It has become very popular to say that manufacturing is returning to the Americas. In a previous Mexico Now article, we detailed some of the reasons and methodologies driving the process. If manufacturing in the Americas is such a good idea, why did so many firms get it wrong? As we explained before, the math was not properly calculated but that doesn't explain it all. For so many firms to make the same mistake, something else had to be happening.
Take this example from a large building materials manufacturer. The CEO met with the Board of Directors who had heard so much about China. They said "So many of our competitors have gone to China, maybe we should go too?" The CEO went back to the firm and told the Vice President of Operations: "The Board thinks we should go to China. Assemble a team and investigate how to do business there." Note that the description changed from "maybe" to "the Board thinks." The Vice President of Operations assembles a team and says: "We are going to China to find partners to manufacture our products." Note now, that the description has gone from "investigate" to "find partners to manufacture." The process changed from examining China to selecting partners for production.
The VP of Operations and team go to China and meet with many people. The visit is choreographed to show China's best qualities and the factories visited show off their capabilities. The manufacturing plants look fine and the VP of Operations assumes that other costs have been fully considered. The report details how, not if, the firm should do business with China. The decision is made with consideration to the lower labor costs versus higher transportation costs. Little thought is given to longer lead times impacting inventory and customer service or to changing conditions in logistics or labor.
THE CHINA BRAND
During the 1990's, China did a phenomenal job marketing its value. They stressed low cost, highly flexible labor. They decreased taxes on foreign producers with aggressive use of free trade zones in cities like Shanghai. Firms came in droves and, as more competitors left for Asia, pressure increased on those who hesitated to follow suit.
The stories out of China were promising to those interested and intimidating to those who were unsure. A cheap labor force ($1.60 to $2.00 per hour as opposed to Mexico's $4.00 per hour) with a seemingly endless pool of eager workers indicated that wage conditions were not only good now but would remain so. The reality was different, of course. Workers required far more training investment due to the lack of middle management, business trained interpreters, ex pats who could speak Mandarin, etc. The workforce was not endless either.
Qualified workers became more expensive and changed jobs driving up training costs again. Even as these limitations were becoming clear, the Chinese workforce was demonstrating it was more flexible than western workers. This flexibility could be traced not only to a work ethic often found in poorer communities but also to the large number of engineers graduating each year from Chinese universities. This availability of techno savvy knowledge workers further enhanced the China brand.
Next came the BRIC, the belief popularized after 2001 that Brazil, Russia, India, and China were the key emerging economies. This prediction had merit based on population growth patterns, natural resources, and other market dynamics. By this time, China was demonstrating clear leadership with a rapidly growing economy that seemed unstoppable.
The result was a powerful China brand that relied on multiple factors, not just labor. The negative factors (logistics, inventory, financial resources, etc.) were swept aside and China was given time to deal with those issues. Ports and roads were upgraded to reduce logistics obstacles and China even considered going into the shipping business to reduce capacity constraints.
The formulation of a powerful brand is dependent on strong fundamental reasons for customers to do business with you and, perhaps most importantly, on a well-designed value proposition aggressively delivered to customers. Coca Cola, Del Monte, IBM, Intel, and other leading brands are constantly supported by sales and marketing campaigns that educate customers as to their value proposition.
China has a strong value proposition that is constantly delivered to their worldwide customers. The reasons to do business in China are many and western firms have taken note. Many politicians think the solution to the resultant trade imbalance is to set up trade barriers. Trade barriers, however, only weaken domestic industries and raise the cost of living on everyone in the country. The higher cost of living reduces disposable income that would have been otherwise spent on healthy local firms' products and services. It's a nasty spiral.
The former US ambassador to China and candidate for President, Jon Huntsman, put it well: "The US has to learn how to compete." We need to change the phrase to "The Americas have to learn how to compete." Get away from the foreign business centers in Shanghai and Hong Kong and one cannot help noticing the complete lack of goods produced in the Americas. The Chinese buy commodities (oil, agriculture) in the west and export manufactured goods. Simply put, western companies don't have a clue how to sell to the average Chinese consumer.
Western firms succeed where demand exceeds supply (automobiles) and when selling to consumers familiar with high quality brands (Rolex). High technology products can be sold but often are not out of fear that intellectual property will be lost. Even these successes are small compared to Chinese exports and not sustainable.
Chinese automotive manufacturers will grow and Chinese high quality brands will emerge as they did in Japan during the 1970's and 80's. The competition will be fierce and unprepared western firms will lose market share. Until SMEs (small and medium sized firms or PyMES) have distribution channels and sell in China, the world market will remain out of balance. This is not sustainable.
If trade only goes one way across the Pacific, logistics costs will remain high and currency battles will continue. More importantly, the Americas' market will lose significance compared to Asia. It is not in China's interest to see its customers fail. China will become the world's largest consumer market within the next 50 to 100 years. It is imperative that western firms learn how to do business with China as a customer as well as a supplier.
THE AMERICAS' BRAND?
Clearly, the starting place is to establish the value proposition. The Americas need to be respected as a manufacturing center in order to export. Labor costs and distribution channel issues drive the challenges faced in establishing that image.
Let's compare three countries with a powerful story to tell, the US, Mexico, and Brazil. The US is known for excellent markets, a highly educated workforce, stable institutions, high levels of security, strong research and development capability, low energy costs, and a world-class infrastructure. The US is also known for high cost labor, arguably higher corporate taxes, and regulations.
When developing a brand, the best bet is not to address negatives and stress the positives instead. The US is a strong attraction for firms that need a local market to sell to, highly qualified knowledge workers, development and protection of intellectual property, security for personnel and other assets, and access to more distant markets through multiple logistics sources. The value of each of these strengths must be calculated using the firm's own cost and profitability structures.
Electronics firms, for example, need rapid access to important markets in the US but have products that can travel fairly cheaply. The advantages to local production need to be calculated not only for labor versus transportation but also for inventory and/or customer service failures. The costs of customer service failures are very high and include expediting, lost sales, and product handling issues.
Imagine a shipment of wheels shipped from China to a US manufacturer of handcarts. Let's assume the wheel costs $4 (6 weeks lead time) from China and $8 (1 week lead time) from a US supplier. The manufacturer will need to carry a minimum of 5 weeks additional inventory to account for the lead-time difference. In addition, the firm will need to carry inventory just in case the shipment should arrive late. The alternative is to expedite the product by air or to be late on customer shipments.
Both options are considered prohibitively expensive which leads many firms to carry far more inventory than they need. The additional inventory costs money in tied up working capital, maintenance, rent for storage, obsolescence, etc. The other positives about the US can also be quantified like security (firms in Latin America report spending up to 2% of revenues on security for high value products).
Training costs can be very high, compared to the US, in some markets especially where the labor force is unfamiliar with modern manufacturing techniques like Just in Time and Lean. Calculating the costs can be complex. Many firms overlook significant cost factors due to their complexity.
Many firms outsourced manufacturing to Asia by negotiating with the first supplier to achieve the lowest price. The Asian supplier would then be left to negotiate with other suppliers. These suppliers were often not vetted by the original firm. The result was often a poor understanding of customer requirements by suppliers further upstream. Disastrous quality failures followed.
Some might argue that firms have a clearer vision now and better understand now how to distribute manufacturing processes around the world. Costly mistakes are informative but no substitute for deeper calculation. The contention that firms have learned enough from their mistakes simply is not true.
The US, for example, is often criticized for over regulation. One does not have to look very far, however, to see catastrophic examples of what can happen when companies do not act in a socially responsible manner. It may not be illegal or a country may not be able to enforce its regulations but the international media swiftly punishes firms that pollute, use child labor, abuse workers, contribute to environmental disasters, etc. Getting away from US regulations may or may not be a good idea.
Brazil is on the rise. Brazil is known for lower cost labor than the US, a growing middle class, educational investment, significant natural resources, and a growing export infrastructure. Brazil is also considered by many to be difficult to do business with (over protectionism) and challenging for moving product around the country (lack of highway infrastructure).
The protectionism issue is often cited but some Brazilians contend that doing business in Brazil is only hard if you start off wrong. May firms will need an education in doing business in Brazil. To develop the Brazilian brand, the country can look to demonstrate its significant modernization efforts in education (workforce development), the industry clusters forming around energy and other sectors, the large consumer market, and Brazil's interconnectivity to major markets in Europe, Africa, and Asia.
Mexico is known for a highly effective workforce, proximity to US markets, NAFTA involvement, rapidly advancing logistics infrastructure, and the formation of powerful industry clusters ranging from automotive to aerospace. Even though many places in the world have security issues, Mexico has been saddled with a great deal of attention on this issue. Mexico is also often cited for high financing and energy costs.
Mexico has worked considerably on advancing its brand. The country studies and publishes information with cost comparisons to other markets. It runs campaigns demonstrating the attractiveness of its culture and natural resources. This is the right model to follow.
BRANDING AND INNOVATION
The branding process is a constant information push. As the business world becomes more savvy and due diligence failures continue, firms will be looking for deeper analysis to ensure they make the right decision. We must determine what the right manufacturing models will be and frame an argument for the Americas.
There are two perspectives here. One is to encourage firms to locate in the Americas through solid return on investment analysis taken to a granular (industry specific level) matched with the more traditional approaches of promoting culture, lifestyle, labor cost, and transportation.
The second is to leverage that brand position to convince others to buy our exports (further supporting our firms).
In the long term, labor, energy, security, and other differences will stabilize. The only sustainable way to keep exporting is through innovation. Innovation requires knowledge workers, markets ready to adopt new products, and speed to market. The Americas already has the advantage in education, market opportunities, and trade agreements to increase speed. More needs to be done.
Japan was often derided during the 1960's and 70's for cheap products. "Made in Japan" was associated with trinkets that broke easily. That brand has changed.
Japan's concentrated effort on quality and the tremendous media campaign reporting it has created the opposite brand image. Japan now exports high technology products all over the world due to their innovative, high quality image.
It takes more than just making innovative products with a highly skilled workforce. The Americas needs to develop and enhance its brands with a unique blend of return on investment, innovation, and culture. The more we analyze and demonstrate value, the more powerful the brand becomes. A powerful brand eventually speaks for itself.