What businesses do during tough times
Imagine that you own a manufacturing company and that you are unable to raise sales or profits, but your costs are escalating out of control. You have examined the cost trends and know that in a year or two you will face bankruptcy unless you take some action.
Your only options are to eliminate and/or reduce costs.
In the past decade or more, many "first world" businesses have faced just this scenario. Rather than go out of business, nearly all embraced "outsourcing" (often to "low cost" countries) in some form or fashion. Some companies simply picked up and moved overseas altogether.
This situation is not necessarily permanent, however. With the recent spike in oil prices, costs of shipping products to the US market have risen dramatically. The most economically advantageous location for can change as economic conditions change. With the cost of shipping a container from China to the US doubling in the last year, some industries, furniture manufacturing is one example, are beginning to return to the US as a result.
In an article published September, 2008 in the McKinsey Quarterly entitled "Time to rethink offshoring?" authors Ajay Goel, Nazgol Moussavi, and Vats N. Srivatsan show that changing economic conditions may have undermined some of the benefits of offshoring:
The production of high-tech goods has moved steadily from the United States to Asia over the last decade. The reasons are familiar: lower wages, a stable global economy, and rapidly growing local markets. These factors combined to make nations such as China and Malaysia favored manufacturing locations.
In the last two years, however, the favorable economic winds that carried offshoring forward have turned turbulent. The new conditions are undermining some of the factors that made manufacturers of every stripe, including those in high tech, move production offshore.Oil prices, and consequently the cost of shipping, have risen to heights few foresaw even just several years ago. Since 2003, crude oil has soared from $28 to more than $100 a barrel. The economics research institution CIBC World Markets estimates that in 2000, when oil prices were near $20 a barrel, the costs embedded in shipping were equivalent to a 3 percent tariff on imports. Today, that figure is 11 percent—meaning that the cost of shipping a standard 40-foot container has tripled since 2000.
The oil spike not only affects exports from Asia but also sharply increases the price its manufacturers pay for raw materials. It now costs about $100 to ship a ton of iron from Brazil to China—more than the cost of the mineral itself. Wage inflation, coupled with a weaker dollar, adds to the challenge: in dollar terms, annual wage inflation in China has averaged 19 percent since 2003 (Exhibit 1). An average production worker, paid $1,740 a year in 2003, makes $4,140 today. By contrast, wage inflation in the United States has averaged only 3 percent. The wage differential between Mexico and China has also narrowed significantly. In 2003, Mexican workers made over twice what their Chinese counterparts did; today that gap has narrowed to 1.15 times. Combined, these trends are reshaping the competitive landscape for offshore manufacturing in a number of locales.
As indicated in the diagram below, products that were once profitably made in areas where the local costs are lowest (dark-gray area) are therefore moving into the near-shoring zone (light-gray area)—or in some cases may now be suitable for production in the United States (blue area).
