There is evidence that the great migration of manufacturing offshore is beginning to reverse. Here we look at whether offshoring or reshoring makes more business sense now and in the years ahead.
A growing body of research shows evidence – albeit mostly isolated and anecdotal evidence – that many large companies are rethinking their offshore production locations. Some United States companies – including Caterpillar Inc., Ford Motor Co., General Motors, Nissan, NCR Corp., Yamaha and Electrolux – are already bringing a portion of their manufacturing capacity back home. Earlier this year, both the Boeing Co. and General Electric publicly said that they are committed to moving parts of their offshore manufacturing capabilities back to the U.S.
Two-thirds of large U.S. manufacturers have moved factories in the past two years, with the most popular destination being the U.S., according to findings published by Accenture in May. The consultancy’s report indicates that approximately 65 percent of senior executives surveyed have moved their manufacturing operations in the past two years, with two-fifths saying the facilities have been relocated to the U.S.
Does offshore-outsourcing still make good business sense?
Why Offshoring Still Makes Business Sense
Companies that have moved some of their business processes offshore say they are more flexible and agile, making them better able to adapt to competition in challenging economic environments, according to 2011 findings from the Center for International Business Education (CIBER) and the International Offshoring Research Network project at Duke University’s Fuqua School of Business.
In fact, many business leaders say a corporate-wide strategy to guide offshoring decisions is increasingly critical to achieving global company growth through better service quality and process improvements.
“U.S. companies that have diversified the scale and scope of their global sourcing of business services and processes in recent years say they are reaping operational and financial returns,” Arie Lewin, Fuqua professor of strategy and international business and director of CIBER, said in a statement. “For companies that are engaged in offshoring, we’ve seen a significant jump in the number of respondents who say offshoring activities have led to improved organizational flexibility, from 48 percent in 2009 to 66 percent in 2011.”
Midsize companies, in particular, report aggressive plans to expand and initiate new offshoring initiatives. Approximately 73 percent of midsize companies told CIBER they have plans to expand existing offshore business processes over the next 18-36 months, up from 55 percent in 2011. Conversely, 41 percent of large companies are planning to expand their offshoring of business processes in the same period, down from 52 percent in the previous year.
According to CIBER, cost-savings are no longer the primary driver of offshoring strategies.
“U.S. companies are transferring more of their professional work abroad, especially in the areas of IT infrastructure, application development and maintenance and innovation processes,” Lewin said. “These companies cite a shortage of qualified personnel among the top reasons for utilizing global sourcing of services.”
Making the case for “responsible offshoring and outsourcing” at Harvard Business Review, Ben Heineman, author of High Performance With High Integrity, recently cited strong business reasons for offshoring:
- The need to stay cost-competitive with companies headquartered elsewhere, either through reduced finished product/service cost or through supply chain efficiencies;
- The need to manufacture, assemble, provide services and do R&D to understand and sell in a local market, and to attract great local talent for jobs that would not normally be offered in the U.S.;
- The need to have a significant employment or plant/equipment presence in a local market because host governments demand it;
- Because such a presence can also pull a company’s high-end exports from the U.S.;
- Because a presence can strengthen that market’s economy and thus increase U.S. exports over time; and
- Because any products imported back to the U.S. can benefit consumers and the economy with lower cost (although foreign operations often sell in foreign markets).
According to recent research from Hackett Group, Inc., U.S. corporations are expected to move an additional 750,000 jobs in IT, finance and other business services to low-cost locations by 2016. The Hackett Group’s offshoring reveals that a total of 2.3 million jobs in finance, IT, procurement and HR will have moved offshore by 2016. This represents about one-third of all jobs in these areas.
Many American firms continue to prefer basing their service operations in foreign locations such as India, China and the Philippines, particularly in the areas of IT infrastructure, contact centers and application development and maintenance. According to Hackett’s research, India is by far the most popular destination, with nearly 40 percent of offshore jobs heading there.
Despite the expected near-term rise of offshoring, various findings indicate that offshoring levels will reach a tipping point in a few years.
Why Reshoring Makes More Business Sense
While the move to reshore may be slow, manufacturers are starting to recognize that many factors previously used to justify offshoring have changed dramatically over the past few years – and the potential cost savings are no longer so impressive.
In some cases, offshoring has negatively affected companies’ competitive advantage, limiting growth and revenue. For example, nearly half of the Accenture survey respondents cited problems encountered with cycle or delivery time, and 46 percent experienced product quality concerns as a result of offshored operations.
According to a Boston Consulting Group (BCG) report in April, however, labor costs (57 percent) are the top factor driving future decisions on production relocations.
“As the wage gap between the U.S. and China shrinks, the days of cheap labor in China are waning. The cost of wages in China is on the rise at a predicted 15-20 percent annually, while U.S. wage rates are increasing at a much slower 2 percent clip,” according to a 2012 report by Reynders, McVeigh Capital Management.
Approximately 92 percent of manufacturing executives surveyed by BCG said they believe that labor costs in China will continue to escalate, and 70 percent agreed that sourcing in China is more costly than it looks on paper.
Labor cost savings are just one factor driving companies to consider reshoring. To compete more effectively, according to BCG, a growing number of U.S. companies are considering shifting operations to the U.S. to improve:
- Product quality (41 percent);
- Ease of doing business (29 percent); and
- Proximity to customers (28 percent).
Meanwhile, rising oil prices have pushed transportation costs higher, driving more companies to turn away from offshoring as the cost advantages of moving production to China and other locations become less significant.
“By reallocating resources to the U.S., companies can reduce the distance to the point of sale and eventually benefit from more accessible, cheaper fuel in domestic natural gas,” Reynders, McVeigh states.
Ultimately, industries are adopting a more holistic view of production by using Total Cost of Ownership (TCO), according to Reynders, McVeigh. Companies that use TCO “find it is cheaper and more predictable to keep manufacturing close to home.”
This trend is expected to reach a tipping point over the next few years, as the total landed cost gap between the U.S. and China continues to shrink, driven in part by rising wage inflation in China and continued productivity improvements in the U.S. A separate Hackett Group study, published in May, concluded that companies are considering reshoring as an option for nearly 20 percent of their offshore manufacturing capacity between 2012 and 2014.
The findings are consistent with a separate BCG report, released in March, which predicted that by 2015 it will become cheaper to produce certain products in the U.S. that are sold to American consumers. According to BCG, the products would span half a dozen industries and include everything from machinery to furniture.
“Reshoring is expected to become more viable with each passing year, as the total landed cost gap of manufacturing offshore shrinks,” according to the Hackett Group, which found that the cost gap between the U.S. and China has shrunk by nearly 50 percent over the past eight years and is expected to stand at just 16 percent by 2013.
Looking ahead, more than one-third of large U.S. manufacturers are considering reshoring from China, according to BCG’s April findings.
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