The technology industry is experiencing renewed growth, and the outlook for many new and emerging industries is now brighter than ever. Spending on information technology returned in the third quarter of 2003 and has held steady at 5 percent per year since. As a result, the technology industry has emerged from the economic downturn of the previous years stronger than ever, but manufacturers have had to introduce more lean and efficient production technologies and processes in order to stay competitive. Examining trends in production and employment for technology industries underscores this competitive response.
After a drop in production in 2001 and 2002 during the recession, most technology sectors experienced an increase in the following years. Productivity gains drove the return to profits for many companies, but job cuts proved to be a necessary means to increase overall worker productivity. Semiconductor manufacturers registered the largest 2-year growth in worker productivity (32% from 2002 to 2004), followed by telecommunications equipment manufacturers (24%) and computer manufacturers (22%). Technology manufacturing continues to expand its output across most sectors, even though manufacturing employment continues to fall. In total, technology manufacturers have shed 1.2 million jobs since the industry’s peak employment in 1998.
A continuing and severe drop in capital expenditures by technology manufacturers furthers shows how companies responded to the downturn by relying on and retooling existing plants rather than making large new investments. The computer and semiconductor sectors registered the largest drop in capital expenditures.
The improvements in production methods do not bode well for the technology manufacturing worker: in most sectors, employment is expected to continue to decline as competitive pressures require more purchasing from offshore locations and more automation at final-assembly plants in the U.S. The computer industry reflects this trend. The computer industry employs about 1.3 million workers and large companies (over 250 workers) are employing a growing majority of the industry’s workforce. Employment in the industry is expected to decline by 7 percent between 2004 and 2014, compared with a projected job increase of 14 percent for the overall economy. Although the output of this industry is projected to increase more rapidly than that of any other industry, overall employment will still decline as a result of continued rapid productivity growth and increased efficiency. Despite this, industry leader Dell appears to be bucking this trend. Its new plant in Winston-Salem, NC is expected to employ 1,300workers by the end of 2006 – 550 more jobs than expected when they announced. The company also continues to expand its Nashville operations.
The Impact of Offshoring and Outsourcing
The increasing global market for manufactured goods has caused the manufacturing industry worldwide to rethink the entire concept of manufacturing. Creating and delivering manufactured goods no longer requires each process to be completed by one enterprise, but rather a global supply chain where each individual process can be completed anywhere in the world. Many manufacturers must outsource for the lowest cost to remain competitive. Despite appearances, improvements in technology have affected manufacturing workers across the globe, resulting in job cuts far larger than what has been experienced in the U.S. Japan and Germany have lost a larger percentage of their manufacturing jobs, 28% and 22% respectively, versus a 15% loss in the U.S. And while China has been blamed for many of the manufacturing job losses in the U.S., they too have suffered large job losses: 15% of their manufacturing workforce over the same period.
Manufacturing job losses do not signal the end of U.S. manufacturing. Several non-cost factors will drive investments in manufacturing in the U.S. long-term: access to inputs/ resources, delivery-time to market, safety regulations, tariffs, security, intellectual property protection, and the customization of consumer products. U.S. manufacturing will remain competitive in capital-intensive industries with plants using advanced robotics and automated processes. Furthermore, many new inventions and products stem from the manufacturing sector’s large investments in research and development. Manufacturing firms fund 60% of the private sector’s R&D investments each year.
There is no doubt that site selection has become more complicated as decisions become more global in nature. Offshoring is now a core calculation in the location of facilities, and U.S.-based divisions at companies are now competing with offshore facilities within the same company for new investment dollars.
For many in the technology industry, outsourcing allows companies to focus on their core competencies and reduce operating expenses, particularly in services. While manufacturers have engaged in offshoring for decades, the spread of outsourced service centers and research divisions globally is a relatively new phenomenon.
The software industry is particularly interested in outsourcing and offshoring. Mature software firms can spend one-third of their research and development budgets on new-product development. Recent case studies indicate that a large outsourcing program can save 25 percent, allowing the company to increase investment in traditional research and development.
Site Selection Trends in Technology
For the purpose of this section, we will limit our definition of technology to the information technology sectors: electronics, software, and data center industries. These industries are umbrella groups for most of today’s leading technologies such as semiconductor chip manufacturing, computer assembly, software design, Internet services, and data centers. Biotechnology companies, while clearly part of the “technology” industry, are driven uniquely by a need for proximity to research universities and the scientific workforce that they train.
While each technology industry and each company will have its own unique requirements and concerns, technology companies are united in their search for the best talent in the world, a low-cost environment, an increasingly the assistance of financial incentives.
The Search for a Talented Workforce
Access to a pool of highly educated, talented, and technically skilled workers is vital to any technology company. Communities with a large pool of technical workers enable companies to grow without recruiting and relocating costly technical talent. Employee talent is an important asset and key differentiator for technology companies. Success breeds success as star companies and best-in-class workers seek out each other. Technical functions tend to cluster in different regions as workforce specialties vary across the globe. For example, a computer manufacturer may have its headquarters and engineering in San Jose, manufacturing in Austin and Taiwan and back offices in Phoenix or Bangalore, India.
Universities play a large role in the technology industry, primarily by producing the best-educated, most current workforce available in new technology. Local technical graduates help companies manage labor costs that are by far the largest expenditure of most high tech service firms. As technologies evolve, skills acquired in school only a few years ago may be obsolete today. Success for companies can depend upon whether workers can quickly upgrade.
Site selectors will evaluate the enrollment and degrees conferred in engineering, life sciences, business and computer science, or any other degrees that are relevant to their clients. Reputation of the school’s programs and graduates is also a key factor. The Metropolitan New Economy Index ranks the leading metro areas for degrees granted in science and engineering. Raleigh-Durham, Austin and Boston were ranked first, second and third respectively.
Research universities consistently are one of the most important catalysts for growth in all technology metros. These universities not only supply knowledge-based workers and research, but also plant entrepreneurial seeds as professors and students often transform technologies into start-up companies. University research is one of the most important drivers of technology site selection decisions, particularly for small and mid-size firms. Many of the nation’s most successful technology firms located in cities with university-level research activity. San Jose is littered with companies that started with local university graduates and technologies, for example Google, Sun Microsystems, and Hewlett Packard. Most if not all of the nation’s technology metros have at least one top-tier research university.
The Role of Costs and Incentives in Site Selection
Cost pressures and competition continue to hinder technology companies. Clearly, the search for a talented workforce is driven in part by the cost of that workforce, but increasingly, other costs in the areas of overhead, construction, and operations are influencing the decision to offshore or outsource.
Healthcare costs have been rising rapidly due to increasing medical liability costs and excessive tort claims. Some companies have seen a rise of as much as 20%. Rising energy costs are another point of concern because the manufacturing industry uses more than one-third of all energy consumed in the U.S. All of these factors make it difficult for American technology manufacturers to compete in the global market, and many choose to move some of their operations overseas.
In response to cost pressures, incentives play an ever-growing role in the site selection process for technology companies. Governments across the globe compete aggressively for marquis investments by technology, both to gain the jobs they create but also to enhance the prestige of the city, state, or country in which companies announce new facilities.
Incentives have traditionally been “embedded” in the tax systems that governments create. Within the United States, the tax system of one state can offer a significant discount in overall tax burden than a neighboring state. Tax systems affect not only the bottom line cost to a business, but also the risk that a company takes in selecting a location. More than ever, companies seek predictability and avoidance of risk in the states or countries in which they invest.
Capital-intensive industries such as semiconductor manufacturers, electronics manufacturers, and pharmaceutical manufacturers have been most attentive to the varying impact of tax systems across locations. While some states suffer high property taxes, which greatly affect manufacturers, they often compensate with accelerated depreciation schedules for technology equipment or investment and R&D tax credits on income or purchases. Income tax apportionment formulas can also vary widely from state to state. States with triple-factor-sales formulas for corporate income heavily favor technology companies who export a majority of their products or services out of the state.
A recent investment decision by global technology leader Intel demonstrates this point. Intel builds about 2-3 plants per year somewhere in the world, each costing about $4 billion to build and $7 billion to operate over the fab’s 5-year lifespan. In 2005, Intel CEO Paul Otellini testified to the U.S. Congress that it costs about $1 billion more over the life of a fab to build in the U.S. than in foreign countries – and not due to labor differentials. Given this disparity, Intel has aggressively sought incentives for its investments in the U.S. In 2006, the State of Arizona adjusted the way it calculates taxes by allowing companies such as Intel with more than $1 billion in sales to calculate their state income taxes based on the company’s in-state sales (which are relatively small), rather than the company’s in-state share of its global property and payroll (which would be much larger). But cash incentives are even more enticing: the government of Israel will contribute over $500 million to Intel’s latest-generation chip plant.
Labor-intensive firms who don’t spend big dollars on facilities generally don’t enjoy the benefits of these sizeable tax incentives or investment cash grants – at least not to the same level. Firms such as software companies or biotechnology research firms are better served by extensive workforce training programs or tax credits that are based on job creation, not investment. Some states are getting very aggressive in incentivizing high wage jobs – New Mexico offers a tax credit worth up to $12,000 per job, per year. While this level of ongoing incentive would put New Mexico at the top of any incentive list, the fact that the state will reimburse any unused credits in the form of cash payments makes this incentive truly worthwhile.
Indeed, tax systems and incentive programs have grown increasingly complicated in recent years, and evaluating them takes a specialized analyst. If pursuing incentives is a strong desire, technology companies would be smart to employ the services of a talented site selector or accounting firm to estimate the true tax impact of their location decision. Often, this analysis is done too late in the process to alter a decision or be used as a basis for incentives negotiations. A knowledgeable consultant will also maximize the value of any incentives, and shuttle the applications through the process.
The Site Selection Process for Technology Companies
The site selection process is comprised of nine main steps:
Determine an Incentives Strategy
Issue a Request for Proposals
Evaluation of Proposals
Incentives Evaluation and Community Interviews
On-site Evaluation of Short-Listed Communities and their Sites
Benchmarking Costs and Tax Burden
Short-list Communities and Engage in Closing Negotiations
Step 1: Project Set-up
It is important to determine project goals, facility needs, and site selection criteria in the initial phases of any site selection project. Initiate a one-day brainstorming session regarding the scope of the project, desired outcomes, and timeframe. These meetings should include top management, facility directors, financial executives, accounting consultants, and site selection consultants. Often, executives have early expectations on where their next facility or office is best suited. A discussion of incentives begins here, with the site selection consultants giving an early assessment of what incentives could be available based on similar type expansions and relocations. Milestones and success metrics should be set. The most effective site selection efforts allow 6 to 12 months for the full evaluation, negotiation, and selection of a community. Most executives prefer much shorter timelines, so it is important for any deadlines or decision triggers be explained to the consultant before beginning the process due to the time-sensitive nature of negotiations.
Step 2: Determine an Incentives Strategy
Most technology companies are moving at a pace too fast to allow the exploration of incentives in their site selection decisions. For many, incentives are often the icing on the cake, sweetening the deal often after a decision has already been made. Software companies are generally too small to see the benefit of financial incentives or just don’t qualify. Others, such as manufacturers, know just how valuable incentives can be. New industries such as nanotechnology, biotechnology, and clean energy, are now caught up in a virtual “incentives arms race” among states and communities. Hiring a site selection consultant is a requirement to effectively explore the full range of incentives opportunities. In addition, a consultant provides a firm “arm’s length” protection from any problems or aggressive negotiations that might sour the public relations impact of an announced move. While the primary goal of incentives is to remedy a prejudiced or burdensome tax system, incentives often become a stamp of approval by communities that technology companies seek in their local public relations. More than ever, incentives are cash-based, where state and local governments commit funds to invest in infrastructure, workforce training grants, free land and buildings, or even straight cash to a company in order to win large projects and make a marketing statement to the world.
Step 3: Issue a Request for Proposals
If a technology company desires to pursue incentives, it is important that its site selection representative issue a “request for proposal” to a large list of communities, usually between 5 and 15. Request the full set of information that will assist in the decision, including information on taxes, incentives, workforce availability and costs, utility costs, and potential sites or buildings. It is best for a site selection consultant to write and distribute the RFP so that it is clearly understandable from the economic developer’s perspective. As part of the RFP, indicate the types of incentives that are of most interest and how the information should be supplied to the company. Technology companies should present themselves to communities in a confidential fashion, using project code names and relying on consultants to interact with local representatives. Contact communities by phone before an RFP is sent to determine which person is the best contact person, and then expect follow-up calls to answer their questions.
Step 4: Evaluation of Proposals
The technology company or its site selection consultant must do thorough research on its list of potential locations. Today, communities maintain much of their information on an economic development website. In fact, site selectors use the Internet to gain most of the information they need in their evaluation before any phone calls or visits occur.
Communities should be evaluated for each of the criteria set out in the Project Set-up phase. Good site selectors will devise a weighted ranking system for all factors and rate communities on each. Factors must be separated into “essentials” and “wants” so that if an absolutely essential factor comes up empty, the community is dropped. For some biotechnology companies, a research university is a requirement. For datacenters, lack of high demand dual power for sites will eliminate a site. Automotive or aerospace manufacturers need strong ports and rail to move their components. While many governments offer to build essential infrastructure, the time required to do so usually eliminates the option.
“Wants” offer a much more subjective analysis. Labor availability, quality of life issues, and cost of living usually fall along a curve where one factor that ranks well can compensate for a factor that ranks poorly. For some technology companies, the need to find highly skilled workers may outweigh any modest cost differences in real estate or wages. Or, poor air service for executives may be endured if highway or rail distribution is superb.
A thorough evaluation of each community based on independent consultant research and the information provided by economic developers will yield a rather clear early snapshot to management. If adequate information is obtained to make early decisions, eliminate communities that are clearly not in the running.
Step 5: Incentives Evaluation and Community Interviews
Proposals by communities will provide some indication of the types of incentives available to a company, but a site selection consultant or internal tax team will be required to measure the true value. A thorough explanation of applicable incentives from a community is ideal, but many cities and states list every incentive available and grossly inflate the value of the incentive to the company. The availability of “subjective” incentives (not statutory) means that close interaction with communities by the consultant will generate a strong incentives proposal.
Give the communities an opportunity to make their proposal presentation to the consultant in person (again, without disclosing who the client is). This will allow a product question-and-answer session, while placing the burden on the community to make a formal incentive offer. Adhere to strict deadlines and milestones with the communities.
Step 6: On-site Evaluation of Short-Listed Communities and their Sites
Short-list the communities that are most likely based on the information and analysis done to-date. Then pursue an evaluation of each community “on the ground”. For technology companies that require very specific sites for new construction, such as an electronics manufacturer, visits to a community must be conducted by an experienced engineering or site selection team. These individuals make drive-by evaluations of sites and typically get information from local economic developers on their acreage, topography, soil type, zoning, geotechnical conditions, utilities, and access points. Often, the lack of sites and infrastructure may remove a community from a site selector’s review list. Technology companies are increasingly focused on the supply of developed, “shovel-ready” sites in communities around the U.S., thus raising the bar for corporate recruitment. Many communities pre-certify their manufacturing sites for specific uses such as semiconductor manufacturing or automotive manufacturing.
Utility evaluations are very important to technology firms. The demands of the digital world result in the large consumption of power. Affordable, reliable electricity is of utmost importance, particularly for manufacturers or datacenters. Dual-feed and gasoline-powered generators are extreme examples of requirements. Reliable telecommunications are equally important. Site selectors will evaluate brownouts, outages due to storms, power spikes and excess capacity for peak periods.
Step 7: Benchmarking Costs and Tax Burden
Technology firms vary in their attention to costs. Manufacturers and large consumers of electricity do thorough evaluations of the costs for various locations. This benchmarking analysis should cover the cost of labor, supplier purchases, air travel among locations, real estate costs, and tax costs. This analysis is generally done by the site selection consultant or an in-house financial analyst. Often, the impact of tax systems is the primarily concern to companies and takes some research and communication with locals to clarify. Sales tax applicability to certain types of equipment that will be purchased and invested must be clearly understood. Depreciation schedules for large manufacturers are equally important.
Step 8: Short-list Communities and Engage in Closing Negotiations
Continue to short-list communities that are missing the “essentials” or that don’t meet an adequate level of “wants” by company management. Determine a short list of cities and notify them of their status. This will signal to them that a final offer is desired. Set new deadlines for this final offer to be accepted.
If incentives are part of the selection process, intense negotiations are required in the final weeks of the decision. Corporate executives must communicate frequently with the consultant on their true level of interest, and internal deadlines for a decision should be reviewed again. Confidentiality should still be kept throughout negotiations with communities.
Step 9: Final Selection
The final selection of a community often rests on one or two key requirements: the availability of a site, the desire of the CEO, a marketing goal, or an incentive. The winning city is almost certain to be the one which brought the most comfort and enthusiasm to the CEO and the executive team. Final visits by company executives to each community to visit with leaders is a natural method of closing negotiations. Thorough evaluations by staff and consultants can provide strong guidance to corporate executives, but not a final decision. Once a decision is made, technology companies should make every effort to maximize the publicity and exposure in the community in order to build goodwill and begin to attract the much needed technical talent that they will need.