The last few weeks have brought news of turmoil in China, including currency devaluations, an economic slowdown, and a stock market plunge. Most economists, including those at the the IMF, think it is premature to talk about an economic crisis. While I agree, I nonetheless believe that the slowdown is due, in part, to an acceleration of “near-shoring,” the practice of producing closer to the customer.
My evidence is a series of separate surveys conducted by different organizations, including the MIT Forum for Supply Chain Innovation.
The MIT Forum launched an online survey in 2012 to understand what U.S. manufacturers were doing about bringing production back to the United States and what factors were driving their decision process. One-hundred fifty-six U.S. manufacturing companies, defined as firms that have their headquarters in the United States, responded. The resulting report, U.S. Re-shoring: A Turning Point, indicated
shift in manufacturing footprint. While 33.6% of respondents stated that they were “considering” bringing manufacturing back to the United States, 15.3% of U.S. companies responded that they were “definitively” planning to do so. The results of the 2014 survey — to which 89 U.S.-based companies and 33 non-U.S.-based companies responded — were very similar.
The more recent AlixPartners survey of manufacturing and distribution companies serving North America and Western Europe suggests that this process is accelerating: Thirty-two percent of the companies surveyed reported that they have already near-shored or are in the process of doing so to meet end-market demand. Of the company leaders surveyed, 48% said near-shoring activities are likely within the next one to three years.
Another indication that near-shoring is accelerating is the Purchasing Managers’ Index (PMI). This index, which is compiled monthly, shows changes in manufacturing activity. A value of 50.0 means no change, while a value above it means an increase in activity and below it a decrease in activity. China’s PMI was 49.7 in August and 50 in July, reflecting a real decline in activity. In comparison, the U.S. PMI was 51.1 in August and 52.7 in July, reflecting a decrease in growth but not a decline in activity, and Europe’s PMI slipped slightly to 52.2 in August from 52.3 in July. Altogether, these figures suggest that the decline in manufacturing activity in China is related to both a softening of local market demand and the impact of near-shoring.
Of course, bringing manufacturing to the United States does not necessarily imply more U.S. manufacturing jobs; nor does it necessarily imply that China is changing its position as a manufacturing hub. However, it may suggest that the world is in the middle of a transformation, with companies moving from a global manufacturing strategy, whose focus is on low-cost countries, to a more regional strategy, where China is for China, the United States (or Mexico and Latin America) is for the Americas, and Eastern Europe is for European markets. As the recent surveys suggest, this trend has picked up pace in the last few years not only because of pressure to return manufacturing jobs to the United States but also because the economics that made off-shoring attractive in the first place have changed for the following reasons:
Oil prices. The move to low-cost manufacturing in the 1990s was driven in part by cheap oil prices. However, the price of oil then tripled in the last decade. As a result, logistics costs increased significantly compared to what they were when the decision was made. Yes, the prices of oil have recently fallen. But so have the prices other commodities, and another twist is the increase in U.S. production of cheap natural gas (using new fracking technology). This means that for some industries, the lower cost of manufacturing in the United States may outweigh the lower costs of shipping goods from China.
Labor costs. In the last few years, labor costs in China have increased annually by almost 20% versus 3% in the United States and 5% in Mexico. So if your company made production-sourcing decisions five, seven, or 10 years ago, it may need to revisit those decisions today.
Automation. Cheap sensors, fast computing, and new technologies have led to new user-friendly manufacturing automation that increases productivity. This improvement in productivity changes the economics and reduces the importance of low labor costs. As a result, the focus of manufacturing companies is more on skillful workers than on countries with low labor costs.
Risk. Global companies have realized in the last few years that strategies such as outsourcing and off-shoring have significantly increased risk because their supply chain is geographically more diverse and, as a result, exposed to all sorts of potential problems. A recent example is the explosion at a warehouse in Tianjin that ships hazardous materials, which was most likely caused by a company culture that flouted regulations. This drives companies to reevaluate their supplier and manufacturing base in order to increase flexibility and reduce risk.
The current turmoil in China will most likely accelerate the trend to near-shoring, but the impact will vary by specific industry and company.
For high tech industries (e.g., the manufacture of laptop computers and mobile phones) recreating the infrastructure in China somewhere else would be expensive and difficult to do. In contrast, it will be easier for footwear and apparel companies to move to lower-cost locations. Manufacturers of heavy products such as appliances or cars that are heavily influenced by shipment costs may find it pays to move production closer to market demand.
The bottom line: Companies need to evaluate on an ongoing basis whether the trade-offs for their particular industry have shifted enough to justify a change in their sourcing strategies.