U.S. Companies Rethink Outsourcing to China

Thanks to our friend Patrick Whelan, Managing Partner at Pegasus Capital Group in Los Angeles, for the following article on the current state of Chinese manufacturing. According to the author, U.S. manufacturers should take heart in the fact that the pendulum may be swinging back in favor of “Made in the U.S.A.”

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U.S. Companies Rethink Outsourcing to China

For the last several years, conventional wisdom has held that moving manufacturing operations to China from the United States was a smart move that could return significant savings in costs of goods sold. However, recent industry trends indicate that more and more companies are making the decision to keep manufacturing stateside. Even more telling? Some companies are actually deciding to move operations back to the U.S. from China.

The promise of cheap labor

Key to understanding why many American companies are moving from outsourcing to “in-sourcing” is to first address the question, why is manufacturing in China so appealing? The short answer lies in the abundance of cheap labor in a growing industrial complex hungry for outside business. Despite obvious drawbacks to manufacturing in China (long shipping distances, significant lead times, etc.) any labor-intensive goods produced in adequate volume that could be affordably shipped seemed like ideal candidates for Chinese production.

The initial challenges in setting up operations in China proved to be significant. American firms faced large upfront investments in time, effort and travel expenses; and the cultural, language and even time zone barriers were not easy to bridge. But once these investments were made and the cheap goods started rolling off the manufacturing line, the investments paid off. At least at first…

An emerging market is a fragile market

Early movers into China may have saved money on labor, but they also learned hard lessons about moving critical operations to a developing economy. According to Ralph Keller, President of The Association for Manufacturing Excellence, “Many companies today are rethinking their off-shoring strategy due to escalating costs, quality concerns, the long lead-time required and the fact that they have not realized anywhere near the savings they had anticipated due to the hidden costs of managing suppliers half way around the world.”

Charlie Barnhart, Co-founder and Managing Principal at Charlie Barnhart and Associates LLC, a company that studies outsourcing, added that “China has a fragile supply chain. During this economic downturn, thousands of companies have gone out of business in China. Companies call their suppliers to see what’s going on and nobody answers the phone.” In addition to an unpredictable supply chain, the long lead times associated with poor infrastructure and the great distance from the manufacturer to the consumer make it difficult for companies to meet fluctuating demand for their products.

In an emerging market, things change quickly

As more manufacturing moved to China, the law of supply and demand inevitably kicked in, causing increased demand for labor and upward pressure on wages. According to a recent article in the New York Times, labor shortages are now rampant in China, caused by a booming economy and the rapid expansion of factories even though the number of Chinese workers entering the workforce has leveled off.

Austin English, President of RCF Associates, a manufacturing consulting company, stated that “due to the economic slowdowns of last year, many of the people working in affected factories in China went back to [the rural interior of the country] and have not returned. This has brought a local bidding war for the remaining employees and has forced one of our clients to budget for a 30% pay hike in 2010.”

In addition, the cost of shipping goods back to the U.S. has skyrocketed due to a shipping capacity shortage and rising energy prices. According to an article in the China Economic Net, freight prices doubled in the 30 days leading up to December 2009. Stephen Sykes, Vice President of Marketing for Artco-Bell Corp., a producer of classroom furniture for children, said that his company’s shipping costs for a single container have increased from $2,200 to over $7,000 over the past eight years.

The effect of these labor and shipping shortages is an overall upward pressure on costs that make China less appealing as an outsourcing partner. According to EDN.net, manufacturing in China is 15-20% more costly that it was just four years ago.

Intangible costs of manufacturing in China

There have been other, less tangible costs tied to manufacturing in China. Our media have broadcast reports about contaminated pet food and lead paint on children’s toys from China. Unfortunately for the U.S. companies affected, saving a few dollars on labor has cost them an incalculable amount in negative PR and lost consumer trust. For other firms, shoddy manufacturing has quietly eroded brand equity.

Still other companies have fallen victim to unscrupulous Chinese companies who take advantage of their underdeveloped intellectual property laws to steal their client’s designs and produce counterfeit goods. The flood of c

heap counterfeits on the local market all but prevents American firms from introducing their own products to the growing Chinese marketplace.

Back to the U.S.A.

Of course, wages in the U.S. are still several times those in China, and will remain so for some time. To a growing number of companies, however, the benefits of moving operations back to the U.S. are compelling.

For some companies, the higher shipping costs alone are enough to sway them toward domestic production. For others, the stability and skill level of the U.S. labor market, the easy scalability of production in U.S. factories, and the ability to exercise greater quality control are critical factors that keep them at home or bring them back. A contribution to the local economy and the ability to say “Made in the U.S.A.” are powerful brand equity builders as well.

Case Study 1:

Artco-Bell Corp of Temple, Texas is a children’s furniture manufacturer. The company recently moved production of all steel and polypropylene goods from China back to the U.S. While the move actually increased their per-unit manufacturing cost, the elimination of the long ocean voyage between the U.S. and China has reduced their total expenses by 20%. Stephen Sykes, Vice President of Marketing, commented that “For a while, [the Chinese] were buying steel better than we could buy steel. But as the scales began to balance as far as what they were purchasing in raw and what we were purchasing in raw, then the freight became the issue. The great equalizer is the boat ride back over.”

Case Study 2:

Sauder Woodworking Co. of Archbold, Ohio provides products to Wal-Mart, Target, Lowe’s, and other large retail stores. In recent years, the company has experienced intense competition from foreign companies along with increasing pressure from their customers to meet shorter delivery times with lower inventory levels. Norm Hoeppner, Vice President of Procurement, says that these factors have led Sauder to reassess their supply chain and move some elements of production to local manufacturers. According to Hoeppner, “one of our biggest strengths is our flexibility and speed of service to our large retail customers. We can’t meet this service when it takes three months to obtain parts from offshore.”

What’s the future of worldwide manufacturing?

If the trends of higher labor and shipping costs combined with the lower quality and legal standards in China continue to play out, they will increase the shift back to domestic production. Manufacturing companies in the U.S. have a significant opportunity to win back contracts from China, and they should do what they can to position themselves to be more competitive.

Perhaps Harry Kazazian, Chief Executive Officer of Exxel Outdoors Inc., a top U.S. producer of outdoor recreational gear, said it best. “You’re never going to have $2-an-hour labor in the United States,” he commented, “but with quality, time, efficiency, you close the gap.”