US Insourcing - Trend or empty campaign promise?

Author : Susan Mucha

23 February 2012

Susan Mucha

One hot topic on the US Presidential Campaign trail is “insourcing.” Former Senator Rick Santorum was one of the first to focus on a manufacturing strategy.

The other Republican candidates have addressed manufacturing-friendly policies, as well. President Obama made it a talking point in his State of the Union address and now seems to be taking that talk on the road.

Original equipment manufacturers (OEMs) whose skillful manipulation of the tax code and offshoring have resulted in low or no US taxes, are eager to show projects that create US jobs to dissuade cash-strapped politicians from creating tax regulations that would make them revenue targets.

However, is the US on a path to significantly growing insourcing and/or onshoring (i.e., companies adding back manufacturing or switching from offshore manufacturers to local contract manufacturers) or is this simply campaign rhetoric that will die down after the election?

Anecdotally, I’m seeing double-digit growth in my US-based regional electronics manufacturing services (EMS) client base. I’m also hearing similar stories in offshore companies. There seem to be three main drivers behind sourcing strategy switches. First, costs in China continue to rise and that has driven many OEMs to re-evaluate total cost and also look at long-term strategy. Second, supply base disruptions in Japan and Thailand have magnified the challenges for companies working at a distance and now sourcing teams are more carefully looking at the cost of worst case scenarios in their sourcing strategy. Third, as demand increases so does the price of oil and ultimately transportation/logistics costs.

The end result is that for high volume projects, sourcing globally in low cost labour regions is still attractive. However, projects with lower volumes and marginal savings are being re-evaluated for build closer to end markets. That seems to be true in both the US and in other regions. Most regional EMS providers would tell you the "insourcing" trend for projects that shouldn’t have been moved offshore in the first place, has been developing for several years.

It is less about perceived changes in government policy and more about the latest generation of sourcing teams beginning to understand the total cost of their offshoring choices.

That said, what economic policies would help grow US insourcing and what wouldn’t? Labour cost is usually not the biggest reason companies go offshore. If it were, disciplines such as Lean manufacturing that enable companies to produce more with less workers would keep the U.S. competitive. U.S. companies have several drivers of cost:

• Tax policies – Many offshoring sourcing policies look at overall tax reduction or the lowering of cost through accessing manufacturing firms subject to lower taxation, so tax incentives to stay onshore and create additional US jobs would be attractive. However, punishment for offshoring would likely hurt US competitiveness, since many companies are best served by a combination onshore/offshore strategy.

• Healthcare cost – Talk to manufacturing executives about out-of-control costs and health insurance will be near the top of the list. In the US, employers are the primary providers of health insurance and most employer-provided plans insulate employees from the true costs of their health care so they have little motivation to help control costs. What we call "Obamacare" has a lot of mandates on services which must be provided through health insurance and no real controls on how much insurers can charge.It also derails efforts to increase costs to consumers that would otherwise motivate them to spend healthcare dollars more wisely. Adoption of policies which motivate more efficient and cost-controlled access to healthcare would improve U.S. competitiveness in this area.

• Regulations – In the US, employers are regulated and taxed at local, state and federal levels. Cash-strapped government entities often see fees, penalties and hidden taxes as a way to raise revenue and this drives increasingly complex regulations and compliance costs. It’s no surprise that states perceived to be business friendly are growing faster than those who see business solely as a source of needed revenue.

• Qualified labour – For over a decade, the US migration to a service economy has been hailed as the right strategy for creating higher paying jobs. That mantra finally seems to be dying a well-deserved death. However, during that period, students shied away from training that would prepare them for a manufacturing career. Manufacturing-related technical curriculums at the community college level were cut back, as well. The end result is that there are fewer skilled workers available to support a surge in manufacturing and many industries such as machining must depend on an aging and expensive workforce. More emphasis on manufacturing company-community college partnerships would definitely improve this area. Another less popular move could be a well-structured temporary work visa programme which focused on importing skilled labor in areas where there was limited domestic supply.

• Supply chain – As volume manufacturing has moved to Asia, so have significant pieces of the supply chain. Materials are often 65-70% of the product cost, so re-establishment of a strong component supply chain is critical to a competitive US manufacturing strategy.

• Tort reform – Rising legal costs have also helped drive jobs offshore. Wrongful termination, workplace injury, sexual harassment and discrimination lawsuits are all easy to file in the US and since juries are generous, businesses often settle even unjustified claims to minimise costs. Finding a way to protect workers who are legitimately wronged by an employer, without necessarily providing huge cash settlements for each complaint would lower costs dramatically. However, given the abuses found in many government-managed workmen’s compensation systems, this will be one of the most challenging areas to address fairly for both employers and workers.

• Intelligent trade policy – Up until China starting devaluing the yuan, logistics costs kept less labour intensive or lower volume projects onshore. The yuan devaluation leveled the playing field by cancelling out the logistics cost differential. A free market policy only works when everyone plays by the same rules.

The fact that low cost regions eventually experience wage and other cost inflation as they grow in popularity will ensure that there is always some motivation for insourcing cycles. But, unless the issues above are systemically addressed in a unified process, it is likely that insourcing trends will resemble the pattern we’ve seen over the last decade: when demand is variable and the cost of working at a distance appears to be increasing, marginal projects will move back onshore. The driver is not US presidential campaign rhetoric, but instead market dynamics.

It is significant to note that while the cost drivers above do impede a massive manufacturing resurgence they don’t prevent innovative companies from staying competitive when all costs are measured. It is positive that we are having a national discussion on the value of manufacturing.

Perhaps I am simply uneducated or just not well enough travelled, but I have yet to visit a strong economy that did it on the service sector alone. I welcome this campaign rhetoric and hope the eventual winner decides to give this area of the economy more than lip service and photo ops. I suspect there are a lot of engineers and production workers that feel the same way.

As always, the opinions expressed in this column are those of the author and do not necessarily reflect those of EMTWorldWide. If you would like to comment on this article please contact the editor at alistair.winning@imlgroup.co.uk.


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