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How U.S. Companies Can Begin To Reshore
That cheap import from China might not be as cheap as you think, so U.S. companies should better analyze total costs and take steps to reshore key parts of their production processes
By Phillip S. Coles
Continuing January’s column on whether we should bring supply chains back to the U.S., I now turn to how we can diversify our supply chains to reduce dependence on goods from China, possibly moving production to the U.S. and increasing supply chain responsiveness—a key advantage. This will be no easy task; China’s population is more than four times that of the U.S., with well-developed supply chains that can produce practically anything. Producing 28% of the world’s manufactured goods, China is called the world’s manufacturing superpower for good reason. At 16.8%, the U.S. is a distant second.
Replacing China’s massive manufacturing capacity would be difficult, but productivity in the U.S. is more than triple that of China and gives a hint as to how to proceed. If U.S. industries innovate, making American labor more productive, and if the government can avoid enacting policies that hinder productivity and lower the workforce participation rate, reshoring is not only possible but desirable. When reshoring is not possible, products can be sourced from alternative countries.
Embracing Shorter Supply Chains
Now that you know those inexpensive Chinese imports probably are not as cheap as they seem, how can you discover what the true costs are? Some costs, such as price and shipping, are easy to see. Many other costs can be hidden, however, such as the cost of holding pipeline inventory (remember, ships are floating warehouses) and associated additional safety stock, increased risk of loss (bad things can happen between here and there) and especially reduced responsiveness due to long lead times associated with long supply chains. It is all but impossible to profit from the advantages of just-in-time (JIT) manufacturing and its benefits to costs and quality when procuring from overseas. Thus, lean companies such as Toyota and Dell have long insisted suppliers locate near their assembly plants.
Case in point: While researching for this article my computer was running slowly, so I decided to visit Dell’s website to purchase a new one. Dell was once one of the best companies at implementing JIT. Famous for the “Dell Direct Model,” which made computers to order, Dell never kept finished computers in stock. Instead, they used the concept of postponement, an element of JIT that reduced the need for inventory and increased responsiveness by allowing the company to produce a finished computer only once an order was placed.
More recently, Dell changed its strategy for computers, trading the responsiveness of JIT for a lower unit price (though not necessarily a lower total cost) paid to assemblers with plants in China such as Foxconn. Because manufacturing was transferred overseas, lead times increased, and demand now has to be estimated far in advance of orders: a “build to stock” rather than “build to order” strategy. Building to stock means stocking inventory “just in case,” based on generally questionable forecasts, instead of producing it “just in time” as orders are received: relying on predictions about future demand rather than reacting to actual demand in real time. Forecasts are notoriously inaccurate, so many additional finished computers now have to be inventoried in the U.S. just in case someone wants a different configuration than the forecast predicted. The result? Lots of inventory and a less responsive supply chain—exemplified by my experience configuring an order.
I selected the Core i7 processor. Then, when I added Wi-Fi, the price dropped! Upon investigating I noticed the processor had automatically changed to the i5, hence the price reduction. After contacting customer service, I learned they had no machines with both the i7 processor and Wi-Fi in stock in the U.S. Despite Dell now having more finished computers in inventory, because of the inherent lack of accuracy in forecasts, it can be the wrong inventory. This is how companies miss orders. Stockouts are rarely due to insufficient inventory; they are usually due to having the wrong inventory. The company made a tradeoff, sacrificing the benefits of flexible JIT manufacturing for the lower unit cost of globalization (there were other factors driving Dell’s decision). The less responsive supply chain created by sourcing overseas prevented the company from having what I wanted. I decided not to buy.
How do we make these tradeoff decisions? In a perfect world we would know exactly the total costs of our alternatives, but as my recent experience with Dell shows, it’s often hard to know what the true cost is. It was obvious Dell could produce more cheaply in China, but the cost of the loss of flexibility to respond to orders is more difficult to determine.
To better estimate the less obvious costs of various tradeoffs, we need to look at obvious costs, quality, risk and product feature variability. If something is a commodity in the sense that there is little variation in features (color, options, etc.), customer demand is steady and there is little risk of supply disruptions, a cost comparison is straightforward. Consider the price of the item, plus shipping and inventory costs. If there is much variation in product features, the increased cost of holding inventory of the various product combinations and stockout risk must be considered. How much does a disappointed customer cost you? If there is risk of disruption from overseas, such as hurricanes, new tariffs on imports from China, etc., those costs must be considered. If these risks are high, increased inventory is only a stopgap measure. Additional resources must be expended to develop a risk management plan.
As part of any such plan, U.S. businesses should develop alternative suppliers and materials, as well as the capacity to shift resources in case of a black swan event that could devastate their organizations. Develop abilities before you need them, so you don’t have to go through the process under the pressure of the event—and while everyone else is scrambling for the same scarce resources.
One way to estimate such costs is to use a free cost calculator that is available on the Reshoring Initiative’s website. A detailed explanation on how to use the estimator is located here. Estimates will provide companies’ management a continuum of high to low returns to reshoring different resources such as materials, supplies or components. When identifying imports that would be good candidates for reshoring, management should attack the ones with clear benefits and highest returns first. Savings from these investments can be used to increase productivity and lower costs; this will increase the possibility of reshoring other items that presently make more sense to source in China based on total costs.
Once good candidates for reshoring are identified, how to create manufacturing capacity in the U.S. becomes the main obstacle. This is where productivity is important. The U.S. has had low unemployment for quite some time; there just are not many people looking for work. Of those who want to work, most have jobs, but others have dropped out of the workforce completely. Labor participation rates are low, at levels not seen since the 1970s. Many potential workers have been sidelined since the pandemic lockdowns. Companies must therefore get more from the fewer employees they do have by improving business operations. Increased productivity has the additional advantage of creating more funds for increased wages and benefits needed to entice more people to return to the workforce. Separately, government must also enact policies to coax more people back into the workforce.
Company management has to invest in technologies that increase outputs per unit of labor—that is, make the existing jobs more productive. However, there are obstacles to doing so. We must deal with those who have a Luddite mentality, constantly “irrationally” concerned about people losing jobs. The Luddite view can be an impediment not only to the increased productivity needed to bring home supply chains, but also to higher living standards. The key to overcoming this attitude is to present increases in productivity as freeing up labor for more productive work, rather than eliminating jobs. Had the Luddites had their way, most of us would still be peasants laboring in the fields on subsistence farms. Don’t fear technology. We will always find better things for people to do.
But technology is costly. Expenditures must pass the return-on-investment test; fortunately, tech is not the only tool for increasing productivity. There are many gains to make through continuous process improvement (kaizen). Correspondingly, the driving philosophy behind Toyota Production System is the constant elimination of waste. This can add as much to productivity as innovation, or even more—and with negligible capital investment. Using these methods will increase capacity and labor availability needed to reshore supply chains.
Public policy decisions have also reduced the labor pool. We must deal with poor-performing schools that do not provide graduates with the skills they need to enter the workforce. The U.S. ranks far behind most of the industrialized world, particularly in math, despite being ranked near the top for education expenditures. Minimum wage laws and other regulations further reduce employment, especially among less-skilled individuals such as teenagers. Despite unemployment reaching 3.5% in March, teenage unemployment was almost 10%. Policies meant to help actually keep low-skilled workers from gaining skills through on-the-job training, skills they need to become successful.
Waiting times for regulatory approval of many projects can be ridiculously long. Less regulation would improve approval times and increase productivity in other ways: fewer people watching people work and more people working. Let’s get more regulators into the productive workforce. With a smaller population than China, the U.S. needs as many people rowing the boat as possible if we are to increase our self-sufficiency. We have to increase workforce participation by making productive work more attractive.
Nearshoring and Alternative Offshoring
However, not all manufacturing can be brought back to the U.S., nor should it. There are many benefits to international trade when there is rule of law. We have good trading partners, such as Mexico, that have the added advantage of being closer than China. Nearshoring the supply chain, such as assembling in Mexico, has distinct advantages. Bringing production closer to home makes it easier to fix problems and reduces lead times. I have worked with partners in Mexico, and compared with flying to China or India, it was much faster and easier (no visas) to go to Mexico on short notice. Time zones are a much lesser impediment as well.
In addition to Mexico, although not as close, Vietnam is a good alternative to China, but with smaller populations than China and lower productivity than the U.S., there is only so much Mexico and Vietnam can produce in the short run. A replacement with much promise is India. India lacks the infrastructure and other advantages of China, and labor unrest is a constant problem. Still, with a population set to surpass China’s, along with a much younger population, India can conceivably serve as a manufacturing alternative and counterbalance to China. Companies such as Foxconn are already moving some production of iPhones and other products they assemble to India, pressured to do so by clients concerned about disruptions in China.
While overcoming difficulties will be a challenge, offshoring to India has great potential. The Indian government has some socialist tendencies, but it is the world’s largest democracy and is not as beholden to the whims of central planners as China. Prior to the year 2000, China did not have the infrastructure or manufacturing advantages it does today. Years of investment and training made it the manufacturing juggernaut it is now. Doing business in India will require the same investments in time and capital that took place in China, but it could reap the same rewards, hopefully without the political drama. I traveled to India on a regular basis from 1989 till 1996 as part of my organization’s attempt to develop a joint venture. It takes time.
Rather than risk continued dependency on China, this three-pronged approach to diversify supply chains can be employed: Move production home by increasing productivity and workforce participation. When this is not practical, nearshoring to Mexico, South America, Canada or the Caribbean will provide many of the same benefits as reshoring. Finally, develop capabilities in alternative nations such as Vietnam and India to reduce dependency and the risks associated with procuring everything through one country. It will take time, and not everything needs to be shifted away from China, but the time to start is now.