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For decades supply chains have become stretched, cumbersome, and opaque as companies chased cheap labor offshore and then imported products to sell in the U.S. market. But since 2010, rising Chinese wages, low U.S. energy costs, intellectual property concerns, and advancements in technology and automation have been influencing more companies to consider U.S. manufacturing.
With today’s supply chain turmoil, including special tariffs on China, you’re probably re-evaluating your China sources. Isn’t it time you put the total cost of ownership (TCO) to work for a smarter approach to supplier selection?
The Strength of the Reshoring Trend
Even before the turmoil of 2019, in 2018 the number of companies reporting new reshoring and foreign direct investment (FDI) was at the highest level in history, up 38% from 2017 to 1,389 companies. These companies announced more than 145,000 manufacturing jobs. Companies are investing and sourcing domestically because it makes good economic sense for them to do so.
About 60% of companies traditionally decided to offshore based on comparing wage rates, Ex-Works prices, or landed costs. Much of the strength of the reshoring trend has been due to companies becoming familiar with a broader range of factors (costs and risks) they had previously ignored.
The cycle of offshoring, learning, and then reshoring is well documented in a recent article entitled “Why in the world did they reshore? Examining small to medium-sized manufacturer decisions.” These observations from Ohio State University professor John V. Gray’s detailed academic case studies are consistent with the conclusions from the multi-thousand company Reshoring Library and the Total Cost of Ownership Estimator® user databases.
Gray’s study confirmed how companies learn from offshoring. The Reshoring Initiative’s data quantifies that:
- Most companies offshored seeking low wage rates and prices.
- Accumulated offshore experience and rising offshore costs have driven companies to reevaluate their offshoring decisions.
- Approximately 25% of the offshore work would have a lower total cost if sourced domestically; use of TCO can justify reshoring some work, but far from all.
- It is far easier to reshore work that is outsourced offshore than in-house offshore.
Decisions to reshore manufacturing operations, as compared to decisions to offshore, incorporate a wider range of factors, many of which are difficult to quantify. Collectively, these costs are known as the “hidden” costs. When added to Ex-Works price, they equal TCO.
Analyzing Total Cost of Ownership – Doing the Math
The shrinking savings from low, but rising, offshore wages and Ex-Works prices are increasingly offset by dozens of hidden costs. TCO is a key tool in the sourcing decision process, quantifying whether the costs and risks avoided offset the often-higher U.S. manufacturing cost or price.
Making sourcing decisions based solely on price often results in a 20-30% understatement of offshoring costs. TCO analysis helps companies objectively quantify, forecast, and minimize total cost.
It takes into account: freight and duty; travel expense and time; inventory carrying cost; warranty; intellectual property (IP) loss; impact on product innovation from having manufacturing distant from engineering; and the losses from stock-outs due to long delivery times.
TCO also quantifies many other factors, such as those associated with the risk of supply chain shocks or disruptions caused by natural disasters and political unrest. It helps to forecast the impact of future wage and currency changes. Using this information, companies can better evaluate sourcing, identify alternatives, and even make a case when selling against offshore competitors. One Chicago area contract manufacturer won a $60 million order by showing its customer that the manufacturer’s TCO was lower than its lower-priced Chinese competitor’s.
The Value of TCO in Supplier Selection
Placing a real value on more than two dozen often ignored yet relevant costs, most of which individually represent only a small percent of a product’s final total cost, can tip the scales in favor of producing at home. In aggregate, savings from domestic sourcing will offset some or even all of a 15-30% advantage in purchase price enjoyed by low labor cost countries.
It’s All About the 25%
About 25% of what is being sourced or produced offshore for U.S. consumption would be more profitably reshored even without current tariffs. In view of tariff uncertainty and other trade actions, this is an excellent time to do the math, identify that 25%, and reshore it now. With 15% tariffs in place, about 40% of Chinese imports would be more profitably reshored.
Increasing Freight Costs
“Freight Cost” has always been high on the list of offshore costs; however, we expect this cost, along with green considerations, to become even more relevant as the International Maritime Organization (IMO) implements new emission reduction initiatives in 2019/2020. In an effort to reduce the shipping industry’s sulfur dioxide emissions by 50% from 2008 levels by 2050, the IMO will enforce a ban on ships using fuel that has a sulfur content of 0.5% or higher, down from the current 3.5%. Emission reduction costs per ship will run between $1 million to $10 million with an estimated overall industry cost of $60 billion in additional fuel bills, raising shipping costs by about 10%.
The TCO Narrative
The TCO Estimator, a free online tool, guides companies through a comprehensive system for recognizing and adding all the costs and risks associated with offshoring and reshoring. The relevant factors must be accounted for if you want a complete picture of the total cost. Careful examination of total costs and changing conditions can lead to new opportunities in supplier selection.
Considering switching from China or other offshore sources? Before following the stampede into unprepared countries, gather data and do the math. Thomas can help you find the best U.S. suppliers; the TCO Estimator will help you compare those suppliers to your offshore alternatives on an apples-to-apples basis.
Image Credit: Maxx-Studio / Shutterstock
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