The beginning of 2017 will be remembered for the inauguration of President Trump and the resulting acceleration of interest in U.S. manufacturing investment. The Reshoring Initiative and BLS & Co. have both witnessed this acceleration.
After a slow 2016 start, the U.S. rate of FDI (foreign direct investment) and reshoring announcements doubled starting in November 2016, driving the Reshoring Initiative’s 2016 total to a new record. Based on BLS & Co. recent client and prospect activity, overall interest from both U.S. and foreign-based companies that are considering U.S. manufacturing is up almost double from this time last year. In some cases, the companies have been considering U.S. manufacturing for some time due to global economic conditions and improvements in technology and automation, and the time is now right. For others, the proposed national policy changes have them considering a U.S. location as part of risk management, just in case major policy changes, especially import tariffs or a border adjustment tax, were to go into effect.
Take, for example, a recent foreign-based BLS & Co. client that was considering its first North American operation. The company originally intended to invest in a plant in Mexico and then invest in a U.S. plant two years later. That plan changed immediately to focus on the U.S. plant first upon the election of President Trump, who ran on a “pro-business” platform and made pledges to lower taxes and the regulatory environment, and invest in infrastructure projects in the U.S.
The proposed Trump platform is neither simple nor are we sure of its passage. The most widely discussed and probable change would be a reduction of the corporate tax rate from 35 percent to 20 percent or even 15 percent, making the U.S. tax system competitive with almost all other countries.
Reductions in regulations would reduce costs and might, in some cases, make it possible to use processes now effectively forbidden. A cost-effective healthcare plan could cut labor costs by up to five percent. Most controversial is the BAT (Border Adjustment Tax), which would tax imports and subsidize exports. The BAT tax revenue would fund the corporate tax rate reduction.
Conditions and Insights Have Changed
Fifteen years ago, for high-volume consumer goods and many industrial products to supply the U.S. market, site selection was easy. China had wage rates about five percent of U.S. levels, had joined the World Trade Organization (WTO) in December 2001, had a domestic market growing at 10 to 12 percent per year and was welcoming firms to invest there. There had to be a good reason not to place the facility in China, even to supply the U.S. market. As a result, U.S. imports from China surged from $100 billion in 2000 to $321 billion in 2007.
Chinese costs have risen and companies are recognizing costs and risks previously ignored. Since 2000, Chinese wages have been rising 12 to 15 percent a year, reaching about 20 percent of U.S. levels, driving the Ex-Works price gap down from about 40 percent to about 20 percent. The Reshoring Initiative estimates that about 25 percent of what is now offshore would come back if companies went beyond price and quantified the total cost. Total cost includes factors such as duty, freight, inventory carrying cost, IP risk, impact of distance on innovation, etc.
New technologies are rapidly boosting U.S. competitiveness, further leveling the playing field. Industry 4.0 digitization is enabling localization of supply chains. Smart factories using advanced manufacturing technologies, coupled with close proximity to the U.S. market, enable speed, flexibility and more efficient processes to produce higher quality products while reducing costs. A recent BCG (Boston Consulting Group) report shows how connectivity and interaction among parts, machines and humans will make production systems as much as 30 percent faster and 25 percent more efficient. Industry 4.0 has the potential to positively impact U.S. competitiveness and accelerate the reshoring trend.
China is Less Welcoming
There is evidence that as the wage gap narrows, China is losing its manufacturing luster. Mr. Dewang, chairman of Fuyao Glass, China’s biggest manufacturer of automotive glass with plants also in Ohio and Illinois, claimed that the overall tax on manufacturers is 35 percent higher in China than in America. He went on to say that when China’s higher land and energy costs are factored in, the advantages of its lower labor costs disappear.
Seventy seven percent of American companies surveyed in 2015 said they are feeling “less welcome” in China, up from 47 percent in 2014. Common drivers of this trend are raising concerns about protectionist policies, unfair monopolistic practices targeting foreign firms with some carrying huge penalties, rising labor costs and regulatory challenges. Thirty eight percent said they were relocating to the U.S. due to the American energy boom and stable U.S. wages.
China’s Manufacturing 2025 industrial policy may also spell trouble for U.S. companies manufacturing in China. With immense Chinese government assistance, China aspires to have domestic industries own about 80 percent of their home market by 2025. With less promotion of international competition and reduction of domestic companies’ tax burden, China intends to create upwards of 11 million new Chinese jobs. If U.S. companies lose Chinese market share, can their shipments to the U.S. justify their Chinese facilities?
Offshore, Nearshore or Reshore?
Nearshoring to Mexico is now a better choice than China for many products, particularly for those with a production process that is labor intensive. Lower wage rates, a closer proximity to the U.S. market, lower IP risk and better communication due to time zone differences make Mexico an attractive location vs. China. Nearshoring to Mexico is also a better choice for the U.S. since Mexican exports contain 40 percent U.S. content vs. five percent U.S. content in Chinese exports.
Proposed Trump policies on tariffs on goods imported from Mexico may drive more companies to consider U.S. manufacturing. There is also some risk of the Mexican peso recovering some of its 50 percent decline, raising wage costs substantially.
A 2015 AlixPartners study found that 40 percent of surveyed companies recently reshored or nearshored or are in the process of doing so. Companies that reshored or nearshored enjoy lower freight costs, improved time to market and higher customer service levels. However, the availability of skilled labor, product quality and consistency make a stronger case for reshoring to the U.S. over nearshoring to Mexico. Fifty-five percent of North American respondents found the U.S. is the most attractive destination, up from 42 percent in 2014 when the U.S. ranked No. 1 for the first time, with Mexico ranking second.
The good news is that the bleeding of manufacturing jobs to offshore has stopped. According to Reshoring Initiative data, in the last decade the U.S. has gone from losing about 220,000 manufacturing jobs per year to breakeven in 2014 and 2015. Preliminary 2016 results show reshoring and FDI had a net gain of about 20,000 U.S. jobs vs. offshoring.
Reshoring is, in many cases, a fast and efficient way to strengthen the U.S. economy and benefit manufacturing companies by reducing total costs, improving balance sheets and supporting innovation. The savings on non-manufacturing overhead costs as a result of producing in the market in which the products will be sold can often overcome a 15 to 20 percent manufacturing cost gap caused by an 80 percent wage gap.
Total Cost of Ownership
The Reshoring Initiative provides a range of resources to help manufacturers make better sourcing and siting decisions. To help companies decide objectively to reshore or offshore, the Reshoring Initiative’s free online Total Cost of Ownership Estimator® can help corporations calculate the real P&L impact of reshoring or offshoring. Recommended reading is “Getting A Company Started with TCO” to plan your TCO analysis.
Comparing Locations for Reshoring
Before beginning a location search, it is critical for a company to first define its operation, including the size, requirements and location factors that are important to the success of the operation. Items such as incentive programs offered at the state and local levels should not even be considered until the operational needs are first identified and a location strategy effort has been conducted to help narrow the list of potential location options to those that can meet those operating needs.
For many FDI or reshoring operations, one of the most important location drivers is availability of workforce with desired skillsets to operate, maintain and repair the automated equipment that will power these new production processes.
Dealing with Ambiguity
It is difficult to make the big decisions when U.S. national policy is so uncertain. Here is a rough outline of how to incorporate the concepts outlined above:
• Use TCO to evaluate alternatives in this priority order:
a) Repurpose offshore owned-facility to serve the offshore market.
b) Incrementally invest domestically to serve domestic market.
c) Shut offshore owned-facility.
d) Build new domestic facility.
• If the U.S. is best or close on TCO:
a) Source or build in the U.S.
b) Apply automation.
d) Pick the right U.S. location.
• If U.S. is high by 10-20 percent, delay until U.S. policy is firm.
• If U.S. is high, greater than or equal to 20 percent, nearshore or offshore.
• Build your skilled workforce to be ready for any scenario.
The process of creating a strong location strategy and the execution of a reshoring transition takes careful planning, but the projected payoff of long-term corporate sustainability in a healthy national economy is worth the effort. Balancing the trade deficit by reshoring and FDI will bolster the manufacturing base, stabilize the economy, cut the budget deficit in half, add jobs and create wealth in the middle class. T&ID