Managing the Complexities in Reshoring/Nearshoring

By AlixPartners

In shifting their production facilities, companies can realize projected
gains by following eight key tenets. But even as such opportunities for gain have grown more attractive, the steps required to succeed at them have become more demanding. A decade ago, deciding where to base manufacturing operations was relatively easy. Labor in low-cost countries such as China, Malaysia, and Vietnam was so inexpensive that companies could generate bottom-line benefits even factoring in higher transportation and inventory expenses and lower productivity. However, the gap in labor costs has closed, quality considerations have become dramatically more important, and companies in a variety of industries are increasingly shifting manufacturing away from Asia and back to either the United States (reshoring) or Mexico (nearshoring). Nearly all of the respondents to our annual nearshoring survey confirm that their nearshoring decisions are as important as or more important than they were a year ago (figure 1).

The survey, now in its fourth year, gauges current executive thinking regarding manufacturing and sourcing. More than 40% of executives participating in the survey (down slightly from prior years) indicated that nearshoring is a possibility whereby their companies could better serve US demand; of that 40%, 86% said they’ve already begun the process or expect to within two or three years (figure 2). However, the decision to shift production from a far-from-market facility to a closer facility is complex, and companies must factor in (1) changes to the current supply base, (2) customers, and (3) the expected return on investment (including relocation costs). And management teams are increasingly taking note of the economics associated with those undertakings.

Changing economics

One reason for today’s greater complexity is that the cost benefits from manufacturing in Asia have eroded. Wages in China have been rising 5 to 10% annually in recent years—a trend that is expected to continue as demand for factory labor outpaces the supply of workers in the manufacturing centers of coastal China. In fact, many of the country’s major municipalities—where the bulk of manufacturing and assembly is done—have instituted 10% annual increases in the minimum wage. Shanghai’s minimum wage has increased from RMB960 per month at the beginning of 2010 to RMB1, 820 in fall 2014—
an increase of nearly 90% in less than five years.

In addition, appreciation of the yuan against the US dollar has made production in China less attractive for US companies. Since 2005, the yuan has gained 31% versus the US dollar— even with the dollar’s recent pullback in fall 2014.

As Asia becomes less attractive, Mexico has become more so. The annual Manufacturing Outsourcing Cost Index conducted by AlixPartners shows that China held a clear advantage over Mexico and India back in 2005 for fabricated metal parts; since then, China’s cost advantage has been deteriorating. Mexico (along with India) is now among the least expensive countries for the manufacture of US-bound products, with an advantage over China that is growing bigger (figure 3). For plastic molded parts, the story follows a similar pattern, with Mexico now among the cost leaders. Producers that effectively exploit the cost differential might enjoy a competitive advantage compared with producers that continue to source from suboptimal countries.

Clear risks ahead

Program execution is as important as the decision itself regarding where to locate manufacturing operations. A global vertical transportation systems manufacturer’s recent efforts to return production to South Carolina from Mexico provide a cautionary tale. In late 2012, the company began a program to close down its factory in Nogales, Mexico, and relocate the production to South Carolina. The program was supposed to save money and reduce order lead times by locating production closer to customers and design engineers. But the plan fell short of expectations for several reasons.

First, the company eliminated several product lines to reduce the number of base elevator types in the United States from seven to three. At the same time, the company was upgrading its enterprise-resource-planning system, which handles all of the manufacturing, supply, distribution, and financial data. The company also closed down two other US factories and transferred the workers to South Carolina to staff the new facility, along with local workers.

All three factors introduced execution challenges, and as a result, production at the new facility ramped up far more slowly than the company had expected. The company’s order backlog grew to the point where some customers cancelled orders. To keep up with demand, the plant in Nogales was forced to remain open six months beyond the originally planned closure date. The delays cost the company at least $60 million and depressed company earnings into 2014.

Rigorous planning is critical

Any effort that relocates production operations, such as reshoring or nearshoring, has the potential to significantly disrupt the existing supply chain. Myriad details—such as shipping and packaging requirements, quality approvals, and workforce training—require careful planning and execution; and shortchanging the planning or executing the transition too quickly can have disastrous results. To complicate things even further, most often those tasks are layered on top of key managers’ existing responsibilities, meaning that both their extra tasks and their day-to-day job duties might suffer by not receiving the full attention they require.

Based on recent client engagements, we have identified eight planning and execution tenets that are critical to ensure companies realize the efficiency targets they’re aiming at by reshoring or nearshoring.

  1. Review the business case. There are many hidden—or, at a minimum, uncertain—costs in an outsourcing project. Many of them can be closely estimated by taking the time to obtain quotes from suppliers related to the move. Such estimates are especially critical for large, repetitive costs like equipment rigging and transportation and refurbishment of any older equipment that needs to be transferred.
  2. Be practical. Start with the biggest opportunity, and give priority to the moves that make the greatest business impact. Analyze rigorously and prioritize ruthlessly— based on financial and operational analysis—to identify the things with the greatest potential impact.
  3. Search globally for sourcing partners, but don’t neglect your own neighborhood. To get the best pricing, companies need to cast a wide net when sourcing—often looking to low-cost countries such as China, Vietnam, and Mexico. However, local suppliers can sometimes be very competitive with those alternatives while also providing the additional benefit of a much smaller and more flexible supply chain.
  4. Establish the right legal entity. Local corporate and tax structures can significantly affect the financial performance of outsourced operations. As a result, you need to make these decisions well in advance of initiating a move, so that the tax and accounting implications can be integrated into the business case. (For example, the paperwork required to establish a maquiladora in Mexico can extend beyond reasonably expected durations.)
  5. Be aware that inventory equates to time and customer service. The only way to manage the transition is through adequate inventory banks, which have to be managed daily at the stock-keeping-unit (SKU) level to prevent shortages and manage transition activities. That task alone is generally well beyond the bandwidth of most internal planning managers, who already have full workloads.
  6. Make your plans—which are essential, of course, but which need to be flexible. The entire project needs thoughtful planning, but those plans should have the flexibility to cope with inherent uncertainties in demand and supply. Similarly, financial projections must take into account all of those uncertainties, and project managers must be given the authority to make broad decisions regarding timing so they can keep the project on course.
  7. Risks are everywhere; manage the critical ones. Every project is unique, but all of them have common risks. For example, start-up challenges, quality defects, and supply delays are all relevant in virtually every relocation project. Success often hinges on companies’ understanding of the specific dynamics in order to evaluate relative risks and take mitigation steps.
  8. Institutionalize the improvements. Management must be responsible for oversight. Improvements need to be formalized through standards and planning so that any backsliding is clearly visible and can be addressed. This requires strong emphasis on basic management processes and discipline to avoid supply gaps and ensure that project savings actually translate to the bottom line.

Case study: Solid execution leads to shareholder value

In 2013, a private-equity-owned manufacturer of automotive aftermarket components faced declining revenue and eroding margins. Competition had increased, and the company’s customers were expecting lower prices. In response, management assessed the company’s manufacturing operations and identified a number of areas where it could reduce costs in order to remain competitive, including relocating production to Mexico. However, the company recognized that achieving the projected savings—on time and on budget and while preserving critical standards for quality and customer service— would be a significant challenge involving a complex set of interrelated activities.

The original plan called for outsourcing to two companies in Mexico within five months all of the downstream injection molded metal components used in the assembly of end products. In total, the plan encompassed about 800 SKUs. Senior executives reviewed the plans, dug into the production processes, assessed the risks, and realized that the project would require much more detailed and rigorous planning and oversight than they had anticipated. As a consequence, they programmatically applied the aforementioned eight tenets.

The executives realized inventory equates to time and customer service.
Specifically, the company’s inventory planners and production team would need to monitor inventory levels for all 800 SKUs affected by the project. Such a detailed approach let the team plan and adjust production schedules to accommodate some large, unplanned orders that threatened to disrupt customer service at the outset.

The executives were practical.
More important, the team would need to revise the scope of the relocation. The original plan would have outsourced all of the plastic parts to a molder in Mexico. After a more detailed review of the end products and customers those plastic components fed, the team realized that the original plan would have to be revised and updated to account for the supply of items to OEMs and their more-stringent quality and part approval processes. The analysis found that the company could still outsource more than 90% of its production capacity without moving the OEM parts.

In the end, the company moved more than 750 of the originally planned 800 SKUs without any disruptions to customer orders. The timing, initially estimated at five months, was stretched to just over six months to account for changes in the plan that would mitigate risks, enable it to handle inventory buildup, and enable it to fill several large, unplanned customer orders. Ultimately, the project delivered $8 million in annual savings beginning in 2014—nearly twice the targeted amount on which the program had been predicated—and justified.

A systematic approach

As the economics of outsourcing, nearshoring, and reshoring evolve, companies have more options than ever regarding where to base their manufacturing operations, but determining the best solution—and executing the changes—are correspondingly more complex. By applying the tenets set forth here, companies can de-risk their projects, thereby ensuring that they can continue to serve customers while locking in projected gains.