Supply Chain Efficiency Still Paramount

In what may come as a surprise to U.S. and Canadian importers who have embraced China as a prime source of supply in recent years, the “2011 U.S. Manufacturing-Outsourcing Cost Index” released by Alix Partners identifies Mexico as the number one location for lowest landed-costs for U.S. customers, a fact which should also be of interest to Canadian importers if for no other reason than proximity to our largest trading partner. In fact, not only has China fallen behind Mexico in terms of total landed-cost advantage, the Alix report lists other low-cost countries such as India, Vietnam, and Russia, albeit with higher costs, as now being more competitive than China.

While this latest information is not expected to result in a major shift away from China as a leading source of supply for North American companies, it gives credence to Mexico’s repeat performance as the lowest landed-cost supplier in 2010, continuing a trend towards that country’s competitive advantage since 2007.

Among the many factors affecting manufacturing costs, the Alix report focused on three critical areas for China in the years ahead: wage inflation, exchange rates, and freight costs. One thing all of these factors have in common of course is predictability, or more specifically, “unpredictability” in terms of forecasting accuracy. The Alix study used a number of scenarios in forecasting how this trend will play out in the years ahead, with various calculations for currency fluctuations and wage costs in China. Currency speculation is a subject for economists, but increases in Chinese labour costs is a trend that can already be quantified.

For example, according to the U.S. Bureau of Labor Statistics, hourly labour costs in the manufacturing sector in the U.S. increased by 19% from 2002 to 2008, while the corresponding hourly wage in China grew by 100%. Alix used a scenario based on annual increases of 30% in Chinese labour costs for their comparative analysis of China vs Mexico in terms of landed-costs, which is not unreasonable considering that the average hourly wage for manufacturing workers in China was $1.36 in 2008, about 4% of the average U.S. hourly wage rate and only 3% of the average European hourly wage rate the same year. To put it in perspective, using the Alix forecast as a benchmark, annual increases of 30% would result in an average hourly wage rate of approximately $3.88 in China by 2012.

The impact of rising labour costs in China is already being felt in some industry sectors there. Global- electronics manufacturer Flextronics had approximately 90,000 employees in China in 2010, but no plan to exit that country as labour costs ranged from only 0.5% of sales for computers, to 10% for power supplies. Since 90% of Flextronics’ production was for export, the company’s strategy had been to locate facilities close to Port areas, but rising wages in urban areas had prompted a move to Ganzhou, in China’s inland Jiangxi Province, where wages were lower. A similar strategy was unfolding at Foxconn, Flextronics’ much larger rival. Foxconn, maker of Apple’s iPad, controlled 50% of the electronics manufacturing services market in 2010 and was also reportedly expanding its workforce in inland China where wages were lower.

The other scenario utilized by Alix assumed that freight rates would increase by (no more than) 5% annually. While transportation costs can be as difficult to predict as currency exchange and wage inflation, 5% does not sound unreasonable as a freight component for outsourcing calculations. The question importers should be asking then, is what will they do if transportation cost increases exceed 5% annually? This sets up an interesting comparison between North American surface transportation costs and potential increases in ocean transportation costs, especially now that the U.S. and Mexico are finally trying to enact the cross-border transportation provisions of NAFTA. Nonetheless, the likelihood of annual transportation rate increases in excess of 5% is not only possible, but many would say plausible, since transportation rates are affected by multiple unpredictable factors including seasonality, fuel costs, supply and demand, capital equipment costs, labour rates, etc.

Making long-term supplier selection decisions in the face of such unpredictability is a daunting task for organizations of all sizes, so a strategy that includes contingency suppliers may well be effective. In other words, splitting the supply base and establishing backup in different countries as a method of hedging against landed cost increases and improving supply chain flexibility.

The trend towards Mexico and other countries as cost-effective, low-cost suppliers illustrates the potential gains available to companies that can react quickly to change. Total landed costs are often underestimated by importers however, and securing suppliers in other countries while maintaining quality, capacity, consistency and reliability requires time and careful planning, and should be undertaken sooner rather than later.

Importers must also keep in mind that locating product suppliers is only the first step. Another prime consideration is logistics suppliers, companies capable of providing integrated services such as customs brokerage, transportation, distribution, documentation and risk-management/compliance capabilities to support the importer’s objectives in increasing competitive advantage.

Posted by: Laurie Turnbull, CITT, P.MM – Supply Chain Consultant, Cole International

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