Don’t write off U.S. manufacturing

Posted on Written by Reagan Haynes

42_manufacturing_01Amid rising labor, shipping costs, some companies bring production back from overseas

There are two sides to every coin. Television pundits fret about rising oil prices and the weakening of the dollar against other currencies, but those are two of the factors giving U.S. companies second thoughts about the advantages of manufacturing abroad.

Just when manufacturing was declared all but dead on U.S. soil, some companies are cutting their losses abroad and bringing manufacturing back home — a phenomenon known as reshoring. It’s probably too soon to label this a trend, particularly in the marine industry, but some marine companies are deciding it’s cheaper to manufacture domestically once they factor in long lead times, reduced efficiency, shipping expenses and rising labor costs abroad.

43_manufacturing_03“There’s stuff we’re moving back to the United States because we can do them more economically here,” says Jim Self, director of Mallory Marine Products, an Ohio-based company that specializes in replacement parts for inboards and outboards.

He says the shift is driven by a strengthening of the Chinese currency and increasing labor costs there. In addition, fuel and freight container costs have risen significantly during the last year, Self says. Factor in drastically longer lead times that create a need to sit on more inventory, and building in America seems increasingly appealing, he says.

“All of those things add up to what can be considerable differences in costs,” Self says.

As a result, Mallory is moving some of its manufacturing in China to its Cleveland and Mexico facilities and plans to move even more to Ohio, as well as to manufacturing facilities it contracts with around the United States.

Those are some of the same reasons why the Boston Consulting Group, a management consulting firm with 75 offices in 42 countries, predicts that companies will increasingly bring the manufacturing of goods targeted for American consumers back to the United States from nations such as China.

Vacant plants

Although 95 percent of American boats are built on U.S. soil, according to data from the National Marine Manufacturers Association, the industry is fragmented and relies on all types of parts and goods from a long and complex supply chain. As some suppliers begin to bring operations back to the United States, there also are global boatbuilders that recognize the benefits of manufacturing domestically.

Peter Johnstone, founder of high-end sailing catamaran builder Gunboat International of Bristol, R.I., recently bought a former Buddy Davis Boats manufacturing plant in Wanchese, N.C. The 36,000-square-foot plant is on the water and came at a bargain price because so many builders walked away from yards during the recession, Johnstone says. “There are a number of very impressive facilities available for a lot less money than it costs to develop [new ones],” he says.

43_manufacturing_04Gunboat is still building its 60-footer in China because the market there shows promise and because Gunboat and its partner yard in China have invested in full-production tooling there. But the 55 will be manufactured domestically, creating 71 jobs during the next 18 months, Johnstone says. “Northern Florida and North Carolina [are] probably two of the most productive and efficient places to build boats right now,” he says. “I’m not sure of any other place that can touch those two.”

Tipping points

Mike Zinser, a Chicago-based partner at the Boston Consulting Group, co-authored a report in March titled, “Made in America, Again: U.S. Manufacturing Nears the Tipping Point — Which Industries, Why and How Much?” The firm looked at “tipping points” in various industries, the points at which it no longer makes fiscal sense to keep operations in China, using “conservative projections” regarding labor costs, currency and demand issues, as well as other criteria. It then examined the advantages of bringing operations to America.

Boston Consulting Group looked at U.S. industries (designated by government agencies such as the U.S. Bureau of Economic Analysis) and identified seven that are close to their tipping points. Among them: transportation goods, which include boat components, Zinser says. The others are computers and electronics, appliances, machinery, furniture, fabricated metals, and plastics and rubber. Those where it still makes economic sense to stay offshore include apparel, textiles and fabrics, the report indicates.

“I think if you look at examples of companies reshoring to the U.S., the factor of costs is important, but in almost every case there was something else involved, too,” Zinser says. “It could be quality issues — they wanted to be closer to the customer to be more flexible — or it could be, ‘I just got tired of doing conference calls at 2 a.m.’

“When the primary argument for going overseas is shrinking, those other issues become more pronounced,” he says. “Our expectation is these trends playing out should cause companies to rethink where they choose production.”

Mallory Marine, which is part of a larger company that also focuses on auto components, is expanding electronic capabilities to bring some of that manufacturing back. “Just because we get an increase in costs doesn’t mean we react immediately,” Self says. “It depends on whether we think it’s a temporary hiccup or a continuing trend, and if it seems like a trend we look for other options.”

Mallory Marine isn’t the only company that expects the movement to continue on its current trajectory. AmFor Electronics, a supplier to marine OEMs, is reshoring some of its manufacturing, and Yamaha is moving ATV manufacturing from overseas facilities back to its factory in Newnan, Ga.

A productivity gap

In 2000, factory wages in China averaged about 52 cents an hour, or 3 percent of what average U.S. factory workers earned, according to Boston Consulting Group data. Since then, Chinese wages and benefits have risen by double digits each year, averaging increases of 19 percent between 2005 and 2010. In some companies, they rose 100 percent. The fully loaded costs of U.S. production workers rose less than 4 percent in that same time frame, and labor unions became more flexible in wage negotiations, the report says.

43_manufacturing_05Chinese labor costs are expected to continue climbing. Boston Consulting Group estimates that workers there will see 18 percent-per-year wage increases through 2015, making them effectively about 25 percent of what U.S. skilled workers earn in low-cost manufacturing states.

The availability of skilled labor in North Carolina was a large part of what attracted Johnstone to the area. “The labor in China is about $4.50 an hour for boatbuilding right now and I think you can safely say it takes them four times the hours to do anything, so you’re up to an $18-an-hour rate,” Johnstone says. “In North Carolina, labor probably averages out at $14, so we think it’s cost-effective in the U.S. already.”

The productivity-adjusted wage gap has been narrowing for the last few years, Zinser says. “If we play those trends out over time, recognizing that labor is only a fraction of the total cost of product, does that lead us to the point where you get to single digits?” he asks. The answer is yes, he says, and that’s before factoring in the costs associated with having a longer supply chain.

Quality control

Overseeing quality in a country such as China is challenging, Johnstone says. “There are no standards and no recourse if someone ships you crap material, so all the materials have to come from the United States or Europe,” he says. “So you’ve got to ship it all there and ship it all back.”

Simple materials such as stainless steel aren’t simple in China, where there aren’t regulations on grades such as 316 and, as a result, they’re often inaccurate, Johnstone says. “There are a lot of vendors that have gone to China for various bits and pieces and I can tell you they’ve all had trouble maintaining the materials and the final quality control,” he says. “You need a bilingual person over there making sure the standards are met and everything has to be well-documented. It can work, but it’s very challenging.”

The downturn has helped magnify those extra costs in a time when companies are looking to cut as much as possible, Zinser says. In the past, manufacturers were able to ignore a higher-percentage defect rate, but with a lingering economic downturn and rising labor costs they are rethinking their bottom lines, he says. The added agility of being able to correct manufacturing errors quickly is another advantage of reshoring that is becoming more appealing, he says.

Supply chain

Then there is the long supply chain. “Historically, because labor costs were so low in China and other parts of the world, those other costs associated with longer supply chains weren’t as evident,” Zinser says. “Now that labor costs are rising, it’s starting to expose costs like less flexible production and six weeks of transit time to get the product to the end market or sitting on excess inventory.”

To eliminate consumer frustration, including OEMs awaiting parts to ramp up production to meet demand, some manufacturers opt to carry more inventory when lead times are longer, Zinser says. Cost-cutting OEMs might start looking for domestic vendors when possible to eliminate the need for that costly extra inventory.

“The lead times in China kill you,” Johnstone says, adding that orders take three months minimum, in addition to the vendors’ lead times.

43_manufacturing_06Yamaha plans to bring the bulk of its worldwide ATV manufacturing operations to Yamaha Motor Mfg. Corp. of America in Georgia by 2013, according to a press release. Doing that will allow the company “to respond more quickly to its customers’ demands while streamlining its supply chain and distribution processes,” Yamaha Motorsports president Henio Arcangeli Jr. said in the release.

Commodity prices

It costs about $130,000 to ship a 35-foot boat from China to a yard in the United States, Johnstone says. “That’s a significant component that may have been OK when labor was $1.50, but when it’s $4.50, it’s gone,” he says.

Mallory Marine has found that some components are actually more expensive to manufacture in China because of rising prices for commodities there, Self says. Brass, copper and rubber, for example, have increased at an inflated rate in China, he says.

“A lot of materials cost more there than here because of such high demand,” Self says, and now the Chinese have more money to spend on goods themselves. “There’s more disposable income as wages go up, so it’s creating more consumer demand.”

Also, it takes extra work to factor in the fluctuating exchange rates between the Chinese yuan — the primary unit of China’s renminbi currency — and the dollar, Self says. And currency values are notoriously difficult to predict. The yuan had been rigidly tied to the U.S. dollar, but the Chinese government allowed it to fluctuate somewhat in 2005 after political pressure from the United States, according to the Boston Consulting Group report. The consensus from analysts is that the yuan will appreciate 3.5 percent annually through 2015. If China were to allow the currency to float freely, it would rise even more dramatically, the report says.

Why the U.S.?

Boston Consulting Group also looked at the appeal of countries such as Mexico, Thailand and Cambodia, but determined that the capacity to increase production on a large scale in those places would be limited, Zinser says. “Even though the cost advantage is there, it’s unlikely they would be able to absorb that production,” he says. “Unless there’s already a cluster, is the economy and infrastructure there to support an industry?”

43_manufacturing_07In Central and South America, there are perceived safety risks that also might deter manufacturers from relocating.

The labor markets and productivity rates are also significantly more favorable in certain areas of the United States, particularly the Southeast, Zinser says.

“U.S. workers have more experience operating sophisticated, highly automated production lines and tend to stay in jobs much longer,” the report says.

Johnstone agrees that job loyalty is greater in the United States than in China. “There’s so much pressure on labor rates in China, it’s depressing,” he says. “Chinese workers are the least loyal workers I’ve come across. They’ll change jobs for 20 cents more an hour and you’ve just spent six months training them.”

Based on the rate at which labor costs have risen in Western Europe — U.S. wages are projected at only 67 percent of those in Germany by 2015 — Boston Consulting Group even anticipates some manufacturers there looking to expand production in the United States. It will also make U.S. goods more marketable to other countries.

Increasingly, products aimed at an American consumer will migrate back to America, Zinser predicts. “It doesn’t mean I’ll close my factory in China; it means I’ll repurpose my factory in China to serve an Asian market,” he says.

“The winners are building flexibility into their supply chains now,” Zinser adds. “For those companies planning to add new production capacity to meet demand in the U.S. market, it probably is time to take a fresh, hard look at the U.S.”

This article originally appeared in the May 2012 issue.

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