U.S. Small Businesses Reevaluate China Outsourcing Strategy

by: Alpha Author

Fascinating read in the March 2011 issue of Wired magazine documenting an increasing trend among U.S. small businesses: They seem to be bringing manufacturing work that had been outsourced to China back stateside (see Small Businesses Buck Trend, ht Jon).

According to Wired:

For U.S. firms, the decision to manufacture overseas has long seemed a no-brainer. Labor costs in China and other developing nations have been so cheap that as recently as two or three years ago, anyone who refused to offshore was viewed as a dinosaur, certain to go extinct as bolder companies built the future in Asia. But stamping out products in Guangdong Province is no longer the bargain it once was, and U.S. manufacturing is no longer as expensive. As the labor equation has balanced out, companies—particularly the small to medium-size businesses that make up the innovative guts of America’s technology industry—are taking a long, hard look at the downsides of extending their supply chains to the other side of the planet.

“Companies are looking to base their decisions on more than just costs,” says Simon Ellis, head of supply-chain strategies practice at IDC Manufacturing Insights, a market research firm. “They’re looking to shorten lead times, to reduce the inventory they have to carry.” When accounting giant KPMG International recently asked 196 senior executives to list their top concerns for 2011 and 2012, labor costs ranked below product quality and fluctuations in shipping rates and currency values. And 19 percent of the companies that responded to an October survey by MFG.com, an online sourcing marketplace, said they had recently brought all or part of their manufacturing back to North America from overseas, up from 12 percent in the first quarter of 2010. This is one reason US factories managed to add 136,000 jobs last year—the first increase in manufacturing employment since 1997.

The U.S. certainly isn’t on the verge of recapturing its past industrial glory, nor can every business benefit by fleeing China. But those that actually build tangible goods should no longer assume that “Made in the USA” is an unaffordable luxury. Unless a company is hell-bent on selling the cheapest goods possible, manufacturing at home makes more sense than it has in a generation.

This is not inconsistent with the anecdotal evidence that I have gathered from my interactions with managers. I have found that managers typically overestimate the benefits of offshore outsourcing (i.e., the ability to access cheap labor) and underestimate its costs (e.g., those born out of cultural, political, economic, and regulatory differences across countries). Unfortunately, many only learn the hard way – they commit to the outsourcing strategy before they discover the costly mistake.

The article continues:

Once they do [outsource], these businesses often realize something profound: China isn’t the great deal they expected. A January 2010 survey by the consulting firm Grant Thornton found that 44 percent of responders felt they got no benefit from going overseas, while another 7 percent believed that offshoring had actually caused them harm. One big reason for this growing dissatisfaction is quality… In addition to quality issues, subcontracting also exacerbates a second major problem with Chinese manufacturing: the lack of safeguards on intellectual property… Finally, sheer distance remains an intractable problem.

The Wired article provided a nice read, touched on some important points, and offered some interesting vignettes. I encourage you to take a look for yourself.

That said however, the issue is not all that new. It is reflective of a long-standing debate in the international business literature, and reminds me of a similar article written in the Harvard Business Review nearly 25 years ago (see Manufacturing Offshore is Bad Business).

Although I agree that there are compelling business reasons to consider offshore outsourcing, it is also important for managers to recognize that the practice is not without strategic consequences.

Disclosure: No positions

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