COVID-19 shined a harsh spotlight on the US — not just on its healthcare system, but its ability to address health emergency, economy and also on its supply chain. From product shortages to capacity constraints in the freight sector, the coronavirus pandemic has impacted supply chains continuously, affecting everything from toilet paper to semiconductors and bringing certain industries to a standstill.
COVID-19 proved a rude awakening for many American companies, particularly those that over the years had offshored production to China and other countries in the Far East. One consequence of the disruption has been that offshoring — once the holy grail of manufacturing and operations — has lost some of its luster. Confronted by the logistical risks along with the rising labor costs in China and the Far East and shipping costs, the economics of being so far away from your base is no longer a slam dunk. Plus, around the world, social, political and geo-economic influences—such as the tariff war between the US and China — are happening more frequently and with much greater effect, having a big impact on businesses.
As a result, companies are re-evaluating their supply chain and business models and are considering the notion of nearshoring or onshoring their operations. Businesses are looking hard at technology, data, locations and manufacturing. And they have begun the process of creating a layer of insulation, which includes using things like nearshoring, to minimize that risk and help lay a foundation for their business to grow.
The shift to nearshoring
Nearshoring — that is, the idea of bringing your production closer to the end destination point — is not a new phenomenon. Indeed, it has served as a counterpoint to globalization and of the movement of US companies to take advantage of cheap labor in China and the Far East. [See: “Nearshoring: The historical backdrop.”]
But the pandemic has turbocharged the argument against offshoring: While the initial appeal of offshoring may have been low labor costs in the Far East and China, recent data shows that the costs of labor in those countries are rising. In addition to the rising costs of labor, the costs of shipping, tariffs and other duty fees are on the rise.
Finally, many companies were unable to control the variables of offshoring and have been caught flat-footed. While some companies were well positioned and had taken action well ahead of the disruption of 2020, the broad base of manufacturers and value adders were unprepared.
Nearshoring: The historical backdrop
Nearshoring is not a new idea. Indeed, there was a surge in nearshoring about a decade ago. Prior to that, the impetus of US companies to expand internationally was to take advantage of a lower cost of labor and reduce their total applied costs. In this case, make products in China where cost of labor is low, put it on a boat and ship it over to the US.
But in 2011, the tsunami hit Japan, which put a significant portion of the industrial base of Japan literally underwater. It disrupted the industrial sector with everything that Japan touched, either as a component maker, a semiconductor supplier, or fully finished goods such as cars and appliances. This disruption in the supply chain and damage to the transportation system led to a drastic drop in Japanese exports in manufacturing goods to US and the world.
The aftershock to the supply chain shook manufacturers, prompting companies to re-evaluate risk in their supply chains. But it wasn't enough for most companies to do anything differently because China had been relatively unscathed by natural disasters.
Now, jump to four years ago: As trade tensions begin to rise between US and China, companies started to reconsider. And as the trade war began heating up, US executives were suddenly facing rising tariffs, a fact most executives had never had to deal with in a meaningful way. The cost of labor in China plus shipping used to make it attractive to manufacture in China. With tariffs causing uncertainty, plus the rising inflation internally to China on the cost of labor, manufacturing in China no longer made as much sense as it used to.
Key elements of nearshoring: It’s all about the data
Nearshoring is a commitment not to be taken lightly. It’s important to start with the question: Is nearshoring right for you? The first step is to evaluate whether making a change to your supply chain from where it is now is a good fit for your company. That means assessing whether or not nearshoring makes sense for you. It is more than simply a theoretical question: Most of the risks and disadvantages of nearshoring have more to do with such factors as poor planning or lack of proper due diligence than the business model itself.
Let the data do the talking:
Companies considering nearshoring have to understand the data that moves their business. Nearshoring offers a higher return on investment and focuses on providing value to the client, rather than providing the lowest possible rates. For nearly two decades, manufacturers of labor intensive products have steadily been offshoring the most labor-intensive aspects of their business to China, where labor was plentiful and cheap. What will it mean to the business in moving operations to a new location? In the case of manufacturer who set up shop in China 20 years ago to take advantage of cheap labor and is considering nearshoring, that company might be hard-pressed to manufacture the product competitively. Even with the cost of labor in China rising, you'd be hard pressed to make it competitively. When you add everything else, including freight, to make it a way you could turn a profit by, say, make it in Mexico or in the US, because the labor difference is so significant. Understanding the data and having a confident model on which to decide what to do.
Geopolitics is economics:
Another key point is to evaluate the nearshoring location on the basis of its history and anticipated future actions as it relates to trade and tariffs. What's the relationship of that country with the United States in terms of trade, tariffs, and commercial, sociopolitical and geopolitical relations? Those are factors that have to be considered so that you don't land in a spot that could just create more problems down the road.
Mirroring:
Companies may want to create a mirror of their operation in some other location — not just to the test the waters, but also to have a well-managed redundancy in their supply chain. So that if an issue happens with their supply chain from China, for example, their nearer mirror operation one in Mexico can still function and provide what they need, at least to some capacity, as opposed to being entirely shut down. The mirroring approach is one that many companies use when they look at expanding capacity, but doing it closer to home than they might have done before.
Nearshoring benefits
The benefits of moving operations closer to home include working in the same time zone, fewer cultural differences, greater cost-effectiveness, proximity allowing face-to-face meetings and faster communication and more timely decision-making and problem solving.
- Time Zone: Proximity allows you to be in a similar time zone, making it easier to have face-to-face meetings and manage work.
- Cultural similarities: Nearshoring operations in neighboring locations like Canada or Mexico tends to lead to fewer differences in culture — and therefore better communications. When it comes to countries in Asia, there is a huge cultural difference with the US resulting in misunderstandings and complications that can slow operations.
- Cost-effectiveness: nearshoring leads to better management, and faster communication, which saves a company a lot of money. However, another factor that contributes to its cost-effectiveness is that talent and labor in other countries may also be cheaper.
- Quicker response time: In addition to fluid management and controls, there is also an indisputable quicker response time. This is because when both parties can quickly communicate and solve problems as they are both active at the same time.
- Flexibility: When a company nearshores operations, they free themselves from those responsibilities, giving them more time and flexibility to focus on other aspects of the business.
- No relocation necessary: nearshoring requires no relocation, meaning a company doesn’t need to invest heavily in new assets like moving to a new office in another country.
- Talent development: Finally, a key consideration for senior leaders is that nearshoring, together with the resulting analysis surrounding the decision, provides an opportunity to develop talent. When a company chooses to evaluate nearshoring and reconsider the things they've been doing for the past 25 years — whether that is either launch a new facility closer to home or wind one down in Asia and spin a brand new one — it is an opportunity to strengthen the leadership team. It provides senior leadership with the opportunity to help your team hone its skills of foresight, advanced planning, the use of sophisticated tools to model and take a data-driven approach to making a decision that's complex and can actually change the business.
This, in turn, resonates with the future generation of leadership: It creates a sense of greater purpose as to why you're coming to work. From a talent nurturing and retention perspective, you're giving an opportunity for someone to potentially change his/her career in a good way.
Nearshoring’s hurdles
Despite its many benefits, nearshoring faces a number of hurdles. Some of those barriers are cultural. For some organizations there is a fear of the new, of change and of taking aggressive action; as a result, companies stay on the sidelines, overcome by inertia and paralysis.
For others, it is a sense that the company has to go it alone. They believe, rightly, that they are the experts on their business and that analyzing and assessing the pros and cons of nearshoring is something they can do on their own.
The problem is that most middle market manufacturers are already resource constrained: their current team already has a full-time day job that draws on all their energy and talents. And while they may feel they can do it on their own — they’re capable of conducting these complex analytics to making assertions about things that they believe they know, like global trade, and be able to model what it should look like before they invest in nearshoring or onshoring — most companies, especially middle market ones, lack the human resources and talent to do this stuff. They're dealing with fighting today's fire. They get suboptimal results in an attempt to try to understand should we nearshore or not, because the people being asked to do the work often find them overworked as it is. The outcome is that the quality of the analysis seldom puts them in a position to make a confident, educated decision. That becomes an unintentional kicking of the can.
Case study
A publicly traded home-improvement products manufacturer historically sold its products to big box retailers, distributors and specialty retailers. Given the backdrop of a predictable demand landscape, the manufacturer set up operations offshore in the Far East.
Suddenly, however, COVID-19 hit, and the demand landscape and the manufacturer’s business model underwent a paradigm shift: People are spending much more time around the house as a result of the pandemic, they’re making improvements to their homes and they’re buying a lot more of these products. Meanwhile, the manufacturer’s big box retailers and specialty distributor customers are changing their approach to order fulfillment from the standpoint that orders are now coming from almost anyone, at nearly any time, and can be fulfilled from almost anywhere. And they’re turning to the manufacturer to fulfill those orders directly.
That’s placed pressure on the organization to figure out how to become an omnichannel player: How do we fulfill orders that look like they're shipping from the big box or specialty retailer, but are actually coming directly from us? We're drop shipping for somebody else.
The company was not structured for it: It lacked the systems, the supply base and the ability to package, label, ship and track was non-existent.
They have put in a patchwork of temporary fixes to meet needs, but it's inadequate for the long term. More importantly, they recognize that business will not go back to the way it was: it’s likely that their big box retailers and specialty shops will continue to rely on them to drop-ship orders direct for them.
They approached us to work with them to help them assess their current capability to respond to their customers’ needs. Based on the gaps, what should the ideal omnichannel design look like, then help them design that, simulate it and then help them launch it?
Looking towards the future
Supply chain disruptions have been present since the onset of the COVID-19 pandemic, impacting different companies at different times for different causes. Most recently, a semiconductor chip shortage has curtailed car manufacturing, constraints in steel production have led to sharply higher prices, and COVID-19-related absences have created bottlenecks in logistics networks. As COVID-19 continues to confound the global economy and because the path of the virus remains unclear, supply chain disruptions will continue to evolve for the foreseeable future.
As a result, companies are turning to new levers to create a resilient supply chain. Some of those levers include nearshoring, investing in technology and creating new business models. To reduce risk in the event of a black swan event or the next pandemic, it makes sense to explore having your operations closer.
Your supply chain can be either the basis of strength to you, acting as a springboard to growth — or it can be the source of your greatest weakness. Nearshoring brings your products closer to markets, providing you with greater control over operations and technology. It allows you to de-risk the supply chain, helping to create a platform for growth and positioning your business for accelerated profitability. Baker Tilly professionals are prepared to help your business explore if nearshoring is right for their goals.
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