Low-cost labor: Think hemispherically
By Patrick M. Byrne -- Logistics Management, 9/1/2007
Chances are your company gets at least some, if not most, of its parts or materials from outside the country. It’s also probable that your company’s global sourcing or manufacturing choices were originally based on the availability of low-cost labor. That’s because the traditional view has been that countries or regions with the lowest cost labor are the best places from which to acquire manufactured goods and services.
However, a new dynamic is shifting the landscape of global operations: In many traditionally low-cost countries, labor costs are rising quickly, especially when denominated in U.S. dollar terms. This is what happens when demand starts to catch up with supply. Unfortunately, companies that assumed the permanence of inexpensive labor and underemphasized the impact of other costs, such as raw materials, transportation, and energy, may be stuck with long-term contracts.
Consider that 17 percent of the iron ore that China uses comes from Brazil. It’s shipped across the Pacific and then made into product in China. Many of the finished goods are then sent back to the Americas. The rub is that, when you add up the incremental transport, energy, and inventory expenses required for such trans-shipment, China’s labor cost advantage over places like Brazil or Mexico largely disappears. In other words, a whole lot of product is moving an extra 10,000 miles without realizing significant savings.
At the opposite end of the spectrum is a leading electronics company that previously made all of its U.S.-bound televisions in China. Now more than half of that work is once again done in Mexico. Transportation miles have fallen by 80 percent, and the company has reduced inventories and significantly lessened supply chain risk. In Europe, the same trend is in place, with more and more companies sourcing from Turkey and the Near East, rather than from the Far East.
Clearly, a potent trend is taking root: More and more companies are favoring “hemispheric supply markets.” They are placing a greater premium on shorter transport distances, and thus are choosing more on-shore or near-shore locations for sourcing and manufacturing. After all, higher labor rates are inevitable when companies flood a low-cost labor market—and no company benefits by endlessly chasing low-cost labor around the world.
Thinking “hemispherically” avoids the labor-centric mind-set. Predictability and total value potentially rise. Excess handling, inventory, and transportation costs potentially fall. Political, social, and competitive risks potentially ease.
None of this means that globalization is waning, or that most companies have erred by focusing on regions with lower labor costs. In fact, companies, markets, business strategies and supply chains will continue to be more global than ever, and companies with global operating models that are flexible and adaptable will go on outpacing the rest.
What’s different now is the foundation upon which companies make and implement their global operating decisions. Hemispheric thinking is based on the belief that, because of their instability and unpredictability, labor costs should be less of a dominant factor. Moreover, as technology progresses, labor also will represent a steadily lower percentage of most companies’ cost of goods sold.
So, how can companies keep pace? Our view is that every business should first acknowledge the volatility of labor arbitrage—that operating decisions based purely on low-cost labor should be revisited regularly and not be locked in for the long term. The next step is to insist on a total landed cost analysis for each significant product or component. That analysis must be supported by a strong understanding of (and sensitivity to) cost factors beyond just labor and transport.
Net landed costs are typically calculated by combining acquisition and life cycle costs.
Acquisition costs consist mainly of purchase price but also include transportation and fuel costs; materials handling and storage; training (for new suppliers, products or services); technology testing, and approval; supplier qualification; and supplier retooling costs (for new or customized products).
Life cycle costs include maintenance and spares costs; warranty coverage and administration; software and other upgrades; quality; ease of doing business with suppliers; the cost of political and service risk, as well as the impact of these on inventories and customers; and the cost of asset disposition at the end of a product’s useful life.
A third step is to make network modeling a core competency. Any time your company adds a new product, supplier, or demand point, it’s vital to understand the risks and impact on operational performance and profitability. Our view is that sophisticated network modeling exercises are increasingly likely to point companies back toward in-hemisphere operations.
A final suggestion is to accept the gospel of supply chain adaptability. The aforementioned electronics company wasn’t wrong to put manufacturing operations in China. But it clearly was right to build enough flexibility into its supply chain so that when cost dynamics shifted, it was able to make a change.
That, in fact, is the real point of hemispheric thinking. It’s another strategy for thriving in the rapidly changing economic environment that Accenture calls the “multi-polar world.”
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