Welcome Back U.S. Manufacturing

July 10, 2008
It's too early to tell whether high fuel prices and the falling dollar will be enough to bring offshored operations back home, but some recent moves suggest it's possible.

The falling dollar, high fuel and energy prices, and rising labor costs in traditionally low-wage markets have some manufacturers rethinking how far they're willing to extend their supply chains. Over the past year, a handful of companies have publicly acknowledged that cost pressures factored into their decisions to move production back home.

Depending on the situation, the changing economic climate could make the United States the ideal sourcing country for domestic manufacturers, says Tom Jones, senior vice president and general manager of U.S. Supply Chain Solutions for logistics provider Ryder System Inc. "It really depends on the industry and the cost of the product, the value of what you're shipping and the characteristics," he says. "You can ship a box full of microprocessor chips quite a long ways without a significant penalty on the shipping side, but if you're shipping diapers a long way, which are very bulky, and the cost of transportation is high, you're not going to get what you want with that."

Case in point: The cost of shipping residential heaters from China to Bowling Green, Ky., became too high for Desa LLC. In October 2007 the company's retail heating unit shifted manufacturing operations for the product back to the United States after shipping costs spiraled out of control.

The Long Road Back

Desa, a privately held company that also sells power tools under the Remington brand name as well as lighting products, followed the path of many other U.S. manufacturers that wanted to take advantage of China's lower labor costs to remain competitive.

Desa's Asian migration began around 2000 and picked up steam about four years later when the company moved a considerable chunk of production to China. At the time, Desa was receiving a 15% value-added-tax rebate from the Chinese government on its exports, says Claude Hayes, president of Desa's retail heating division. But in July 2007 Desa lost part of this incentive when China announced that it was reducing the rebate for several products, lowering the company's benefit to 5%. Added blows came over the next year with skyrocketing fuel and raw material prices. Desa's shipping price per container had increased about 50% in one year, according to Bill Wong, Desa's director of marketing. The 2,000-mile trek from the Port of Long Beach, where the company's cargo arrived via China, to the Bluegrass State was no longer cost-effective with diesel prices hovering around $4.05 per gallon, says Hayes.

In addition, the cost of Chinese steel was taking off while U.S. price increases were considerably lower, and the falling dollar vs. the Chinese yuan reduced Desa's labor savings, he says. "So when you look at energy costs, the exchange rate, value-added tax and all the commodities, it's beginning to look a little greener in the United States," Hayes explains.

The decision to move some jobs back to the United States was made easier by the fact that the company never sold the large presses and machine tools located in its Bowling Green plant when operations were moved to China. Desa is paying more for labor now but breaking even with production costs in China through the transportation and commodity savings. The move also puts the company closer to customers.

"Being located in the central part of the United States, almost 60 to 70% of the population in the U.S. is within 12 hours of us," Hayes says. "If you want to get to people, it's a good place to be."

Ramping Up Production

Desa's story may sound encouraging to some, but it's still largely the exception. The more likely scenario for manufacturers trying to stave off higher operations costs overseas is an increase in U.S. production capacity or more "near-shoring" to Mexico. "What they're starting to do is not so much close their plants in China; it's more that they're putting additional volume here, whether here in the U.S. directly or sometimes Mexico or Canada," says Kevin O'Marah, chief strategist for manufacturing advisory firm AMR Research Inc. A recent AMR survey of manufacturing executives shows that 21% plan to increase manufacturing activities in the United States over the next year, while another 21% expect to increase near-shore production (see chart, "Geographical Shifts").

Geographical Shifts

Various factors -- including rising transportation costs, quality issues and currency fluctuations -- have manufacturers rethinking where they source and produce products and components. An AMR Research Inc. survey conducted in late May asked 113 executives about their supply chain plans over the next year. Of those surveyed, 64% come from companies with more than $5 billion in revenue. The rest reported revenues less than $5 billion.

Change in Sourcing Activities for the Next 12 Months

Within the United States
Increase Sourcing -- 23%
Decrease Sourcing -- 25%
No Change -- 52%

Near Shore
Increase Sourcing -- 30%
Decrease Sourcing -- 7%
No Change -- 63%

In China
Increase Sourcing -- 32%
Decrease Sourcing -- 9%
No Change -- 59%

Other Asia/Pacific Countries
Increase Production -- 24%
Decrease Production -- 3%
No Change -- 73%

Change in Manufacturing Activities for the Next 12 Months

Within the United States
Increase Production -- 21%
Decrease Production -- 20%
No Change -- 58%

Near Shore
Increase Production -- 21%
Decrease Production -- 5%
No Change -- 73%

In China
Increase Production -- 28%
Decrease Production -- 8%
No Change -- 64%

Other Asia/Pacific Countries
Increase Production -- 18%
Decrease Production -- 4%
No Change -- 78%

Construction and mining equipment manufacturer Caterpillar Inc. said in June it would invest $1 billion in a multiyear capacity expansion plan for five of its Illinois plants. The increased capacity is in response to growing global demand for mining equipment, says Caterpillar spokesman Jim Dugan. Although Caterpillar has numerous plants located globally, in this case moving some production offshore wasn't in the company's best interests because mining equipment is a heavy, low-volume product and the capital investment to start a new mining equipment facility is substantial.

"In general the Caterpillar manufacturing philosophy has been for many products to have multiple locations around the world in different regions and economic currency zones so we could have a hedge against currency fluctuations," Dugan says. "Also for those smaller products it allows us to manufacture closer to customers. The lead times for those products are a lot quicker relatively speaking than, for instance, for those big mining applications. The large mining customers tend to plan and make their purchases multiple years in advance."

Supply chain management consultant Michael Donovan says the current economic climate probably isn't right for a company to relocate asset-heavy production offshore. "A vertically integrated manufacturing facility for producing complex machinery is very costly to set up outside the United States, especially when current and projected exchange rates are not very favorable for that kind of activity," says Donovan, president of R. Michael Donovan and Co. Another motivation could be the lack of well-trained machinists and technicians in other regions, Donovan adds.

Caterpillar's decision to stay domestic may not have been in response to currency fluctuations or other variables tied to offshoring. But the company is bucking the trend of large, multinational manufacturers responding to demand spikes by employing cheap, overseas labor.

"There's not a boom in U.S. manufacturing. What there is, is a slower departure of U.S. manufacturing," O'Marah points out. "You may have a plant making car parts that's operating at 85% capacity, whereas last year or two years ago you might have run it down to 75% capacity and continued to source more out of your Asian plants. Most folks can produce multiple products in multiple locations, so they decide to put sourcing decisions in one location or another depending upon the total equation."

Home Sourcing

On the same day Caterpillar announced its expansion plan the company said it will likely outsource its tube operations -- currently produced in Aurora, Ill. -- to a U.S. supplier. The decision to seek a domestic supplier fits in with the company's desire for just-in-time delivery to the Aurora plant, which is one of the facilities undergoing capacity expansion, says Dugan. More U.S. manufacturers are considering similar sourcing models as the dollar's value continues to fall, according to a recent survey by MFG.com Inc.

Out of more than 500 responses, 40% of survey participants say the current value of the dollar has an effect on where they choose to source their business. Nearly half of those respondents say they're already sourcing more business in the United States because of the declining currency value. At the very least, more manufacturers have indicated that they're sourcing closer to home in either Mexico or Canada. In the AMR survey, 30% of those responding say they plan to increase their near-shore sourcing activities through next spring.

"Mexico is a good alternative where you have a blend of low-cost labor in addition to a reliable and relatively cost-effective transportation system, but for some other products it makes sense to source back in the United States where the cost of offshoring outweighs the higher cost of labor that we traditionally have in the U.S.," says Ryder's Jones.

Sweet Victory

In some cases, domestic suppliers are taking proactive steps to close the gap even further with offshore rivals. For instance, Coating Excellence International (CEI) in Wrightstown, Wis., turned to technology to win business that began moving to Korea. The $260 million packaging company was in jeopardy of losing orders from the makers of Sweet 'N Low. CEI had been supplying polycoated paper to printers who would then print the pink sugar packets and sell them to Cumberland Packing Corp., the makers of Sweet 'N Low. But Cumberland had begun outsourcing the printing process to Korea, meaning CEI was about to lose the small amount of sales it already had with the New York-based company.

For CEI to remain competitive, the company had to offer something low-wage markets couldn't. In 2005, CEI invested in a robotic palletizing system that automated a formerly manual stacking procedure used to prepare the product for the final production process, says Michael Nowak, CEI's co-founder and president. The new technology investment cut packaging costs enough that Cumberland now uses CEI for its printing services.

"We can't pay the wages that they pay [in Korea], so we have to make more per man hour, so when you look at an individual pack and say, 'How much labor was used to make it?' we could be the same or as good as them," Nowak says. "It's just that we make it by making more, and they make less and have more people involved -- and we've equated the labor rate that way."

Nowak estimates the plant has cut labor costs by 20% to 25%. The company still charges more than the Korean manufacturer, but the cost reduction combined with shorter lead times gives CEI an advantage that overseas competitors can't match. Nowak says he's convinced more U.S. suppliers could be in CEI's position if they would initiate change.

"People sit back and don't invest any money, and they complain when something goes overseas," Nowak says. "Well, it's not going to stay competitive with the rest of the world, and you shouldn't be surprised when you lose your product overseas if you're not continually improving and keeping your efficiencies up."

For the workforce, the irony of all this lies in that the staggering economy combined with globalization means high fuel prices, the plummeting dollar and automation could actually save or create manufacturing jobs.

Visit www.industryweek.com/insourcing to learn about how quality issues may impact manufacturers' sourcing decisions.


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