Offshore Hazards

When doing the financial analysis of “low cost labor” off-shore production or outsourcing, some simple assumptions are often made.

One of those assumptions is that a country that has a history of political stability will continue to do so.

While those of us in the USA may not be all that aware, Tunisia has been a popular location for offshore production for companies in France. On the surface, it makes a lot of sense. The overwhelming majority of educated Tunisians, and a large percentage of the population, speak French.

I can only imagine, in one company in particular, the scramble going on as critical parts of an already weak supply chain are being disrupted by the sudden political upheaval there.

Then, of course, there is China. As my long time readers know, I spent a great deal of time there a few years ago, and started to develop a better sense of what they are about. The USA and China will be sorting out their relationship for the next few decades because China is changing fast.

And that is the point. Those careful financial analyses tend to assume that the future will be much like the present, or at least there will be a linear progression.

Of course the Chinese themselves are interested in moving things along much more quickly, but in their own way.

The government takes a much more active role in the economy, and we are seeing a new model emerge – “government sponsored capitalism” for lack of a better term. There is a clear industrial policy, and bluntly, a stable supply of cheap plastic “stuff” for U.S. consumers is only a side effect, not the purpose.

So it did not surprise me to read this story:

American businesses are nervous about the Chinese New Year

 

There are a couple of key points, the gist of the article is about the annual two week shutdown of just about everything in China as factory workers go home for the holidays.

This time, though, the concern is that many of them will not return as there are new government incentives for rural workers to remain in rural areas.

The low-cost factories that sprung up everywhere in the run-up to the recession died off just as quickly when we stopped buying stuff. The infinite capacity model no longer holds.

But the long-term ramifications are actually at the end of the article:

Manufacturing of high-margin clothing goods such as denim and swimwear is growing in southern California.

"Ordering these items from China can take 12 to 16 weeks," Cohen said. But by making these items domestically, retailers can replenish their inventory much faster.

Some electronics manufacturers are shifting some production to Mexico. Others are bringing production of household goods back to the United States.

The Container Store is looking for alternatives to China, including Vietnam, Indonesia, India and Thailand.

"We also source 30% of our plastic products in the United States," said Williams.

"We want the best quality products. Sometimes that’s still only found in China," she said. "But for us, a delay in shipment, or no shipment is also a serious problem."

What we are seeing is businesses starting to wake up to some realities. Unit cost means nothing if you can’t get the stuff when you need it. And three and four month lead times means your sales and operations planning had better be dead-on, because you HAVE to sell what you predicted.

If you are relying on your supply chain management to substitute for the bulk of your production, then your supply chain management had better be world class. Sadly, companies with weak production management – the ones who see offshore as the “solution” tend to also have weak supply chain management.

We can also see Chinese companies quickly starting to emerge in their own rights, designing and selling innovative products rather than just being a contract manufacturer. They are learning, and learning fast… much faster than the Japanese learned in the time leading up to the late 1970’s when “Made in Japan” came to mean all of the best stuff.

What this means for business in the USA and Europe is that they, too, have to learn fast how to (again) stand and compete on our own – they have to decide to become good at operations rather than pretending they can simply design something, and have someone else make it for them to sell. If they are competing against another company that can design AND produce, they will be at a disadvantage because most of the value is created in production.

The next ten years will be interesting times. I’d suggest taking a page or two from a global company that, while it has certainly had its problems lately, succeeds while building product in the same labor market where they sell it.