The typical intent of governmental economic development is to increase the number of manufacturing jobs and boost the positive economic contribution of manufacturing at either the state or federal level, or both. Such efforts typically take the form of financial assistance and incentives related to either relocating Original Equipment Manufacturer operations, or opening up new OEM operations local to a particular site. This approach has had dubious positive impacts.
For instance, many states employ “smokestack-chasing” to lure manufacturers from another state to theirs. This is, of course, a zero-sum game from a national perspective. Similarly, the manufacturers opening up new operations often fail to live up to their employment and financial-impact commitments. Just ask Wisconsin how their deal with Foxconn worked out!
Bottom line is that state and federal economic development programs add up to a significant investment that may or may not yield acceptable results. Yet these programs typically don’t provide financial assistance—at least not at the same level—to “incumbent” manufacturers who, by the way, have paid taxes and providing good-paying jobs for years, if not decades. Go figure!
One really has to wonder whether this is the best way to invest the country’s economic value dollars.
Missed Costs and Misplaced Priorities
OEMs today typically do not take into account the overall costs associated with sourcing overseas, or the revenue-related benefits of sourcing more locally. Rather, they focus almost exclusively on quoted piece-price and the costs associated with getting purchased parts from their supplier’s shipping dock to their own receiving-inspection area.
What is not widely recognized is that there are internal OEM costs driven by the supplier selection process above and beyond order fulfillment costs. For instance, customer fill rate—which is associated with market share, revenue and profit—is often supported by having pre-built finished product. This inventory comes at a significant internal cost, usually driven by a lack of supply chain order-fulfillment agility.
Both customer fill rate and pre-built finished product are executive-level performance metrics that are primarily associated with a company’s marketing function. The conundrum is that marketing has little to do with controlling the costs associated with maintaining or increasing customer fill rates. Let me explain.
At most companies, marketing is responsible for forecasting market demand. Market forecasts typically have error. What often isn’t recognized is that over the last couple of decades, this magnitude of forecast error has dramatically increased. Why? Because of consumer expectations of having product immediately available. And if product is not immediately available, buying from a competitor that has a similar product in stock has become more and more a reality. Why? Because over time, the products of competing manufacturers have become more and more alike, usually due to cost-reduction efforts. So buying another “brand” does not result in loss of value from the customer point of view.
Because of increasing forecast error, marketing has recommended higher and higher levels of pre-built finished inventory in an effort to not lose sales. This is required not because lack of responsiveness in the OEM’s own manufacturing facilities. Rather, it is due to sourcing with suppliers that can’t respond quickly enough to react to market demand that doesn’t align with the forecast. And the major reason the OEM’s can’t respond quickly is due to firm order commitments—often given to overseas but not to domestic suppliers—and order-fulfillment time.
The automotive industry provides a real example of this impact. All automobile manufacturers pre-build finished goods inventory to maintain customer fill rates, holding the inventory either at dealerships or their own distribution centers. The difference is that in 2019—the last year of “normal” automotive production and sales—the average quantity of this inventory was about 100 days for U.S.-based OEMs and 50 days for their Japanese competitors. Why? Because U.S. manufacturers have had a strategy over the last three decades of sourcing their purchased material overseas, while Japanese manufactures believe in “assembling product in your primary markets and sourcing where you manufacture.” The largest market for automobiles worldwide is the US, so they’ve located their manufacturing facilities in the States and, when they could, also sourced in this country. This resulted in excessive lead times for schedule changes for companies like Ford and General Motors, and significantly increased order-fulfillment ability for companies like Toyota, Honda and Subaru.
So, the cost(s) associated with pre-built finished goods inventory and loss of revenue associated with customer fill rate reduction has little to do with marketing and everything to do with purchasing. Unfortunately, most U.S.-based OEMs don’t understand and source primarily based on piece-price.
I have recently written a book—Better Business: Breaking Down The Walls Of The Purchasing Silo—that lays out the business case for local sourcing. But it will take more than books to influence OEMs that are ingrained in standard accounting systems and OEM quarterly reports to financial analysts (where short-term gains are needed to maintain stock price and, by the way, are the primary basis of executive level bonuses).
An Economically Sound Business Case
I believe that an improved economic development strategy can be justified: one that, unlike today doesn’t rely on excessive financial support.
My premise is that more OEM executive attention for sourcing “locally,”—i.e., in the United States—could be attained if the federal government brought together a group of industry supply management, manufacturing and financial experts to define and publicize the in-house costs and market-based revenue shortfalls related to market-forecast error and un-agile supply chains. In other words, put together an economically sound business case for manufacturing and sourcing in the primary markets served. And then put them in a formula format, so that OEMs have a tool for evaluating potential sources.
There is another financial element that supports such an approach. What is commonly not understood is that there are significantly higher numbers of jobs and economic impacts related to the manufacture of purchased material than in OEM customer operations. And that supplier manufacturers are typically “incumbents” who have been around for years, operating mostly without government financial support. The strategy proposed above would have at least three positive outcomes:
1. Higher OEM sales, revenues and profits
2. Lower OEM internal costs
3. Increased business (and jobs) for this country’s manufacturer suppliers.
Along the lines of that third point, it must be pointed out that the current financial-based strategy that the federal government and the states use to attract OEMs has not “trickled down” to U.S.-based suppliers. Why? First, because of OEM overseas sourcing strategies. And second, since although many OEMs giver lip service to collaborative partnerships, in actuality, they highly leverage their suppliers rather than work towards creating mutually beneficial relationships.
Paul Ericksen’s book is Better Business: Breaking Down the Walls of the Purchasing Silo. Ericksen has 40 years of experience in industry, primarily in supply management at two large original equipment manufacturers.