Texas has become a manufacturing juggernaut, trailing only California in total manufacturing output and employment. To support its manufacturing, Texas imports almost $400 billion in products, parts and commodities. Oil and gas related products are the foundation for the state’s manufacturing, but there are other significant sectors including: computers, semi-conductors, aerospace and motor vehicles. To achieve this level of commerce, aggressive global sourcing has become a necessary, complex and integral part of the supply chain process.
Searching around the world for products and components is referred to as global sourcing. Low cost country (LCC) is the designation for a country with low landed cost relative to other countries. A landed cost is the total cost of a product once it has arrived at the buyer’s door. Landed costs include the original cost of the item, all brokerage and logistics fees, complete shipping costs, customs duties, tariffs, taxes, insurance, currency conversion, crating costs, and handling fees. Not all of these components are present in every shipment, but those that are, are part of the landed cost.
Once the domain of large or multinational companies, now mid-size and smaller companies actively engage in the process. Lowest landed cost, higher quality, improved engineering and manufacturing capabilities, innovation and a way to spread risk are the reasons why global sourcing is so important.
Offshoring, Nearshoring and Onshoring
Most everyone is familiar with the term offshoring – it refers to going to distant countries, primarily in Asia – for manufacturing; nearshoring refers to near-by countries such as Mexico; and onshoring refers to bringing back manufacturing to the U.S.
While there has been a lot of hopeful discussion about bringing manufacturing back to the U.S., but for the vast majority of industries, this is not a viable option. Offshoring to Asia is the dominant component of global sourcing today with China leading as the big destination country. China is by far the largest and most experienced source country for products and the reasons are substantial. China has the best infrastructure, quality systems, manufacturing expertise, engineering support, seven of the top ten busiest container ports in the world, and they are still price competitive on most products.
Kinks, however, are starting to show in China’s ability to be the dominant player in years to come.
Problems with the Dragon
Wage rates have been increasing at 15-20 percent each year in China due to a shortage of qualified workers along the coastal regions and the “Greysia” effect as the population gets older. In the short run, new factories are being built in the interior sections of China where there are still plenty of workers, but birth rates will have to increase in order to remain competitive. The Yuan has strengthened against the U.S. dollar and that trend is expected to continue making Chinese exports less competitive. China eliminated most tax preferences for Western countries, and it lacks strict enforcement of intellectual property rights and endemic corruption. Recent actions have raised fears of reprisals against Western companies pushing back against its trade policies and other interests. In addition, ocean transport costs are much higher than freight rates from nearshore countries like Mexico.
China’s Third Plenum, a four day conference of top Communist officials,recently concluded with reforms that will address some of their problems. The two most important reforms are changes to the One-Child Policy to allow urban couples two children, and introducing market reforms that should open up competition from state-owned enterprises.
China Plus One Strategy
The China Plus One Strategy adds the backup plan element to manufacturing. Companies maintain the bulk of their Asian manufacturing / supply in China, but have at least one other country to hold down costs and dependency on China. This strategy recognizes the reality that China is still the most dominant supplier and has the fastest growing consumer market in the world and adds a backup – just in case.
There are a number of Asian countries emerging from the China Plus One Strategy, but the most important to Texas manufacturers based on their top imports are Vietnam, Thailand and Indonesia. All three of these LCC’s have low wage rates and are highly focused on growing manufacturing capabilities and infrastructure, even though they are many years behind China. Vietnam is especially keen on exploiting the China Plus One Strategy. All three countries share some of the same challenges: lack of infrastructure, corruption, lack of accountability, transparency and big slow bureaucracies. Thailand and Indonesia also have social instability with anti-government forces and terrorism. Indonesia has had travel warnings posted by the U.S.
Mexico (nearshoring) is the most important non-Asian country source especially for Texas manufacturers and Mexico is also the beneficiaryof China’s growing problems.
Mexico has long been an LCC and has significant infrastructure and diverse manufacturing base. Mexico graduates 115,000 engineers each year and its close proximity (nearshoring) to the U.S. reduces travel time and freight costs over Asian countries – a big plus. There is also the NAFTA benefit. For mid-size and smaller companies in particular, Mexico has significant advantages as an LCC over Asian countries. Mexico has its problems too with corruption, slow bureaucracy, lack of accountability and cultural differences, but U.S. manufacturers are moving back to Mexico. U.S. Foreign Direct Investment into Mexico grew from $15.5 billion in 2012 to $35.0 billion in 2013 with much of this investment in manufacturing.
Global sourcing trends in 2014 are driven primarily by events in China. The author acknowledges that some industries have focused their sourcing on other parts of the world, but Asian countries and Mexico are still the most important to most manufacturers in Texas. China is still the lowest landed cost country and the easiest entry for small and mid-size companies, and has the fastest growing consumer market for those companies seeking revenue growth. Emerging Asian countries like Vietnam are getting a lot of attention. Mexico has reemerged as a primary global supplier with many advantages over Asian countries.
Lee Mulkey is the Founder and CEO of ALM Company, an advisory firm serving global manufacturers, distributors and marketing organizations. Lee has served as President and CEO of three global companies. He earned his BBA from University of Texas at Arlington and MBA in International Business from the University of Dallas. www.ALMCompany.com
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