Harry Moser and the Total Cost of Ownership Estimator

Harry Moser was frustrated.  He had spent his entire career in domestic manufacturing, including over 4 decades selling machine tools and foundry equipment.  He had anxiously watched the slow, steady stream of offshored U.S. manufacturing jobs become a tsunami as the new millennium dawned and decided he’d seen enough of it.   In the mid 2000’s, as president and then chairman of +GF+ Machining Solutions, Moser lobbied the Association for Manufacturing Technology, the National Tooling and Machining Association and the Precision Metalforming Association to join forces to support reshoring efforts that would ensure the future sales and use of U.S. made machine tools.

Transitioning out of his role with +GF+, he began making presentations and writing articles on how to beat Chinese competition in the U.S. market.  Having read the canon on the hidden costs of importing, he noted that almost every writer mentioned the hidden costs that many procurement departments ignore when comparing the cost of an imported part to a domestically made part, and that they all stressed that buyers should make purchasing decisions based on what is called the “total cost of ownership.”  However, not one writer offered a spreadsheet that would allow a purchasing manager to actually calculate it.   It was surprising to Moser that a profession that so values accurate numbers did not have a simple tool to accurately calculate the true cost of ownership so that a comparison could be made between the cost of buying or making an import vs. the cost of buying or making a domestic part.  He decided to change that.

In 2010, Moser founded the Reshoring Initiative with a mission of bringing good, well-paying manufacturing jobs back to the U.S. by assisting companies to more accurately assess their total cost of offshoring and shift collective thinking from “offshoring is cheaper” to “domestic reduces the total cost of ownership.”  Job One for Moser was to delve back into all the articles he had read and list the myriad costs, risks and strategic impacts that affect total cost of ownership.  He then wrote software that would assign dollar values to each item on the list and had the software critiqued by colleagues from across the country, most notably by his contacts at the Association for Manufacturing Excellence.

That software became the Total Cost of Ownership Estimator, which now resides on the Reshoring Initiative website, and can be used at no charge by any purchasing department interested in calculating the true cost of importing.  Since the site was launched, the Estimator has been used over 1,500 times.

The Total Cost of Ownership Estimator is an excellent tool to help one better understand the difference between the price of something and its total cost.   The price of an item is the amount of money that exchanges hands for the item.  It’s simple.  The price of the widget is $2.00 so I give the cashier $2.00.  The total cost of an item is fully loaded with other factors that determine whether the purchase is actually a good value.

For B2B buyers, this comparison can be particularly critical.  In determining the total cost of ownership, B2B buyers must weigh not only the price of a widget, but also such factors as:

  • The minimum order size (If you are forced to order a higher amount, then negative cash cycle ramifications must be added into the total cost)
  • Length of time until delivery (If it takes a long time before you receive the product, then you need to order higher amounts – which costs more – to prevent an out of stock situation)
  • Ease of communication with the source (If poor communication issues due to either time zone differences or language problems cause your employees to constantly call or e-mail the vendor, the additional cost of the employee’s time must also be considered)
  • Poor quality (If you reject parts and/or replace defective product made from those parts then the cost of this waste must also be added in to arrive at the total cost)
  • Supply chain disruption risk (e.g., political instability in the overseas manufacturer’s country or strikes at shipping ports)

As the pricing gap narrows between imports and domestically made products and parts, calculating the total cost of ownership becomes ever more critical.   Even the Commerce Department has recognized the importance of the total cost of ownership approach to measuring the speed and effectiveness of supply chain partners.  Their March 2015 report titled “Supply Chain Innovation: Strengthening America’s Small Manufacturers” notes that when a manufacturer uses a total cost of ownership approach to sourcing – instead of simply buying from the supplier with the lowest per piece cost – the additional costs of added shipping time, risk of inventory being damaged during transport, and interruptions of the supply chain become more readily apparent.

B2B buyers can play a role in the renaissance of U.S. manufacturing by simply breaking the habit of automatically buying from overseas and redoing the math on whether importing parts – or moving manufacturing overseas – is the cost effective investment decision.  U.S. manufacturers of B2B parts don’t want handouts; they simply want a level playing field.  By taking a close look at the total cost instead of the price per piece, U.S. B2B buyers can level that playing field.

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.

Time is Money: How Offshoring Increases Supply Chain Risk

Any amount of friction that slows down the speed of a supply chain, whether domestic or global, has a cost; and the cost rises exponentially as the degree of friction rises.  The opportunity cost of lost sales, the necessity of financing higher levels of inventory to protect against transportation delays, and the personnel time and effort used to secure alternate sources are only three of the many additional costs associated with supply chain disruptions.  And when you offshore to overseas countries, the number of risk factors that impede timely delivery multiply.

Do you think an uncontested election on the other side of the globe would have any bearing on the cost or availability of a T-shirt?   In January 2014, the Bangladesh National Party (BNP) boycotted national elections that brought Sheikh Hasina to power.  The BNP had hoped that Hasina would step aside before the election and accept neutral oversight of the polling process.  She refused and ran unopposed.  In January 2015, on the one year anniversary of the election, the head of the BNP, Khaleda Zia, was planning to lead demonstrations to protest the election that brought Hasina to power.  To prevent the demonstrations from taking place, the government placed Zia under virtual house arrest in her party’s offices.  In response, Zia called for the BNP faithful to blockade roads, rails and rivers, slowing down or halting apparel shipments from Bangladesh to the U.S. and other countries.  In 2014, Bangladesh exported $4.8 billion of apparel to the U.S., ranking third behind China ($29.8 billion) and Vietnam ($9.3 billion).  The blockade and resulting supply disruptions sent shock waves through the Bangladeshi economy, as apparel manufacturing accounts for approximately 12% of the country’s GDP.

The week after the triple disaster of the Japanese earthquake, tsunami and nuclear meltdown in 2011, the price of certain computer chips used for smartphones, digital cameras and other devices spiked over 30%.  Some Japanese auto plants were forced to halt production due to damage from the natural disaster and the resulting shortage of certain key parts, delaying the delivery of some car models to U.S. dealerships.

And these types of supply chain disruptions don’t happen only in overseas countries.  The International Longshore & Warehouse Union (ILWU) represents labor in 29 west coast ports.  Their 6-year labor contract with the Pacific Maritime Association, which represents the west coast carriers and terminals, was set to expire on July 1, 2014.  Talks dragged on for months beyond the expiration of the contract, leading to work slowdowns in the winter of 2014 that created massive backlogs of imports on container ships off the west coast.  The strike was eventually settled after federal government intervention, but the backlog of goods bound for factories and stores in the U.S. took months to dissipate, leaving importers scrambling for alternate sources.

Given the negative impact that such risk factors have on speed to market, many U.S. firms are taking a hard look at their extended supply chains and opting to source at home.  In 2009, U.S. Block Windows, a manufacturer based in Pensacola, Fl, decided to reshore production of acrylic blocks.  Formerly, the company would ship acrylic resin to China where it would be molded into blocks for various sizes of residential doors and windows, then shipped back to Pensacola.  “With the manufacturing in China, you had to forecast out lead time that with transportation could mean 12 to 14 weeks to delivery,” said Roger Murphy, the company’s president. “So you were always carrying more inventory than you needed and you also were at risk for being out of something if demand spiked.”[1]  Six successful years later in 2015, Murphy admitted that he made the decision to reshore less out of patriotism than to protect his bottom line.  Given that he reshored at a time when low cost China imports were flooding the U.S., how did reshoring help his bottom line?  By increasing his speed to market, he was able to fulfill orders in four production days.  The shopworn cliché is truer today than ever before – time is money.

HanesBrands announced in January 2015 that it was expanding its hosiery plant in Clarksville, Arkansas, adding 120 jobs.  The plant is one of the largest factories of its kind in the world.  Hanes plans to reshore the finishing and packaging of some of its hosiery products.  In a press release, Hanes Senior Vice President of Global Operations, Javier Chacon explained, “It is not easy for a U.S. plant to compete with offshore competitors, but the capabilities of our plant workforce and management team in Clarksville to continuously adapt, automate and improve efficiency is a testament to the resiliency of this facility since it opened in 1988.”  The company also noted that some of the key competitive reasons for expanding in Clarksville include the plant’s size, the high quality of the hosiery produced there, lower energy costs, and proximity to the U.S. market.  In other words, why slow yourself down by manufacturing socks in Arkansas, shipping them overseas for finishing and packaging, then shipping them back to the U.S.?  It takes far too much time; and that’s before supply chain risk is factored in.

The Reshoring Initiative’s “Total Cost of Ownership Estimator,” mentioned in our previous chapter as a tool for recognizing the benefits of the FEWER principle, also shines a light on the hidden costs of slower, extended supply chains.   Even the Commerce Department has recognized the importance of the total cost of ownership approach to measuring the speed and effectiveness of supply chain partners.  Their March 2015 report titled “Supply Chain Innovation: Strengthening America’s Small Manufacturers” notes that when a manufacturer uses a total cost of ownership approach to sourcing – instead of simply buying from the supplier with the lowest per piece cost – the additional costs of added shipping time, risk of inventory being damaged during transport, and interruptions of the supply chain become more readily apparent.

After decades of offshoring as a default sourcing position, more U.S. manufacturers are recognizing that a sourcing strategy that may have worked ten years ago is simply too slow today.  In the fall of 2014, L.E.K. Consulting interviewed a number of senior U.S. sourcing executives in a variety of manufacturing industries and one of the key themes they heard time and again is that strong demand from the end buyer, be it a consumer or a B2B purchasing manager, is driving companies to manufacture in closer proximity to their ultimate customer.  Key benefits included “greater responsiveness, better positioning in the markets being served and more accurate demand forecasts,” as well as more rapid innovation and end-market customization.[2]  Note the link between the compression of supply chains and the ability to go FASTER and make FEWER.  Supply chain proximity to the ultimate customer enables greater responsiveness and more rapid innovation (FASTER), as well as end-market customization (FEWER).

[1] Johnson, Ron, “Reshoring brings jobs back to U.S., including Pensacola,” Pensacola News Journal, January 17, 2015.

[2] Connerty, Michael and Wingard, Carol, “American Manufacturing: Not a New Dawn But a Welcome Advance,” Industry Week, December 17, 2014.

Why We Sign Bad Trade Deals

Most of the damage done to U.S. manufacturers by the federal government has been through the implementation of unbalanced trade deals.  Keep in mind that this is coming from someone who was at one time an ardent free trader, and even testified before a U.S. Senate sub-committee in support of NAFTA, declaring that it had not gone far enough.  Why my turnaround?  To quote the economist Paul Samuelson, “Well, when events change, I change my mind.  What would you do?”

We enter into trade agreements under the presumption that they will lead to higher exports and lower priced goods for U.S. consumers, a virtuous cycle that will be a boon for our economy.  In 1995, I believed this to be true.  Yet today, the value of our exports is dwarfed by the tide of imported goods, and our trade deficit continues to worsen.  Since we granted China Permanent Normalized Trade Relations Status (PNTR) at the turn of the new millennium, unleashing a veritable flood of low-cost imports, median household income has actually dropped in the U.S., from $56,800 in 2000 to $51,939 in 2013.  In fact, since China was granted PNTR, median household income has never been higher than in 2000 (the next highest since then was $56,436 in 2007).

From 2000 until 2007, our total trade deficit soared from $372 billion to $761 billion.  Even now, our trade deficit is 36% higher than it was in 2000.  Meanwhile, our trade deficit with China has skyrocketed.  In 1999, the year prior to the U.S. granting China PNTR, our trade deficit with China was $67 billion.  By 2007 it was $259 billion.  For 2014, it was a record $343 billion.

Why is this happening?  Because we are entering into trade agreements with parties that don’t play by the same rules.  If I own a factory that manufactures a widget, and I’m held to certain wage, safety and environmental standards, but my overseas competition is held to minimal standards or no standards at all, then my competitor’s widget will cost a heckuva lot less than mine.   This is simple common sense.  Those who disagree will claim that this is a naïve position and that the issue is far more complicated.  But it isn’t.  And I might even reconsider my position if the lower priced goods coming from overseas meant a better lifestyle for me and my fellow citizens.  But our standard of living, as measured by median household income, has actually suffered.  Yet the same pro-trade arguments are trotted out for the Trans-Pacific Partnership (TPP) as for China PNTR and NAFTA.

The Trans-Pacific Partnership is a trade agreement currently being negotiated between the U.S., Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam.  Note that China is not on the list.  It’s ironic that one of the main arguments in support of TPP is that it will help counterbalance the influence of China in the Pacific Rim.  China’s influence in that area of the world is to a great degree due to our support of their entry into the WTO, our massive imports of China-made goods, and their buying of our debt.  In other words, TPP is a trade deal that attempts to solve a problem created by a trade deal.

One of the greatest dangers of TPP is its potential effect on the nascent apparel manufacturing renaissance in the U.S.  In his presentation at the spring 2014 meeting of the Americas Apparel Producers Network, Roger Gilmartin, Managing Director of O’Rourke Group Partners, an international management consulting firm, estimated that if TPP passes U.S. job losses in the apparel industry alone would number 150,000 if the yarn-forward rule is eliminated.  The yarn forward rule requires that everything from the yarn to the fabric to the cut & sew operations be sourced from signatory countries.  If the yarn-forward rule is negotiated away by the U.S., Vietnam, which is becoming a major exporter of apparel to the U.S., would be allowed to source its fabric from China.  This would, in effect, give China a duty-free back door into the U.S. apparel market.  And let’s keep in mind that even without TPP our trade deficit with Vietnam is already surging, from $16 billion in 2012, to $20 billion in 2013, to$25 billion in 2014.

TPP could also lead to a loosening of our safety standards on imported meat and other foods.  According to a June 2014 report from Public Citizen, if the TPP member exporting country claims that their safety processes and standards are “equivalent” to those in the U.S., and the U.S. refuses entry of their goods, the exporter could bring a challenge to an international tribunal that would rule on whether the U.S. violated the treaty’s protocol.[1]  In essence, we could be dangerously dumbing down our food safety standards.  Further cause for concern is that the FDA has continuously cited seafood exporters in both Vietnam and Malaysia for selling products that contain contaminants.  During the 5-year period from 2007 to 2012, the FDA rejected 1,380 shipments of Vietnamese seafood.[2]  According to Public Citizen, the FDA has placed 192 Vietnamese fisheries on a “red list” due to risk of salmonella contamination.

How and why are skewed trade deals passed by Congress?  In the past, trade promotion authority (TPA) has been used to grease the skids.  Congress periodically grants the president this authority – sometimes called “fast track” – when negotiating trade deals, and Obama is now pressing Congress to renew fast track to facilitate passage of the Trans-Pacific Partnership.  TPA is helpful to passing trade deals because it prevents Congress from picking the deal apart.  After the negotiated deal is presented, they have a simple “yes” or “no” vote.  Trade negotiators claim that without TPA, negotiators from other countries won’t make final concessions because the deal hammered out by the U.S. negotiators may not get through Congress, or may be amended.   The problem with TPA, particularly in regards to the Trans-Pacific Partnership, is that the negotiations are being held behind closed doors, which means Congress will not have adequate time for due diligence on the treaty’s contents before casting a vote.

The administration cannot have it both ways.  If it wants fast track authority, then it must keep Congress apprised of the details of the negotiations as they progress.  If the administration wants to keep the negotiations secret, then no TPA.  Proponents of TPP and fast track authority will claim that it’s not that simple.  Again, this is not complicated; it’s common sense.

In his January 2015 State of the Union address, Obama admitted that past trade deals didn’t work out well, but then asked for fast track authority while assuring that his trade deals (TPP, TTIP) would produce better results.  So, we are being asked to take the administration at their word that this is a fair agreement without knowing its details, and Congress is being asked to give them fast track authority before anyone sees the final text of the deal.  Seems to me Obama should have listened to his own advice concerning Cuba that he gave in the same speech, “When what you’re doing doesn’t work for 50 years, it’s time to do something else.”   Amen, Mr. President.   Since fast tracked trade deals didn’t work out well for U.S. families for the last 50 years, let’s try something else.

[1] http://www.citizen.org/documents/food-under-nafta-wto.pdf

[2] http://abcnews.go.com/Business/consumers-eating-feces-tainted-shrimp-fish-seafood-asia/story?id=17491264

Less is More with 3D Printing

Amara’s Law states that we tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.  So it was with the birth of the internet, and so it will be with the proliferation of 3D printing, the most extreme manifestation of the FEWER principle in action.  3D printers allow the user to manufacture one custom piece.  How does a 3D printer work?  Think of it as the opposite of making a sculpture.  As opposed to taking a solid block of material and slowly chipping away at it until it is the desired shape, 3D printers use a hose-like nozzle to craft a product or part from the ground up, minimizing waste.  The nozzle is directed by a computer graphics software rendering of the product or part.

3D printers have been in use in industrial situations for decades, primarily for creating prototypes to speed up the product development process.  However, over the last 5 years, prices for the machines have plummeted and desk top versions have become widely available.  This has spurred legions of makers to experiment with the technology, leading to further refinements in the technology and potential uses for the machines.  Worldwide shipments of 3D printers will reach 217,350 units in 2015, up from 108,151 in 2014, according to Gartner, Inc., an information technology and research & advisory company.  They also estimate that 3D printer unit sales will more than double every year between 2015 and 2018, by which time worldwide shipments are forecast to reach more than 2.3 million.

Although they have traditionally been used by large manufacturers to speed up the product development process, 3D printers are nearer to making the leap to consumer products than many think.  Nike has used 3D printing to create custom sports bags, and in a recent interview, Under Armour’s Senior Innovation Design Manager, when asked whether the company has any plans for 3D printing, responded, “If you want to put something in your hat (figuratively), definitely something big is going to happen in the future.”  It sounds as though a cap tailored exactly to the shape of your head is in the works.

In a January 2015 article on the availability of 3D printed shoes, Andrew Wheeler writes that “as the air of customization reaches the minds of an infinite number of consumers, the show shopping impetus is shifting from ‘let’s see what’s available’ to ‘I want it to look exactly like this’ or ‘this is exactly what the shoe company should do’ or ‘why don’t they just make them like this’ and so on.”  Given the rapid proliferation of 3D printers – and products made by them – one could substitute almost any word for “shoe.”[1]

Local Motors, based in Phoenix, describes itself as a “free online and physical workspace where creativity, collaboration and design drive vehicle innovations.”  This online community, augmented by a small number of employees, designs, builds and sells what they call “badass vehicles.”    Revenue is shared by those in the online community who helped create the product.  At the January 2015 North American Auto Show in Detroit, Local Motors introduced a 3D printed car that can be made in 40 hours.[2]  CEO Jay Rogers noted that fully 95% of the volume of the car is 3D printed; the motor, springs and tires are not.  Clearly Local Motors is working toward the ability to offer a stock chassis and allow consumers to customize body design, number and type of seats, trunk size, etc.  It will be some time before such vehicles are deemed safe for normal road conditions, but time is the only obstacle.

Larger companies are also exploring innovative ways to use 3D printing.  Let’s say it’s your anniversary, you are taking your spouse out for dinner, and you want the chef to serve pasta in the shape of a rose. You simply bring the rose design on a USB drive and hand it to your waiter, who passes it along to the chef.  She installs the drive onto a 3-D printer and serves up the dish in 20 minutes. Seem far-fetched?  The global pasta company Barilla is currently working with a research organization to design a 3D pasta printer that will churn out custom designed pasta at restaurant speed.[3]  Also in the food realm, at the 2014 SXSW trade show in Austin, the Oreos booth featured two custom-made vending machines with a 3D printer that enabled attendees to create and eat custom 3D printed Oreo cookies based on trending social conversations.  Users pick from 12 “trending” flavors and colors of cream filling, then watch their cookie being “printed” in two minutes.  And the  “My M&Ms” website allows consumers to add messages, photos and art to their candies.

Joshua Harris is working on a clothing printer that would allow you to create your own T-shirt at home, styled to your exact body type.  When the garment begins to get a little ragged, you simply load it back into the printer and it breaks down the thread for use in a new shirt.[4]  The fact that 3D printers will one day allow you to make your own clothing at home reminded me of an increasingly common sentiment I saw in the comments section at the end of an article concerning 3D printed dresses.  Someone mentioned that it could be a lucrative revenue stream for the company selling the customized dresses and one wag responded, “Sell it?  Why?  We can just easily replicate the pattern and print it ourselves.  For the price at (the design company) you could buy a high end printer and do it yourself.[5]

3D printers have a synergistic relationship with the burgeoning consumer desire for more customized products, and they reinforce the importance of implementing the FEWER principle in any manufacturing operation.  They are here to stay, they will become more affordable, and they will be increasingly used not merely for prototypes, but for production runs.  It may not be next year, but it will be within 10 years.

[1] http://3dprintingindustry.com/2015/01/27/half-leather-3d-printed-delcams-3d-printed-shoes/

[2] http://www.cbsnews.com/videos/taking-a-test-drive-in-a-3d-printed-car/

[3] http://restaurant-hospitality.com/food-trends/3d-food-edges-closer-reality-restaurants?NL=NED-19&Issue=NED-19_20150105_NED-19_304_CPY1&sfvc4enews=42&cl=article_3_3&YM_RID=CPG03000001472225&YM_MID=2984

[4] http://www.tuvie.com/clothing-printer-concept-for-2050-allows-you-to-produce-your-own-clothes-from-home/


Why China Labor Costs are Increasing – and Why It’s Good for U.S. Manufacturers

In August 2012, the Wall Street Journal reported that labor costs in China had risen 150% since 2004.[1]  Most analysts expect the trend to continue.  During that same year, wages in China’s Pearl River Delta, considered the geographic heartland for China manufacturing, rose 10.4%.[2]   A 2011 Boston Consulting Group study predicted that wage and benefit increases of 15% to 20% per year will cut China’s cost advantage over wages at lower cost U.S. states from 55% in 2012 to 39% in 2015.

Much of this increase in China labor costs is driven by the simple law of supply and demand.  According to the Asian Development Bank, the working age population in China increased from 407 million in 1978 to 786 million in 2004.  This surge in population created a huge supply of cheap manual labor at precisely the same time that China was ramping up its manufacturing and exporting capabilities.  But the one-child policy, instituted in 1979, had an unforeseen consequence – it has led to a precipitous decline in the number of new laborers entering the workforce.  In 1975, there were six children for every elder in China; by 2035, if present trends continue, there will be one child for every two elders.  The working age population is expected to decline by 7 million per year through at least 2020.[3]

In November 2013, when it finally recognized the approaching demographic train wreck, the Chinese government loosened the one-child policy, allowing an estimated 11 million couples to apply for approval to have a second child.  But the expected baby boom is not materializing.  Officials predicted the new policy would lead to 2 million new births annually, yet only 804,000 couples have applied to have a second child.[4]

Another ominous development is that the new, smaller workforce is predominantly male.  The one-child policy exacerbated a cultural preference for male descendants.  For every 100 female births in China there are now 124 male births, and in some provinces the ratio is even higher.  As the number of total available laborers decreases and the ratio of male to female increases, the workforce will become more demanding, increasingly mobile, and more willing to change jobs to chase higher pay.

Foxconn is a massive manufacturing and assembly operation in China that is second only to Walmart in total employees.  They are known primarily as a key piece of the supply chain for Apple’s iPhone.  In 2013, it was reported that yearly turnover in their Shenzhen Longhua facility was 60%.  Turnovers in most other factories in the same area average 40%.

The increasingly male-dominated workforce is also becoming more militant.  2,000 workers at a Foxconn factory caused widespread damage in September 2012, when they rioted and clashed with 5,000 police officers dispatched to the scene.  Explanations for the riot ranged from a conflict between workers from different provinces to dissatisfaction with pay and working conditions.

In April 2014, more than 30,000 workers at a Taiwanese-owned shoe factory in the southern province of Guangdong went on strike to protest the company’s failure to pay full social security and housing fund contributions. The factory produces athletic footwear for brands such as Adidas, Nike, Reebok and Timberland.   The strike is further evidence of the rising cost of labor in China caused by a shortage of migrant workers, and the increasing militancy of China’s factory workers. Both factors help to level the playing field for U.S. manufacturers competing with China.

At the same time that the labor force is shrinking, the number of jobs in higher paying manufacturing industries in China is increasing.  According to a 2011 report from consulting firm Accenture, average hourly wages for manufacturing workers in both the telecommunications and heavy manufacturing industries are 50% to 60% higher than wages in more traditional light manufacturing.  One importer told me that the China factory from which he sources his line of relatively inexpensive tote bags was forced to shut down for a time after the 2011 Chinese New Year because most of the workers simply did not return after the holiday.  He presumed that most of the employees had taken jobs in other better-paying industries.

As the shrinking workforce in China shifts to higher paying manufacturing jobs in the automotive and high tech industries, companies in light manufacturing will be forced to pay higher wages simply to keep workers.  These rapidly rising wages are creating an expanding middle class, and as factories increasingly turn to satisfying their demands, less factory capacity and labor will focus on exports. Will China’s anemic birth rate of the last 20 years continue to provide an adequate labor force to service both domestic AND overseas markets?  Keep in mind that most businesses will follow the path of least resistance, and it is always easier to service a domestic market than an overseas one.  My bet is that China manufacturers will service the domestic market first.

Media attention to dangerous or unfair working conditions at overseas factories has also played a role in increasing labor costs at those factories.  Major brands and big box retailers are now paying closer attention to the working conditions at factories in their supply chain to prevent adverse publicity.  Even before the tragic Tazreen factory fire in Bangladesh, Apple had been putting pressure on their largest supplier in China, Foxconn, to improve wages and working conditions at its factories.  This is largely due to a series of suicides and labor riots at their factories, and the subsequent bad publicity.   In October 2014, the U.S. Department of Labor reported that over 168 million children (a number which equals half the population of the U.S.!) are working in factories around the world, many of them forced to do so, and toiling in deplorable slave labor conditions.[5]  Brands can no longer turn a blind eye to such atrocities, given the glaring light that social media shines on them.

It is likely that the emphasis in China’s current 5-year plan on developing “strategic emerging industries” such as biotechnology, high end equipment manufacturing, and clean energy vehicles is simply making a virtue out of necessity.  In the near future, factory workers available and willing to take lower paying light assembly jobs in traditional manufacturing industries will be few and far between.  The labor shortage in China, and resulting increases in labor costs, will continue to put upward pressure on the price of manufactured goods coming from China for years to come.  Only time will tell, but not even a tightly controlled economy like China’s can suspend the law of supply and demand indefinitely.

So why wouldn’t importers simply shift their procurement to other emerging Pacific Rim manufacturing countries with lower labor rates such as Vietnam?  What about India or Africa?  Many are exploring the possibilities, but most of the countries hoping to compete with China do not currently have the infrastructure (highways, rail lines, ports) that are essential to moving the flood of goods that have been pouring out of China over the last decade.  In addition, even though China has a very spotty record when it comes to creating safe working conditions and complying with environmental regulations, other countries are even worse.  All of this is bad news for importers and for overseas manufacturing companies hoping to break into the U.S. market.  But it bodes well for U.S. manufacturers looking to take back U. S. market share from their overseas competitors.

[1] Orlik, Tom, “Made in China is Getting More Expensive, The Wall Street Journal, August 11, 2012, page B16

[2] Lahart, Justin, and Orlik, Tom, “Fade in China, Made in America,” Wall Street Journal, March 10-11, 2012, page B16

[3] Lommen, Yolanda Fernandez, ADB Briefs No. 6, October 2010, page 2

[4] Burkett, Laurie, “No Baby Boom After Shift in One-Child Policy,” Wall Street Journal, Saturday/Sunday, November 8-9, page A6

[5] http://time.com/3479472/child-labor/

How Wall Street Drove Offshoring

A report released in 2013 by the MIT Taskforce on Innovation and Production noted that some of the fastest growing companies of the past 30 years, including companies such as Dell, Cisco, Apple and Qualcomm, have almost no domestic manufacturing capability.  Why?  The task force places the blame squarely on 1980s financial markets that placed higher valuations on “asset light” companies.  The report notes that “first among the business functions that companies started moving out of their own corporate walls was manufacturing – for that produced reductions in headcount and capital costs that stock markets immediately rewarded.”  Wall Street turned manufacturing into nothing more than a cost center.  This financial strategy, while effective for improving the bottom line over the short term, led to the massive offshoring of manufacturing jobs, particularly after China’s entry into the WTO.  By throwing manufacturing employees out of work, money was taken from the pockets of U.S. consumers that had traditionally been customers of those same companies.

How did that affect small, family-owned manufacturers?  Extremely low wages in countries like China led larger companies to offshore to reduce manufacturing costs.  In order to remain competitive against low wage overseas manufacturers, smaller domestic companies had to slash margins at the same time that their revenue was decreasing.   Ultimately, the math no longer added up and companies either closed or were sold to companies that were already offshoring.

So this is also an issue of large companies vs. small.  Multi-national companies are vocal proponents of trade agreements because many have come close to maximizing their market share in the U.S.  Each additional dollar of sales revenue is tougher to get due to the level of competition here.  For them, the biggest revenue upside is in emerging markets like China.  So they favor trade deals that lower trade barriers into an emerging market, even if the deal is skewed in favor of the emerging market country and against domestic manufacturers.

Take a look at the roster of membership and the list of board members of the US-China Business Council (www.uschina.org), which lobbies to expand commercial relationships between the U.S. and China.  You won’t see many names of smaller companies like Quill or Just-A-Stretch.  Council membership is composed primarily of companies more interested in selling into China than rocking the boat with China over unfair trading practices.  In a January 2013 report entitled “China and the U.S. Economy: Advancing a Winning Trade Agenda” the Council strongly defended more liberal trade policies with China.  Some of their positions in this report include:

  • Let’s move on from China’s currency manipulation to issues that really do matter
  • We have options when China doesn’t play fair – like the WTO
  • U.S. companies are a positive influence in China
  • Investment from China supports jobs in America.

China currency manipulation is not an issue?  Though he does nothing about it, even the U.S. Treasury Secretary continues to insist that China manipulates its currency to the detriment of U.S. manufacturers.  And do you really believe that we should put faith in the WTO to pass judgment on our trade policy?  Keep in mind that this is the same WTO that recently ruled the U.S. should not force meat producers to put a country of origin label on their products.  Seems reasonable to me to want to know where the meat you are about to eat came from – but the WTO thinks otherwise.   And as to investment from China supporting jobs in America?  Sure it does, but keep in mind that some of those U.S. companies are selling at a distressed price precisely because of offshoring and the resulting inability to compete against imports.  Meanwhile, the Chinese direct foreign investment money used to fund those acquisitions comes largely from their exporting of products – made with cheap labor in sub-standard working conditions – to the U.S.

Some larger companies that were quick to offshore have also neglected to revisit that decision now that the costs of overseas manufacturing are rising.  Instead of merely comparing the price of a part or product made domestically vs. overseas, they should take a closer look at what is called the total cost of ownership.  The total cost of ownership includes variables above and beyond the price of the product itself.  Those variables include transportation costs, minimum order sizes, supply chain risk (port disruptions, political instability, etc.) and a number of other factors that are often ignored when comparing the price of an imported and domestically made item.  The Reshoring Initiative has created a Total Cost of Ownership Estimator, an essential tool for any CFO calculating the relative advantages of domestic and overseas production.   Companies would be wise to keep in mind that the price of an item is not necessarily the total cost.

There has also been a failure on the part of individual smaller companies to adapt to the new global environment.  In my relatively brief experience in the textile business one of the biggest challenges I have encountered is the service level of the domestic vendors whose companies have been devastated by the migration of apparel manufacturing to China.  Many are now surviving, for the most part, on business that is either highly regulated (e.g., seat belt strapping for the automotive industry) or the result U.S. government set-aside programs.  Several of the domestic houses with which I’ve dealt seem not to have learned the lessons of the webbing migration to China.

I have often needed samples or short production runs to test new products.  Procuring from a U.S. vendor a sample of a new design to show a customer is usually an agonizingly slow process.  China manufacturers generally respond much more quickly to sample requests than U.S. companies.  It seems that the reliance on longer run set-aside business has actually enabled some U.S. based manufacturers to continue their bad habits from days long past.

Being relatively new to the textile business, it has amazed me that so many of few remaining survivors of the domestic business have missed the lessons of the last 50 years.  For the most part, they seem to be keeping their eyes on the brass ring of large orders from regulated industries, propping up their obsolete business model and turning their backs on small projects with big potential because they view them as too much trouble to pursue.  Meanwhile, the loss of one important customer could put them out of business.

So there is plenty of blame to go around for offshoring.   Misguided government policies and consumer inattention to country of origin were also important factors that we will address at another time.  But when it comes to the massive wave of offshoring that began in the 1980s, Wall Street led the way.