Several factors are challenging the conventional wisdom that manufacturing will continue to be outsourced to Low Cost Countries (LCCs) for the foreseeable future. According to analysts at BMO Capital Markets, â€śnearsourcingâ€ť or â€śreshoringâ€ť are stronger trends that will strengthen North Americaâ€™s manufacturing base.
China has long been a preferred destination for outsourcing of manufacturing operations for its cost-efficiency. However, BMO reports that increasing wage rates, an appreciating RMB and increasing freight costs due to higher fuel prices are eroding its advantages relative to the U.S. and other LCCs. It cites a 2011 AlixPartners study concluding that China is losing ground to the U.S. and other LCCs in its Manufacturing-Outsourcing Cost Index.
Additionally, the study forecasts that over the next five years the three aforementioned factors could work to erode or erase Chinaâ€™s competitive advantage for some products destined for North American consumers.
Sourcing in North America would mitigate many of the top challenges of international sourcing identified in a 2010 Boston Consulting Group study, including late deliveries, product quality issues and customs delays. BMO states that products targeted for nearsourcing to the U.S., specifically, will be those with low unit labor costs and modest volumes, including auto parts, construction equipment and appliances. When all product costs are taken into account, certain U.S. states such as South Carolina, Alabama and Tennessee should have some of the lowest production sites in the industrialized world and a weakening dollar will only help.
BMO cites a 2011 AlixPartners survey reporting that 43% of global executives had nearsourcing plans within five years or had completed a nearsourcing initiative within the last three. This ongoing shift could force plants in China to refocus output mostly on Chinese domestic consumption while capacity for North American consumers is nearsourced, BMO concludes.
Furthermore, it is expected that Mexico will be a huge beneficiary of the North American nearsourcing trend. Mexico delivered products at the lowest landed cost to the U.S. And Mexico has the added benefit of product delivery times as short as one to two days compared with several weeks for more expensive trans-Pacific shipping. Its proximity to the U.S. cuts down on travel times for North American-based managers and makes coordination easier due to better alignment of timezones. Furthermore, as a result of NAFTA, many goods manufactured in Mexico can enter the U.S. duty-free.
One of the few drawbacks to investing in Mexico remains security concerns, but these are expected to improve with time.
BMO cites the Boston Consulting Groupâ€™s conclusion that as long as the U.S. â€śprovides a favorable investment climate and flexible labor force, the U.S. can look forward to a manufacturing renaissanceâ€ť as a result of nearsourcing. However, manufacturing abroad will likely still make economic sense for many products with high labor content targeted to Asian consumers in particular.