COVID-19 outbreak underscores U.S. need to bolster supply chains, reduce dependence on foreign trade
By Michelle Comerford, Biggins Lacy Shapiro & Co and Harry Moser, The Reshoring Initiative
The COVID-19 pandemic has been the most dramatic driver of personal behavior change and economic turmoil in the last 50 years. Its most notable impact going forward may be on global manufacturing footprints. The severe negative impacts of the pandemic will lead to renewed economic growth and stability if the country learns from this crisis.
The reshoring movement started around 2010 and, for some companies and industry sectors, grew strongly through 2017. The disruptions and shortages caused by the global shutdowns cast a brighter light on the risks associated with a complex global supply chain. A recent report by the United Nations Conference on Trade and Development (UNCTAD), as cited in a recent Wall Street Journal article, stated, “The COVID-19 outbreak will potentially accelerate existing trends of decoupling and reshoring driven by the desire…to make supply chains more resilient.”
A recent survey of over 1,000 manufacturing companies conducted by Thomas, an industrial sourcing service provider, found that over 50 percent of manufacturers are “likely to extremely likely” to bring production and sourcing back to North America post-coronavirus. Additionally, as a result of the virus’ global impact, 47 percent of U.S. manufacturers report they are now seeking new domestic sources of supply.
It is important to note that de-globalization was already happening before the coronavirus brought the world to a grinding halt. Due to rising costs, increased risk, geopolitical turmoil, trade wars, increased recognition of costs, risks and environmental concerns, global supply chains that were once so appealing were becoming less attractive.
In 2011, Boston Consulting Group (BCG) authored a study titled, “Made in America, Again,” which highlighted a number of global economic factors shifting in favor of U.S.
manufacturing. The report noted that the trend at the time was “in its early years,” but concluded that within five years, “rising Chinese wages, higher U.S. productivity, a weaker dollar, and other factors will virtually close the cost gap between the U.S. and China for many goods consumed in North America.” Ultimately, the report concluded that for many products sold in North America, the U.S. would become a more attractive manufacturing option and predicted a shift in capital investment. While the U.S. has not completely closed the cost gap on most products, about 60 percent of reshoring has been from China. Nine years later – and in the wake of a global pandemic – U.S. manufacturing’s stock continues to rise. Factor in geopolitical advantages, and a push for reshoring will accelerate.
Over the past three years, the Trump Administration has further accelerated the reshoring trend with lower taxes and regulations, and its implementation of tariffs on certain imported goods. With rising costs in China, the trade wars further compelled some offshore manufacturers to consider domestic investments.
In response to the earlier offshoring trend, Harry Moser created the Reshoring Initiative (RI) in early 2010, to facilitate job growth and increased domestic production. According to Moser, RI was developed after “witnessing over 30 years of increasing U.S. trade deficits and a loss of self-sufficiency.” In fact, the annual rate of jobs coming from offshore, a combination of reshoring and FDI, increased from 6,000 in 2010 to 192,000 in 2017. Cumulative jobs brought back represent about five percent of total U.S. manufacturing employment, as of December 31, 2019.
Moser and the RI continue to advocate reshoring efforts and anticipate an uptick in activity due to the widespread impacts of the current pandemic.
An Unprecedented Blow
In early 2020, the coronavirus outbreak delivered an unprecedented, systemic, paralyzing blow to our tightly linked global supply chains, exposing the U.S. overdependence on imports.
With mandatory shutdowns and worker restrictions in plants across China, many companies were left with an inability to get products/parts/supplies sourced from China to the U.S. market. One report from Dun & Bradstreet indicated that 92 percent of the companies with tier-one suppliers in the Wuhan region of China are in fact U.S.-based. (Wuhan was the first region to be shut down by the coronavirus in late-2019.)
To illustrate this point, consider Atlanta-based company, G95 Inc., a manufacturer of outerwear with built-in filtration technology. The disruption from the outbreak in China left the company with over 1,000 unfilled orders. So, it reshored its supply chain from China to a Grand Rapids, Michigan, contract manufacturer amid the pandemic. G95 owner Carlton Solle said, “As a business, if you don’t have anything to sell, you’re not a business, and you’re out of business pretty quick.”
This isn’t the first time a virus or natural disaster in Asia has disrupted company supply chains – for example, SARS in 2003, the 2011 Fukushima nuclear disaster and the 2011 Thailand floods. However, most of these outbreaks – and accompanying commercial impact – were limited at the time.
Today, supply chains are much more complex than they were then. U.S. companies may theoretically rely on suppliers in multiple countries, but often, even those suppliers are still sourcing some parts for their products from China. For example, according to the Wall Street Journal, Apple Inc. works with suppliers in 43 countries, all of which receive components from Apple’s contract manufacturers in China.
Top Governmental Concern
Shortages brought on by the pandemic have made Americans and government officials keenly aware of the country’s overreliance on imported goods, particularly essential medical devices and pharmaceuticals. According to the Department of Commerce, 97 percent of all antibiotics in the U.S. come from China and U.S. manufacturers source 80 percent of their active pharmaceutical ingredients (APIs) overseas, primarily from China. The nation is also the chief supplier of APIs for producers in other countries.
This has many government officials at the federal and state levels calling for reshoring. At a recent White House press briefing, Peter Navarro, director of trade and manufacturing policy and national Defense Production Act policy coordinator, said “Never again should we rely on the rest of the world for our essential medicines and countermeasures.”
Other countries have made similar statements and moves to protect themselves from future risk. Most notable to date has been Japan, which announced it would be spending upwards of $2 billion to help move Japanese companies out of China and back to the island nation.
Government Support May Accelerate Timelines
Reshoring of these operations in a timely manner will likely receive some government support through new or revised policies, direct incentives, and/or a combination of both. One level of support is sustained future product demand. President Trump is currently considering an executive order that would limit federal contracts for medical supply purchases to U.S. manufacturers and require purchases from multiple companies to ensure price competition. In a draft of that order, Trump remarks, “It is critical that we reduce our dependence on foreign manufacturers for essential medicines, medical countermeasures (to) ensure sufficient and reliable long-term domestic manufacturing” that prevents shortages of supplies, to “mobilize our nation’s public health industrial base.”
Direct purchasing contracts will also provide additional momentum. In May 2020, the administration announced a $354 million, four-year deal with Virginia-based Phlow Corp. to manufacture generic drugs and pharmaceutical ingredients required to treat COVID-19. “This is a historic turning point in America’s efforts to onshore its pharmaceutical production and supply chains,” Peter Navarro said. The project “will not only help bring our essential medicines home but actually do so in a way that is cost competitive with the sweatshops and pollution havens of the world,” he added.
Will Mexico be the Major Benefactor?
Many are also wondering whether Mexico might see steeper benefits than the U.S., given its proximity to the U.S. market and lower labor rates. Despite its positive positioning, back in 2012, a BCG report predicted that although Mexico will likely see some of the reshored activity, its ability to absorb a dramatic increase in production will be limited by the availability of skilled workers, infrastructure, and supplier networks, as well as by safety concerns and disruption risks related to the drug trade and other unstable conditions that exist for facilities there. Much of this has held true. We expect the U.S. pace of “reshoring” to exceed Mexico’s nearshoring, since the U.S starts with a much bigger base. Mexico’s manufacturing will grow at a higher percentage rate. A strong flow of work from China to Mexico is actually also in the interest of the U.S. since Mexican exports contain about 40 percent U.S. content, while Chinese exports contain five percent.
Current and potential trade agreements may also become a factor here, particularly with the revision of the “free trade” arrangement through NAFTA. The recently passed USMCA (new NAFTA) agreement includes some additional requirements for products to achieve duty free status, such as minimum wage requirements for automotive components, that will have to be factored into a North American production strategy.
Industries Prime for Reshoring
A follow-up BCG report in 2012, identified seven industry sectors most prime for reshoring based on their lower reliance on low-cost labor and higher volume of imports from China. The report concluded these industries as “nearing the point in which rising costs in China could prompt more companies to shift the manufacture of many goods consumed in the U.S. back to the U.S.” Those industry sectors included computers and electronics, appliances and electrical equipment, machinery, furniture, fabricated metals, plastics and rubber, and transportation goods.
According to the Reshoring Initiative, this “return” has been strong for industries like transportation equipment, which saw 935 companies and 299,000 jobs return to the U.S. between 2010-19. Computer and electronic products manufacturing has also increased in the U.S. in that span, with over 550 companies and nearly 110,000 jobs returning to the U.S.
In the wake of the COVID-19 pandemic, several other industry sectors have been highlighted that can be added to this list as either having a heavy reliance on imports and/or are essential goods that require complete national control in case of future emergencies. These include pharmaceuticals, medical equipment, chemicals, hygiene and health products, and suppliers to aerospace/defense industries. U.S. officials increasingly believe bolstered domestic supply chains will reduce the nation’s dependence on foreign sources – particularly China – for these crucial supplies.
In fact, according to Reuters, “(While) many Chinese drug ingredient makers began reopening (in late winter)…transport bottlenecks, shortages of raw materials and staff absences due to quarantines… limit(ed) the amount (that) factories (were able to) produce and export.”
Proponents of wide-scale reshoring, especially as it relates to crucial pharmaceutical products and personal protective equipment (PPE), suggest that the collective health of the United States’ 331 million residents should not have to be left to the whims of Chinese factory capacity/output.
Near Term vs. Longer Term
Reshoring a manufacturing operation is no easy task and will require time, likely resulting in increased inventory safety stock in the near term to minimize production disruption during the transition. Once stabilized, inventories will probably drop by about 50 percent.
As new manufacturing plant investments are being considered, many companies will likely find themselves designing completely new production processes driven by rapidly evolving technology including artificial intelligence and machine learning. These advances will allow many traditional processes to be replaced by automation and robotics for more efficiency.
Along with domestic production comes local sourcing for supplies, parts and ingredients. Given the heavy concentration of offshored facilities for some sectors, many of those supply chains remain clustered abroad. As a result, the complete restoration of U.S. supply chains can be a lengthy process. However, automation and technologies such as 3D printing will also open up more options for filling these gaps, and perhaps allow established U.S. manufacturers to expand into new business lines. The number of U.S. manufacturers across the country who retooled their existing lines quickly to produce essential products such as ventilators, face masks and hand sanitizer are quality examples of this possible development moving forward.
Evaluating the Reshoring Option
No doubt, evaluating whether to reshore is a complex proposition. Traditionally, the business case has been centered around a comparison of manufacturing costs per unit and, with low labor rates found in Asia, most companies chose not to increase U.S. production. Logistical costs were often ignored in the past. But the addition of risk factors related to pandemics, as well as natural hazards, geopolitical issues, quality control and intellectual property protections are now making the factors other than manufacturing cost too large to ignore.
This complexity has made tools such as the Total Cost of Ownership (TCO) Estimator from the Reshoring Initiative a vital part of the discussion. The tool helps companies include 28 other costs and risks in addition to pure manufacturing costs, resulting in a true total cost of producing in the U.S. versus China (or other countries), and preventing miscalculations of typically 20-30 percent.
The results are especially favorable to the U.S. for companies that serve the American market. These operations will see a reduction in costs for transportation, utilities, inventory, travel and operational risk factors, as well as an increase in sales due to having a “Made in the USA” label.
Figure 1 shows the power of using TCO instead of price for sourcing and siting decisions. The successive curves show Chinese Ex Works price, TCO and TCO with a 15 percent Trump tariff in place for hundreds of analyses by TCO users. Figure 2 shows that the percentage of cases where the U.S. is the more profitable solution rises from eight percent to 32 percent to 46 percent respectively for these three cases. Companies that buy and site based on price are missing huge profit opportunities for 20 to 30 percent of what they now import.
Location Opportunities Abound in the U.S.
The size and geographic landscape of the U.S. offers a variety of location options to consider for reshored manufacturing operations, each of which may offer different upfront and ongoing cost environments as well as varying qualitative factors. Location factors, such as labor skill availability and cost, available property characteristics, transportation and utility infrastructure, will all vary in importance to an operation, depending on its requirements.
State and local government development incentives are often helpful in making final investment decisions but should not be a conclusive site selection factor until a location strategy analysis effort has been conducted. This helps narrow the list of potential location options to those that can first meet required operating needs.
For most manufacturing operations, one of the most important location drivers is availability of workforce with desired skillsets to operate, maintain and repair the automated equipment that will power these new production processes. A recent BLS & Co. reshoring client emphasized this point, when defining the location requirements for their operation, by saying that “all the incentives in the world would not make an impact on the project if [we] were not able to find the workforce with the skills to operate the production equipment in the new plant.”
Manufacturing Investment on the Rise
Thanks to the light cast on the risk of dependence on global supply chains for essential goods in the wake of COVID-19, the consideration of production disruption and sourcing risk factors are sure to carry heavier weight in location strategy. Altogether, the manufacturing location decision-making process will certainly look different post-pandemic, with variables ranging from concentration of U.S. suppliers, to various ROI analyses/calculations on bringing production onshore. Of course, federal incentives and resulting reshoring momentum will also be strong indicators. Expect the pace of U.S. production to accelerate in the months and years ahead, amid changing geopolitical environments and the threat of future health crises.
Risk will be minimized with production and supply chain in the target market, whether U.S. or another major country. The key question for companies is whether the savings on the 28 cost and risk factors are sufficient to offset the likely higher manufacturing costs even in the most competitive site in the developed countries. BLS and RI are available as a unique team able to help companies decide whether to bring manufacturing to the U.S. and, if so, where to locate. We anticipate a multi-year surge in reshoring and FDI as the U.S. emerges from the current crisis.
Michelle Comerford is the industrial and supply chain practice leader of Biggins Lacy Shapiro & Company (BLS & Co.). Biggins Lacy Shapiro & Company is a location economics consulting firm. For more information, visit www.blsstrategies.com or connect with Michelle directly on LinkedIn.
Harry Moser is the Founder and President of the non-profit Reshoring Initiative (RI). RI’s mission is to bring five million mfg. jobs back to the U.S. Harry was inducted into Industry Week’s Manufacturing Hall of Fame 2010. For more information visit www.reshorenow.org or connect with Harry on LinkedIn.