Advanced countries are concerned about maintaining their standard of living as developing economies progress. There are many determinants of standard of living but it seems to me that “being more desirable” than others is key. In that case, your products and services will be preferred over others’ and your value increases relative to others’. How does this tie to operations, the subject of this blog and my professional interest? Well, you are more desirable if you are more efficient (doing the same as others but at lower cost) or you provide something better (provide more quality, innovation, flexibility, or speed at the same cost than others). Indeed, those are the two fundamental strategies to gain competitive advantage and are clearly associated with your operational competencies.
Offshoring has often been driven by efficiency concerns but may come at a cost of “providing something better.” Indeed, supplying the US from China typically takes longer, incurs more transportation and overhead costs, and may be at risk of quality and IP risk. In addition, just like heat moves from high to low temperature and thereby reducing the temperature difference, trade-inbalance also serves as a dynamic adjustment process (for example of wage differences). A recent study by the Boston Consulting Group (BCG) provides interesting data on how this trade-off is changing:
Within the next five years, the United States is expected to experience a manufacturing renaissance as the wage gap with China shrinks and certain U.S. states become some of the cheapest locations for manufacturing in the developed world, according to a new analysis by The Boston Consulting Group (BCG).
With Chinese wages rising at about 17 percent per year and the value of the yuan continuing to increase, the gap between U.S. and Chinese wages is narrowing rapidly. Meanwhile, flexible work rules and a host of government incentives are making many states—including Mississippi, South Carolina, and Alabama—increasingly competitive as low-cost bases for supplying the U.S. market.
“All over China, wages are climbing at 15 to 20 percent a year because of the supply-and-demand imbalance for skilled labor,” said Harold L. Sirkin, a BCG senior partner. “We expect net labor costs for manufacturing in China and the U.S. to converge by around 2015. As a result of the changing economics, you’re going to see a lot more products ‘Made in the USA’ in the next five years.”
In addition, one should make location decisions based on total landed cost (see our paper).
“And since wage rates account for 20 to 30 percent of a product’s total cost, manufacturing in China will be only 10 to 15 percent cheaper than in the U.S.—even before inventory and shipping costs are considered. After those costs are factored in, the total cost advantage will drop to single digits or be erased entirely, Sirkin said. “
The study cites several companies that are already rethinking their production locations and supply chains for goods destined to be sold in the US. Interestingly, the authors argue that a similar process is less likely to happen for Europe which will depend more on the Far East because of the European inflexible labor laws. This seems like a sensible prediction of the near future (next five years) and it is in line with our advice to design tailored operations strategies. But as with any forecast, its precision reduces the farther out we forecast and time will tell what the global situation will be in 2020 and beyond.
The De-coupling of Free Trade and U.S. Competitiveness
In Chapter 19 of the 1817 classic On the Principles of Political Economy, and Taxation, David Ricardo mentions , in addition to war, removal of capital and a new tax as destroyers of the comparative advantage which a country before possessed in manufacturing. Administrations/Congresses of both parties have been unable and/or unwilling to connect-the-dots, between the declines in U. S. Global Competitiveness and the following changes since the 1990’s:
– That has the effect of a new tax on U.S Exports, namely China’s manipulation of the U.S. Dollar.
– A Change in U.S. Corporate Tax Regulations that led to the flight of capital from the United States.
– Enactment of Value Added Taxes (VAT), which tax U.S. exports, by an increasing number of our trading partners.
The first change, which dates back to 1995, is China’s pegging its currency to the U.S. Dollar, in form this is not a tax, but in substance acts as a tax on all U.S. exports to all U.S. Trading partners, not just exports to China. Since China’s economy has been growing multiple times faster the U.S economy, without China’s manipulation of the Dollar, there would downward pressure on the Dollar and upward pressure on China’s currency. The peg keeps the Dollars from declining as much as market forces would warrant and therefore results in an overvaluation of the Dollar. This overvaluation has the same effect as a tax on U.S. exports.
The second is a change in U.S. Corporate Tax Regulations, dating back to 1997, which began allowing U.S. Corporation the deferral of payment of tax for foreign earnings, as long as those earnings were not returned to the United State. The result is not only the loss of U.S. tax revenue but also an incentive for the remove of capital and with capital the related jobs.
The third change is the significant increase in the number of U.S. Trading partners that have enacted Value-added taxes and dramatic increase in the dollar volume of U.S. exports subject to VATs. In 1990 U.S. exports were subject to consumption taxes levied by about 45 U.S. Trading partners but by 2010 by all but about 20 U.S. trading partners levied their consumption taxes, averaging 17%, on over $ 1.280 trillion of U.S. exports. The United States Government levies no Federal consumption tax on the over $ 1.948 trillion of exports into the U.S.
The unresponsiveness of U.S. Political leaders to these changes that David Ricardo, the father of classical political economics, warned; has subject U.S. businesses and workers to a similar plight as the frog in the boiling water parable. Other relevant warnings follow:
“It is not the strongest species that survives, or the most intelligent but the most responsive to change”
– Charles Darwin
“It is not necessary to change…survival is not mandatory”
– W. Edwards Deming
“The U.S. trade deficit is a bigger threat to the domestic economy than either the federal budget deficit or consumer debt and could lead to ‘political turmoil.’ Pretty soon, I think there will be a big adjustment.”
– Warren Buffett, January 2006
A commonality possessed by Ricardo, Darwin, Deming and Buffett is their ability to be system thinkers and therefore dots-connectors. Our political leaders’ lack of system thinking is the learning disability that must be overcome to restore the United States to its former greatness.
Jan,
This topic is of personal interest to me as well. I’ve analyzed the direct costs associated to manufacturing locations; labor, transportation, tax, quality and inventory carrying costs. Using a “toaster oven” as the comparative product I’ve developed this set of data to contrast the total costs between the 5 countries (the data doesn’t format well in a blog – I apologize):
Per unit
Labor Trans. Tax Quality Inv.Cost Total Cost
U.S. $0.77 $1.36 $- $0.53 $0.38 $3.05
China $0.14 $5.36 $0.19 $1.06 $0.58 $7.34
Brazil $0.23 $5.36 $0.19 $1.06 $0.58 $7.42
Cambodia $0.11 $5.36 $0.19 $1.06 $0.58 $7.30
Outsourcing drove manufacturing as rising labor costs in the US, especially pension and healthcare. Once outsourcing became en vogue, moving the jobs to the lowest wage country became a natural result. However, in spite of the current wage discrepancies favoring developing countries, it is more cost effective to manufacture as close to the consumer as possible.
This achieves not only better margins as costs are reduced but it also creates a stronger consumer market as employed consumers buy more stuff. If a company has committed to being a design and brand company with manufacturing outsourced, they could still bring that outsourcing closest to the consumer. This means that domestic manufacturing for all/most countries would improve as consumers live everywhere.
In the U.S., this creates the opportunity for “manufacturing centers of excellence” built around a particular product/technology/capacity. So all of the internationally outsourced toaster ovens could be consolidated into a few domestic outsource companies that provide economy of scale, higher quality, shorter supply chains and much more product/market agility.
Ultimately, this allows greater customer innovations the manufacturer can offer their customer (retailer) that serves the consumer. My favorite strategy is defined in the book Blue Ocean Strategy. By making the competition irrelevant, revenues increase, margins increase and the business grows. Having a short, agile and responsive supply chain is a key element of any Blue Ocean Strategy. Domestic production, nearest the consumer offers the most fertile ground.
You tabulation adds up five costs for non-U.S. countries, which is non-applicable for the U.S. and which of the U.S. cost is -$.53?
Hugh,
Formatting is a problem when you try to copy and paste from Excel into a blog. I’ve reformatted the information in Word…so let me try again:
Per Unit
Labor Trans. Tax Quality Carrying Cost Total Cost
US $0.77 $1.36 $0.00 $0.53 $0.38 $3.05
China $0.14 $5.36 $0.19 $1.06 $0.58 $7.34
Brazil $0.23 $5.36 $0.19 $1.06 $0.58 $7.42
Cambodia $0.11 $5.36 $0.19 $1.06 $0.58 $7.30
The – sign and the $0.53 were different values (tax and quality, respectively). Hopefully when I hit post comment it will be more evident with Word formatting v. Excel. The only way I can tell is by hitting Post Comment..here goes.
I can send anyone the information that is interested…just email me at sjchristensen@babblewareinc.com. I can see the formatting didn’t work.
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