved operations offshore to mainland China. Like their counterparts based in the U.S., Taiwan-based firms such as Pou Chen, the shoe company, and Mitac International, which makes Magellan GPS devices, have moved labor-intensive operations to mainland China, retaining higher-value design and R&D jobs in Taiwan. What’s next? In their quest to find even lower-wage locations, some U.S. and Asian companies could take a serious look at outsourcing in once politically untenable locations such as Myanmar (Burma) or North Korea.
Nevertheless, comparative labor costs are only one of several considerations involved in choosing whether or not to outsource production, says Fisher. Other factors involved in such a “complicated process,” he notes, include transportation and logistics costs; costs incurred from holding the extra inventory needed to guarantee against supply chain risks; longer lead times for developing new products overseas; and the challenge of managing quality control and product development from a distance of several thousand miles.
While he agrees that the tipping point has moved in favor the United States, “it is very product-specific,” says Fisher. For example, Converse Shoe now makes its line of “distressed shoes” — which have holes in them — in the U.S. in order to meet the special complexities of managing quality control. Although many low-end apparel and footwear products are sourced from Asia, New Balance, American Apparel and Timbuktu also make some of their products in the U.S., although they source some products offshore. Unlike standard brands of athletic shoes, these are higher-margin, lower-volume products that benefit from a strong corporate brand and a made-in-the-U.S.A. label, in a consumer segment where that label really counts.
Re-shoring may also make particular sense for bulky goods, which naturally incur higher transportation costs — including appliances, as in the case of GE. As manufacturers extend their supply chains ever deeper into remote areas — such as inland China and more remote parts of Southeast Asia — they struggle to overcome the inefficiencies and gaps that raise the cost and uncertainty of importing finished goods to the United States in a timely manner, Fisher notes.
At GE Appliances, the decision to bring back numerous product lines from China and Mexico was based on a very complex assessment of costs and risks involved — not just those involving wages, but also the cost of putting into effect a range of innovations in the company’s manufacturing technologies and management practices.
“We changed the way we looked at costs,” says Earl F. Jones, director of government relations and regulatory compliance at GE Appliances in Louisville. Downplaying the wage gap between the U.S. and lower-wage countries, GE calculated the often hidden factors involved in sourcing cumbersome, heavy appliances from outside suppliers. These vairables included greater supply chain complexity, “longer cycle times, quality considerations and responsiveness to local demand,” Jones notes. By sourcing from China and Mexico, GE was incurring added inventory carrying costs so that the company would be able to respond to any sudden supply chain disruption or other unpredictable event.
Just as fundamentally, Jones adds, when a firm like GE outsources the production of any high-value product, “you are losing your core competencies. You lose ownership” of the product, “even if you retain control over designing it.” Over the longer haul, “your suppliers also become your competitors as they build your parts.”
According to Jones, GE’s new approach to manufacturing is predicated on four key elements: Increased collaboration between labor and management; new approaches to manufacturing; new technologies and working with government. The approach took years to germinate, beginning with a 2005 labor agreement that was GE’s “first competitive wage agreement” because it enabled new employees to come in at wage rates lower than in the past (although still well above those in China or Mexico).
Beyond that, management has completely redesigned its approach to manufacturing, he says. “The old teams worked in functional silos. But the new approach is ‘one team and one goal.'” Each team has its own goals and its own metrics for measuring those goals. Using the same terminology pioneered by Japanese manufacturers who pursue this path, members of various teams are said to “go to the genba,” a common location where they meet to discuss various issues. Initial experience shows that this approach “eliminates waste and drives down the hours per unit,” Jones notes.
The spirit of innovation has extended deep into the manufacturing plant, he adds, including the search for new ways to maximize output within a limited amount of floor space at the new U.S. location. Engineers had to leverage “lean manufacturing” principles to improve productivity while increasing quality. The plant’s newly designed assembly lines for dishwashers are more than 50% shorter than traditional assembly lines, reducing production time, increasing efficiency and improving quality since it is easier to identify problems. By repositioning the new assembly lines in the back of the factory, closer to staging areas for parts, transportation times within the plant have also been cut. Other innovations include getting production workers involved in the design of work stations and processes, and improving the timely supply of parts to work stations. The result: GE claims that overall production-time per unit has been cut by 65%.
While GE’s experience may fuel the argument for those who want to see jobs return to the U.S., Fisher notes that one fact is often overlooked in the re-shoring debate: the nature of the jobs themselves. When critics of outsourcing clamor for the return of American jobs from foreign locations, policy makers and voters should ask themselves: “What is best for the U.S. economy? Many of the jobs that have gone offshore, such as positions in sewing apparel or steel mill work, are bottom-rung” positions that few American workers would accept even if they were available to them. If millions of jobs are brought back to the U.S., manufacturers would be forced to pay substandard wages acceptable only in developing countries like China, he adds.
Misconceptions and Exaggerations
Whether it’s off-shoring or re-shoring, Morris Cohen, professor of operations and information management at Wharton and co-director of the Fishman-Davidson Center for Service and Operations Management, says that U.S.-based companies will continue to do what they need to do in order to maximize their profits. No matter how rapidly Chinese wages or global transportation costs may rise, outsourcing will continue to be a fundamental practice in today’s globalized economy. “This is an emotion-charged issue, which will have a significant impact on the outcome of the presidential race,” notes Cohen. “Much of the discussion that we have seen from both sides, however, is at best over simplified, and in some cases misleading. Statements often have been made that are based on misconceptions and exaggerations in order to score political points.”
Although many view outsourcing as unpatriotic, that’s hardly the case, according to Cohen. “All firms make sourcing decisions in order to get the best inputs for producing the goods and services that they sell to their customers. Sometimes, the sourcing decision is to produce internally — that is, to make the product by building and operating factories. Sometimes, however, the decision is to source from an outside supplier.” Moreover, much of this sourcing activity often takes place within the U.S. or other domestic markets.
“No firm makes everything, and overall, more than 60% of the cost of manufactured goods can be attributed to goods and services that the average firm buys from its suppliers,” says Cohen. Recent surveys of major companies have found that about 40% of the raw materials, semi-finished and finished product they purchase are sourced from outside of their home market, he adds.
“It seems reasonable to expect companies to make choices that maximize their profit and thus ultimately increase shareholder value,” Cohen says. “The consequences of outsourcing — and off-shoring, in particular — are felt by multiple stakeholders who are affected by how a company runs its business. Stakeholders include the firm and its shareholders, its customers, the labor force working for the company and for its suppliers and, ultimately, the economies of the countries in which the company operates. Some stakeholders will benefit from a decision by a company to outsource, and some will be losers.”
For example, Apple’s decision to off-shore the manufacturing of its iPhone and iPad has reduced costs for the company and therefore increased its profit. And while the move has not created any jobs in the U.S., Apple customers have enjoyed access to their favorite products at a lower price, so they have “more money to spend on other goods and services,” Cohen notes. While many Americans complain about the disadvantages of off-shoring — including job losses and plant closings — politicians and consumers often ignore its positive impact on their own purchasing power.
Ultimately, Cohen believes that the correct balance can be struck through careful planning. “By choosing appropriate policies and decisions, it should be possible to generate ‘win-win’ solution scenarios where all are better off. Finding such solutions is the challenge facing us today.”