Why Supply Chains Will Compress and Drive Reshoring

The following commentary appeared in the newly published book, “L’Industrie Americaine: Simple Rebond ou Renaissance?” (American Manufacturing: Simple Rebound or Renaissance?)  by Thibaut Bidet-Mayer and Philippe Frocrain and published by Presses de Mines – Transvalor, 2015.

Conventional wisdom holds that the U.S. manufacturing revival is driven largely by factors such as lower energy costs, stagnant labor rates and the influence of the federal stimulus.  And whereas these factors have certainly contributed to the rebound, they don’t tell the full story.

Over the long term, the revival of domestic manufacturing in the U.S. – and in other industrialized nations – will be driven by the trend toward geographic compression of supply chains.  Why are supply chains compressing and how does this affect the revival of domestic manufacturing, whether in the U.S. or in Europe?

There are three primary reasons and all are intertwined.

The first is a trend away from long production runs of commodity-type products and toward shorter production runs and more customized products.  Consumers are increasingly demanding goods and services more tailored to their own needs or desires.  Motorola’s decision to assemble its Moto X in Austin, TX, instead of in China was the result of a product development decision to offer consumers a wider range of customization options.  Because they did not want to sacrifice speedy delivery, shortening the supply chain link between final assembly and the consumer became a necessity.  Many of the phone’s parts are still sourced in Asia, but final assembly is being done in the U.S. so that the more customized version of the phone can be delivered to the customer as quickly as possible.

The second factor leading to the geographic compression of supply chains is the need for manufacturers and retailers to minimize inventory levels.  This is, of course, a financial consideration driven largely by cost-saving measures such as lean manufacturing initiatives at the factory level.  Buying large quantities of goods overseas, paying for them in advance, and waiting 3 or 4 months for them to arrive on a slow boat from China is no longer cost effective, especially given the upward pressure on the price of goods from China.  No doubt one of Tesla’s strategic reasons for partnering with Panasonic to build a lithium ion battery factory in the vicinity of their plant is to minimize supply chain risk by eliminating the long lead times and high minimums of importing the batteries from overseas.

The third, and perhaps most important, reason for the geographic compression of supply chains is the increasing importance of speed to market.  In a manufacturing world dominated by offshoring, executing speed to market conflicts with the goal of minimizing inventory levels.  For example, if a manufacturer is importing intermediate parts, speed to market can only be accomplished if one eliminates the risk of depleted inventories.  Thus, companies buy massive amounts of parts inventory and store those parts on warehouse shelves for assembly as needed.  Only a compressed geographic supply chain – especially one including domestic vendors that provide short production lead times and smaller minimum order sizes – can reconcile the conflict, allowing for lower inventory levels yet still enabling speed to market.  The concept of supplying “fast fashion” to retailers, giving them the ability to respond more quickly to fickle consumer demand while carrying lower inventory levels, is an example of satisfying the need for greater speed to market.

Why are these trends currently more evident in the U.S. than in other industrialized economies?  Because the U.S. remains the largest market in the world, and to be successful here it will be increasingly important to manufacture here.  This explains the amount of direct foreign investment, particularly from China, pouring into the United States.  Raymond Cheng, CEO of a Hong Kong-based consulting firm which coordinates deals for China companies that want to establish a manufacturing presence in the U.S., points out that, “For many of these companies, their biggest customers are in the United States.  It’s a tactical advantage to be next door to your biggest client.”

Of course, we still face an uphill manufacturing battle against imports.  The fact that parts for the Moto X are still being sourced in Asia illustrates one of the two key challenges faced by U.S. manufacturers if the renaissance is to continue. In the furious race to offshore manufacturing over the past 25 years, we decimated entire supply chains that will now need to be rebuilt.

The second challenge is the “skills gap” between available manufacturing jobs and the unemployed.  We need better training programs both for the chronically unemployed and for young students if we are to fill the manufacturing positions open now and in the future.

But these are challenges that can and will be met.

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