Investment Consulting Associates

A much heard statement in the media nowadays is that the US is steadily losing ground to emerging and developing economies if it comes to locating manufacturing business activities. In contrast, we also saw increasing anecdotal evidence of a trend which is called “re-shoring”, which involves a re-migration of business activities back to the US from overseas locations. This fourth chapter in the series on US competitiveness will take a closer look into the total cost of producing overseas versus producing domestically, and tries to highlight hidden costs of relocating overseas, often ignored by internationally operating companies.

By means of a real business case, we present all relevant cost drivers that should be considered to arrive at accurate financial scenarios for making a strategic decision to relocate overseas or to expand domestically. Any financial base case analysis of the impact of offshoring manufacturing activities must take into account all the costs associated with an offshore initiative. The Total Cost to Ownership approach (TCO) analyzes the entire cost a company incurs when producing or purchasing a particular manufactured part overseas. The TCO approach consists of the following key components:

• Raw material Costs
• Packaging Costs
• Transportation Costs
• Customs and Duties Fees
• Inventory Costs
• Lead times and local warehousing Costs
• Quality control Costs
• Travel Costs
• Training and Productivity
• IP Risks
• Exchange Rate Fluctuations
• Inflation Rates

5.1 Business Case

Company – XYZ – is productive in the automotive industry and is a first tier supplier to OEM automotive manufacturers. It produces high-technology braking and gearing systems, for which it also uses its own software systems, fully integrated with their “hardware” products.

For their supplies of specific steel products, they are depending on several suppliers that are located globally. The board of directors is following a vertical integration strategy to allow for further growth of the company. One strategic question is to source the steel from third parties or produce and process the steel for their products internally. Second important question is where to locate the steel processing plant. Would it be more beneficial to locate the steel plant overseas and potentially benefit from lower cost levels, or does it make more sense to keep it close to the other facilities located in the US, to minimize lead times and minimize transport costs?

We will apply the TCO approach to these two strategic questions and try to provide a fact based answer to both questions.

Source: Reshoringmfg.com 2011

Now let’s consider a unit price of one component steel of $100 versus $70 in China. The reason why packaging costs is typically higher in China, is because of export packaging is much more complex and has to meet specific standards of the countries of destination and origin. An important cost driver here are the import and export duties for this product (i.e. 4% for steel parts), and the associated fixed (Broker and Customs Fees) and handling fees. Given the nature of the product (i.e. weight / value ratio) we furthermore assume that all supplies are shipped per surface freight. Adding all costs for the US and China we have a total Cost of Goods Sold (CoGS) of $101 compared to $75,09.

This case study demonstrates that off-shored production may mean “cheaper price”, but not necessarily “lower Total Cost of Ownership”, as will be demonstrated further below. Sourcing or producing locally means long lead times, transit and warehousing issues, urgent matters which requires traveling, and other hard costs. The next page shows a summary of the different cost drivers for this particular case study.

In our series regarding the US competitiveness for FDI, we began examining the different drivers behind corporate FDI decisions, followed by a closer look of different views and opinions by various subject matter experts addressing these FDI drivers. Now we continue our assessment with a factual benchmark of the global competitiveness of the United States (US) versus emerging and low cost economies. Based on several comparative global benchmark reports as well as national statistical resources, we have computed and modeled a competitiveness score for all countries under study.

To assess the competitiveness of the US we have used Investment Consulting Associates´ (ICA) web-based location benchmarking software product LocationSelector.com. Below are the aggregated location groups that we took into consideration for this benchmark analysis. More specifically, the six location groups consist of several location factors, and in total we modeled 61 location factors.

1. Business environment
2. Business risks
3. Infrastructure
4. Labor cost
5. Macro economy
6. Tax

Based on our LocationSelector.com scoring model that transforms the actual country values in a relative score between 10 and 100 (e.g. best in class country for a particular location factor receives a relative score of 100) we have calculated the overall country competitiveness scores:

Source: LocationSelector.com

The overall competitiveness score implies that the US not only has been, but still is a very competitive investment location compared to all emerging low cost and high growth markets. The US consistently score well in terms of business environment, business risks, infrastructure and tax. However, the location groups Macro Economy and labor puts China, Vietnam and Indonesia on the forefront due to China’s strong future growth figures and the low labor costs of Vietnam and Indonesia.

In terms of labor costs the US obviously are still far behind, but whereas in the past we saw a trend of corporates making investments decisions based on cost levels only, in present times we see examples of companies re-entering the US again after a low cost adventure. This indicates that corporates are increasingly giving (and should also give) more priority to the softer factors, as these embrace a lot of hidden costs.

The next sections will stipulate further on the different details per location group, included in this competitiveness benchmark assessment.

Business Environment

This location group not only consists of several criteria of the most recent World Bank’s Doing Business In Reports, but also includes the FDI Confidence Index, the Intellectual Property Protection Index and statistics relating to the Efficiency of the Legal Framework. In total we included 42 different location factors relating to this location group only. Overall, the US scores significantly higher compared to its competitors, i.e. 90.87 with maximum scores on 30 out of the 42 location factors. Behind the US and ranking second is Mexico, with a competitiveness score of 64.08 followed by Vietnam with a competitiveness score of 57.43.

The findings suggest that the business environment of Vietnam is considered more favorable than China’s. This is also what we experience in our daily corporate site selection activities: bureaucratic concerns that corporates face in China are reflected by low scores on dealing with construction permits, starting a business, closing a business and employing workers.

India and Brazil have the least appealing business environment according LocationSelector.com. Yet, these countries have and still do enjoy large inflows of FDI projects, and this can partly be explained by the fact that these countries represent a significant internal market, which is still one of the most important drivers for foreign investment. In this perspective it is therefore not that surprising that these countries were popularly labeled as the BRIC’s.

Business Risks

Business risks encompass corruption levels and economic freedom. Here the US score best on both aspects, while Vietnam has the highest degree of business risks among all competing countries. A large gap exists in general between the US and the runners up Mexico and Brazil with scores of respectively of 100, 36.52 and 28.86. This implies that the US are much more stable than its global competitors, and provide corporate investors with a low risk investment location.

Infrastructure

The quality of road, rail, air transport, and sea ports is, among others, a measure of the physical effectiveness of corporate supply chains. A higher score implies a more effective supply and distribution of finished goods to final customers by using different modes of transport. The US clearly stand out as reflected by the best possible score of 100. China ranks number two, but with a large difference in score with the US, i.e. almost 50 base points out of 100. Interestingly Brazil has the worst overall score in infrastructure. However, with the World Cup and the Olympics in the next 6 years, improvements in this area are expected.

Labor

The location group Labor in our benchmark analysis includes the average hourly compensation costs for all direct employees in manufacturing. Here we clearly see the relative high labor costs of the US and the favorable low costs in Indonesia and Vietnam. The results here coincide with our experience in Asian corporate site selection activities that routine and labor intensive production is relocated out of China to countries such as Vietnam and Indonesia.

Macro Economy

As a proxy for purchasing power, we used the GDP per capita and the estimated GDP growth rate over the next 5 years. China ranked first based on these two location factors. This is due to the high GDP growth rate forecasts for the next five years, whereas the US has the lowest growth figures among the competing countries. The highest score for US relating to the location factor GDP per capita does not compensate sufficiently to overtake China.

Tax

The location group Tax encompasses the corporate income tax for resident companies, ease of paying taxes, number tax payments, time to comply and total tax rate. Also here, it is the US that score best with maximum scores for the ease of paying taxes and the time to comply. Second place with less than 10 base points difference is Mexico. The US, however, scores lowest on corporate income tax for resident companies, whereas Brazil scores best by far. Interestingly, the total tax rate in Brazil is ranked lowest, which illustrates President Lula’s social agenda and strict taxation rules on foreign capital entering Brazil.

The final ranking in competitiveness as illustrated below suggests 4 main groups:

1. Competitiveness score 61< US
2. Competitiveness score 51-60: Mexico and China
3. Competitiveness score 41-50: Indonesia, Vietnam and India
4. Competitiveness score 30-40: Brazil

Source: LocationSelector.com

A competitive and low risk investment climate, with relatively stable wage inflation, increased productivity levels and a skilled labor pool in the US compared to rapid rising labor costs and seemingly overheating economies in South East Asia are shifting the global landscape of FDI. It does however all depend on the type of business you are in. As Tim Ryan, co-chair of the House Manufacturing Caucus said: “We must face the fact that the US will not produce any sport shoes anymore” and “While much of manufacturing has become more competitive and efficient, advanced manufacturing in areas such as green technology is critical to the country’s economic future”, illustrates the new direction and era in US manufacturing.

According to the US department of Labor, US output per hour at US non-farm businesses rose 5.2% from mid-2009 until the end of 2010, while hourly wages rose only 0.3% in relative terms. This increased productivity in combination with the strong competitive environment (highly favorable for market, efficiency and strategic asset seeking FDI) plays a big role in the current “reshoring” movement – repatriating production back to the US from overseas, as surveyed by Reuters and MFG.com. Of all the companies surveyed, as much as 15% say they have repatriated production back into the US in the past 2 years. Trends like reshoring often sustain for decades as opposed to years (just as the offshoring trend), and now that the balance between cost levels versus risk levels is changing in favor of the US, we expect to see more and more jobs re-generated due to reshoring.

Investment Consulting Associates (ICA) will publish the last and final FDI blog next week. This final FDI blog will demonstrate a business case simulation of a manufacturing plant in the US versus the competing low cost locations.The final report on “The United States: The revival of a manufacturing powerhouse” is presented by ICA and Atlas Advertising at the 2011 IEDC conference in Charlotte, North Carolina.

Dr. Douglas van den Berghe

CEO Investment Consulting Associates - ICA

In a series of blog posts discussing the competitiveness of the U.S. for Foreign Direct Investment (FDI), we are continuing the conversation with this topic: the market voices.

The U.S. suffered hard during the latest economic downturn. Even today a lot of uncertainty concerning the economic situation exists. When scanning through news reports and articles, not surprisingly, the creation of jobs and stimulating economic development is the single most important theme in American politics. The United States faces a daunting challenge in creating jobs: at current rates, it will take until 2016 to replace the 7 million jobs lost during the 2008–09 recession. Research from McKinsey & Company titled Job Creation and America’s Future, indicated recoveries are becoming increasingly jobless due to firm restructuring and skill and geographic mismatches between workers and jobs. Technology is changing the nature of work. Where jobs are being disaggregated into tasks, work is becoming virtual and firms are increasingly relying on flexible labor.

These trends offer new opportunities for creating jobs in the U.S. This voice is echoed and built upon by Wired Magazine which states that “as the smoke from four years of charred capital starts to dissipate…we can see the gradual emergence of a whole new category of middle class jobs: a realm of work that could begin to close the gap in American employment. These new middle class jobs are what you might call smart jobs.”

Smart jobs are defined here as innovative and high tech but don’t require employees having a PhD, although they do require on the job training or a vocational program. These smart jobs tend to scramble the line between blue-collar and white-collar. Their titles tend toward the white—technician, specialist, analyst—but the underlying industries often tend toward the blue, towards the making of physical objects. While these jobs involve factories and machines, plastics and chemicals, the operating of the necessary instruments demands far more brains than brawns.

Interestingly, these new innovative middle class smart jobs are also located far from the traditionally innovative regions such as Silicon Valley and New York. They are cropping up all over the United States, in regions where you don’t traditionally expect. Dayton, Ohio, for example, is a hot spot for Radio Frequency Identification (RFID) technology. Calcasieu, Louisiana, has become a hub for PVC and synthetic rubber, while job growth is flourishing from Richmond, Virginia to Provo, Utah in the information technology industry. To emphasize the development, an article from wired.com titled New, High Tech Hope in Poverty-Wracked Old South , illustrates I-85 as the new high tech corridor and is located in two of America’s poorest regions.

This development has not been unnoticed by the federal and state governments. As Industry Week quotes Tim Ryan, co-chair of the House Manufacturing Caucus, as saying “while much of manufacturing has become more competitive and efficient, advanced manufacturing in areas such as green technology is critical to the country’s economic future”. Ryan continues by saying “Everybody has to come to grips with the fact that we are not making tennis shoes any more. We are not going to make certain low-end manufacturing products. One of the real assets the U.S. always had was the fact that we supported that kind of cutting edge research and partnered with industry to make it work.” Even the government is calling for the U.S. to lead the world in advanced manufacturing.

Adding to the discussion on moving production back to the U.S. was Industry Week’s article titled Are You Sure it is Cheaper to Go Offshore? The article demonstrates that the total cost of the supply chain or Total Landed Costs (i.e. the sum of all costs associated with making and delivering products to the point where they produce revenue), is not only dependent on item by item product costs. Observing transportation costs, customs and duties and costs associated with increased lead times makes the U.S. much more attractive compared to many competing locations in Asia. Among others, the existence of third party logistics (3PL) and even 4PL providers who specialize in optimal supply chain management justifies this statement. A trend is emerging in the U.S. where 3PLs are helping manufacturers better understand the total cost of their supply chain and are therefore seriously beginning to look into the viability of adopting nearshoring strategies.

Combining the innovative characteristic of the U.S. and the increased focus on efficient supply chain management with the continuing rising labor costs in China (according to a study by the Boston Consulting Group), it is no surprise that Reuters and MFG.com confirm a “re-shoring” movement in the U.S., (i.e. repatriating production back to the U.S.).

A few examples of re-shoring and new foreign investments in U.S. manufacturing industry:

• Ford Motor Company and Wham-O (the makers of the Frisbee®) are cited as having already brought production back to the U.S.
• Germany-based Automaker Quaprotek USA invests $22 Million in a new Tennessee facility that brings over 120 jobs to the area.
• Presair, a manufacturer north of New York City, will return production of its switches from China by this Fall, 2011. The reasons included long lead times for product and the tying up of capital needed for expansion. While Presair will see its costs jump 8% with the move back to the U.S., its CEO Art Blumenthal believes those higher costs will evaporate with the rising costs of manufacturing in Asia.
• NCR plans to begin a second production shift, which will result in a total of 800 new (re-shored) jobs to Columbus, Georgia.
• In July 2011, American chocolate manufacturer Mars Inc. has announced plans to build a brand new “state-of-the-art” chocolate manufacturing facility in Topeka, Kansas—its first such site in the U.S. in over 35 years.

More interesting findings of the Reuters/MFG.com survey show that 40% of North American manufacturers with off-shored production are investigating bringing that work back to the U.S. within the next year. Additionally, Peter Dorsman, Senior VP of Global Operations for NCR, who recently moved production back to the U.S. from China to respond more quickly to competition and market trends, has received many phone calls from CEOs of other companies looking to follow suit and re-shore some or all production.

In this FDI blog post we have taken an anecdotal perspective from the market on the competitiveness of the U.S. and the revival of a future manufacturing powerhouse. Our next FDI blog post will make a fact-based analysis of U.S. competitiveness by benchmarking the U.S. against competing emerging markets on cost as well as risk levels.

Investment Consulting Associates (ICA) and Atlas Advertising will continue the conversation around this idea through a shared series of blog posts. The full presentation of research will be presented at the 2011 IEDC conference in Charlotte, North Carolina by ICA.