When Polaris Industries sought to expand production of its all-terrain vehicles while lowering costs, the Minnesota-based company followed long-established trends by looking outside the United States. But instead of moving from its plant in Osceola, Wis., to Asia, Polaris looked south, to Monterrey, Mexico.
General Electric this year is moving even closer to its home market. The company is shifting production of a new hybrid electric water heater for the U.S. market from China to a factory in Louisville, Ky. And next year, Swedish appliance manufacturer Electrolux will close its cooking appliance manufacturing plant in Quebec and move production to a plant in Memphis as part of a global campaign to reduce costs.
Relocation is a fact of life in manufacturing, but in each of these cases companies are reversing a decade-old trend by moving production closer to their target markets in the U.S. They are examples of a growing trend by U.S. companies called near-sourcing or near-shoring of production closer to home and away from China. Each company is seeing in its own distinct business the evidence of broader shifts in the economics of supply chains, from the realities of rising labor costs in Asia and energy and transportation expenses to the bigger questions over risk and speed to markets.
All are working to change the economic calculations that underpin supply chains, and they are starting to have an impact on the businesses serving those supply chains.
“Rising wages in China means that the spread is nowhere near what it used to be between China and Mexico, and a cyclical downturn in the U.S. is allowing U.S. companies to start operations here at a low-cost base before labor gets more expensive,” said Stephen Shaffer, senior economist at port design and engineering consultant Moffatt & Nichol.
He cited a number of other risks with sourcing in China that are driving near-sourcing, including tight credit, quality control, foreign exchange, protection of intellectual property, freight rate uncertainty and, within that, high oil prices.
“All of these risks cause people to evaluate the equation differently,” Shaffer said. “Shorten that pipeline and you can hedge your risks and don’t have to finance eight weeks of inventory in your supply chain.”
The volume of U.S. imports produced in near-sourced factories trade moved sharply upward last year, according to U.S. Census Bureau statistics.
U.S. duty-free imports under the North American Free Trade Agreement, which covers most imports from near-sourced plants, grew 16.9 percent in the first 10 months of 2011, to $135.9 billion from $116.3 billion a year earlier. The value of all U.S. imports from Mexico (including oil) in the period grew 27 percent to $218.7 billion, compared with $172.1 billion in the first 10 months of 2010.
The idea that manufacturing will see something of a boomerang effect in sourcing already is triggering a response in the shipping and logistics world, including investment from carriers.
Kansas City Southern, the only U.S. railroad with a Mexican subsidiary, Kansas City Southern de Mexico, is focusing on taking market share away from cross-border trucking. The company’s Mexican carloads increased 15 percent to mid-December from the beginning of 2011. Mexico accounted for about 45 percent of its $1.6 billion in revenue in the first nine months of 2011.
The railroad already is a presence at the Port of Lazaro Cardenas on Mexico’s Pacific Coast. APM Terminals in late December announced a $900 million investment at the port, the latest big financial marker in an upgrade of logistics infrastructure spreading across the region.
Near-sourcing is adding some jobs in the U.S. while moving others offshore. “While this was a difficult decision for us, given the impact on our employees at the Osceola facility, we believe the creation of these manufacturing centers of excellence will strengthen our company over the long term and enable us to maintain our lead in a competitive market,” Polaris Industries CEO Scott Wine said at the time of its decision.
He said the Mexico plant enables the company to maintain its quality while improving on-time delivery to customers and provide significant savings in logistical and production costs.
GE is adding jobs because it’s moving water-heater production back to a Louisville plant where it has idle capacity, and, under an agreement with the union, it’s able to hire new workers at $10 to $15 an hour less than the pay scale for existing employees.
“We have gotten to a point where making things in America is as viable as making things anywhere in the world,” James P. Campbell, president and CEO of GE’s appliances and lighting division, said in an interview with The New York Times. The drop in labor costs is a big reason for the move. “They are significantly less with the competitive wage, and that is a big help,” he said.
But bigger supply chain issues also play a part. GE is moving some appliance manufacturing back to the U.S. because large, bulky appliances can have a high shipping cost from China. The company can source smaller, high-value appliance components in China and import them into North America for assembly in capital-intensive plants. An appliance’s sheet metal parts can easily be stamped with automated heavy machinery at U.S. plants, so there’s no need to outsource it.
Mexico is by far the favorite location for near-sourcing, despite concerns about security raised by truck hijackings and drug wars, according to a survey done last year by AlixPartners, a Chicago-based consultant. Of the 80 large international companies that responded to the survey, 42 percent are already near-sourcing or likely to bring manufacturing from abroad to North America in the next three years.
Cost is still a big factor: Among the respondents who are considering near-sourcing, 63 percent said Mexico is the most attractive location, with the U.S. coming in second at 19 percent. Another 6 percent said they want to stay in North America, but relocate to a lower-cost production location.
“Apparel and textile manufacturers all moved to China in the ’80s to take advantage of cheaper labor, but they are moving production to Mexico now because the wage gap is not as large as it used to be and it has the manufacturing infrastructure,” said Chas Spence, an AlixPartners director.
He said they also are moving to Mexico to shorten their supply chains. “In China they have to put their orders in six months in advance, which ties up their working capital for six months,” Spence said. “There’s not a lot of flexibility to change design. They can’t respond to consumer trends in the fashion industry.”
Auto parts manufacturers also are shifting production to North America to supply U.S. and Mexican plants that make cars for the U.S. market with just-in-time deliveries. “When you have long and unpredictable delivery times and uncertainty about what will come out of the crate with regard to quality, it makes sense to come back,” said David Hartman, China practice director of Blue Canyon Partners, a Chicago consultant that helps business-to-business companies develop sourcing strategy.
He said some of his firm’s customers that outsourced to China have had problems with non-delivery or late delivery of promised supplies. “We’ve developed a culture here where there isn’t any room for error,” Hartman said. “You deliver 5 percent less than what was promised to Wal-Mart, and you don’t deliver to Wal-Mart any more. The auto industry is like that. Nobody is going to wait to buy a car because the shipment of carburetors from China is late because the truck got stopped on the road for being overloaded.”
Most of Blue Canyon’s customers are staying in China despite wage inflation because they supply components to other factories there that are producing consumer products for what is the world’s fastest-growing consumer market. “Our customers are all Fortune 500 B2B customers that are following their customers, and they have to be where their customers are, in the most important market in the world. They have to be in China because of the market, not because of the low costs,” Hartman said.
But manufacturers of consumer electronics such as cell phones and computers, which set up in China in the last decade to take advantage of low wages, are bringing the assembly of these products back from China to factories in the 125-mile deep maquiladora belt along the U.S.-Mexico border. There, they are incorporating technology components imported from China or other Asian locations.
“Certainly, the higher labor costs in China are favoring Mexico for the relocation of maquiladoras, which is taking place, and it provides an excellent opportunity for Mexico to become more attractive for manufacturing,” said Rogelio Ramirez de la O, president of Ecanal, a Mexico City economic analyst. But he is concerned the investment climate is being clouded by security concerns that “are much more overwhelming in the perception of company strategies than relative labor costs.”
He said Mexico hasn’t invested enough in its transportation infrastructure, which is limiting the amount of foreign investment it can attract from China. Foreign direct investment in Mexico fell 19.8 percent in the first nine months of 2011 through September, to $13.4 billion from $16.7 billion in the same period of 2010. “It is quite subdued,” Ramirez said.
If current trends continue, Mexico stands to gain more investment in low-cost manufacturing moving out of China, which could lose its cost advantages for manufacturing products for export to the U.S. altogether in four years, according to a second near-sourcing study AlixPartners released this year. The study predicts the landed cost of Chinese imports in the U.S. could be higher than the cost of similar products produced in the U.S.
The conclusion is based on assumptions that include a 30 percent annual increase in China’s wage rates, a 5 percent annual increase in the value of the yuan against the dollar and an annual 5 percent increase in freight rates, which it called reasonable because “of increasing fuel prices and stabilization pre-boom and bust levels.”
If that scenario develops as forecast, Mexico would become a much cheaper production site than China. But Mexican pastures may not be as green as they look at first glance.
“A lot of CFOs look only at the hard numbers of freight but don’t peel back the onion very far and don’t look at the cost of bringing the components from China or India or Thailand to Mexico for assembly,” said Richard Collins, principal of Dracmarine, a Bowling Green, Ky.-based international supply chain consultant.
His biggest concern with outsourcing to Mexico are the non-tariff issues, including the complexities of moving products across the border from Mexico into the U.S. “You’ll be able to turn inventories a little faster, but it’s not all that it’s cracked up to be because of the complexities of labeling, country-of-origin issues and the paperwork associated with it,” Collins said. “The paperwork is horrendous.”
He believes some manufacturers should keep their production in the U.S. “There are times you might be better off staying in the U.S., particularly if you have an operation that is capital-intensive,” Collins said. “There is plenty of capital up here and low utilization of plants for machine tools and that sort of thing.”