Next-shoring: A CEO’s guide
Proximity
to demand and innovative supply ecosystems will trump labor costs as technology
transforms operations in the years ahead.
When offshoring entered the popular lexicon, in the 1990s, it became
shorthand for efforts to arbitrage labor costs by using lower-wage workers in
developing nations. But savvy manufacturing leaders saw it as more: a decisive
change in globalization, made possible by a wave of liberalization in countries
such as China and India, a steady improvement in the capabilities of
emerging-market suppliers and workers, a growing ability to transfer proven
management processes to new locales, and increasingly favorable transportation
and communications economics.
Something of equal moment is
occurring today. As we settle into a “new normal” catalyzed by the global
financial crisis, the ensuing recession, and an uneven global recovery,
traditional arbitrage models seem increasingly outmoded. For some products, low
labor costs still furnish a decisive competitive edge, of course. But as wages
and purchasing power rise in emerging markets, their relative importance as
centers of demand, not just supply, is growing.
Global energy dynamics too are
evolving—not just the now-familiar shale-gas revolution in the United States,
but also rising levels of innovation in areas such as battery storage and
renewables—potentially reframing manufacturers’ strategic options.
Simultaneously, advances stemming from the expanding Internet of Things, the
next wave of robotics, and other disruptive technologies are enabling radical
operational innovations while boosting the importance of new workforce skills.
Rather than focus on offshoring or
even “reshoring”—a term used to describe the return of manufacturing to
developed markets as wages rise in emerging ones—today’s manufacturing
strategies need to concentrate on what’s coming next. A next-shoring
perspective emphasizes proximity to demand and proximity to innovation. Both
are crucial in a world where evolving demand from new markets places a premium
on the ability to adapt products to different regions and where emerging
technologies that could disrupt costs and processes are making new supply
ecosystems a differentiator. Next-shoring strategies encompass elements such as
a diverse and agile set of production locations, a rich network of
innovation-oriented partnerships, and a strong focus on technical skills.
In this article, we’ll describe the
economic forces sweeping across the manufacturing landscape and examine
technologies coming to the fore. Then we’ll suggest some principles for
executives operating in this new world. The picture we’re painting is of
necessity impressionistic: next-shoring is still taking shape and no doubt will
evolve in unexpected ways. What’s increasingly clear, though, is that the
assumptions underlying its predecessor, offshoring, are giving way to something
new.
Economic
fundamentals
The case for next-shoring starts
with the economic fundamentals of demand (since the importance of local factors
is growing) and supply (as the dynamics of labor and energy costs evolve).
The
importance of local demand factors
More than two-thirds of global
manufacturing activity takes place in industries that tend to locate close to
demand. This simple fact helps explain why manufacturing output and employment
have recently risen—not only in Europe and North America, but also in emerging
markets, such as China—since demand bottomed out during the recession following
the financial crisis of 2008.
Regional demand looms large in
sectors such as automobiles, machinery, food and beverages, and fabricated
metals. In the United States, about 85 percent of the industrial rebound (half
a million jobs since 2010) can be explained just by output growth in
automobiles, machinery, and oil and gas—along with the linkages between these
sectors and locally oriented suppliers of fabricated metals, rubber, and
plastics The automotive, machinery, and
oil and gas industries consume nearly 80 percent of US metals output, for
example.
In China
too, locally oriented manufacturers have contributed significantly to rising
regional investment and employment. The country has, for example, emerged as
the world’s largest market and producer for the automotive industry, and many
rapidly growing manufacturing sectors there have deep ties to it. As automotive
OEMs expand their capacity in emerging markets to serve regional demand, their
suppliers have followed; the number of automotive-supplier plants in Asia has
tripled in just the past decade.
The emerging markets’ share of
global demand is steadily climbing, from roughly 40 percent in 2008 to an
expected 66 percent by 2025. As that share rises, it also is fragmenting into
many product varieties, feature and quality levels, price points, service
needs, and marketing channels. The regional, ethnic, income, and cultural
diversity of markets such as Africa, Brazil, China, and India (where some local
segments exceed the size of entire markets in developed nations) is raising the
ante for meeting local demand. In the automobile industry, for example,
fragmenting customer demand has led to a 30 to 50 percent increase in the
number of models. Ninety percent of recent capital expenditures in the
automotive sector have involved product derivatives worldwide and capacity
expansions in new markets.
Surging local demand helps explain
why rapid wage growth in China hasn’t choked off manufacturing expansion there.
Wages have nearly doubled since 2008, partly as a result of domestic
minimum-wage policies.3
(The country’s 2011 five-year plan called for 13 percent average annual
minimum-wage increases, a rate some provinces have already exceeded.) True, in
a few labor-intensive, trade-oriented industries, such as apparel production
and consumer electronics, labor-cost changes do tend to tip the balance between
different geographic regions; manufacturing employment in Bangladesh and
Vietnam, for instance, has benefited from China’s wage surge, even as Chinese
manufacturers are seeking to raise productivity.
But these are far from the only
implications of rising wages. Just as Henry Ford’s $5 day helped create a new
consuming class, so higher wages in China are increasing local demand, thus
reinforcing the local-investment choices of OEMs and suppliers. At the same
time, there is little evidence of a zero-sum game between China and advanced
economies, such as the United States. Rather, the narrowing labor-cost gap
reinforces the importance of local demand factors in driving manufacturing
employment. Indeed, factor costs often have the greatest impact on location
decisions within a region—for example, Airbus moving to Alabama instead
of Texas or North Carolina. These costs interact with policy factors, such as
infrastructure spending and tax incentives, to shape a region’s overall
economic attractiveness.
The
impact of energy costs
The price of natural gas in the
United States has fallen by two-thirds as gas production from shale deposits
rose by 50 percent annually since 2007. A narrow range of sectors—gas-intensive
manufacturing, such as the production of petrochemicals, fertilizer, and
steel—are benefiting most directly. Some downstream players in the energy value
chain have begun shifting investments. Dow Chemical, BASF, and Methanex, for
example, have announced plans for new US manufacturing capacity to take
advantage of cheaper, abundant energy supplies.
These moves are important for such
companies and subsectors; McKinsey Global Institute (MGI) research suggests
that by 2020, lower-cost energy could boost US GDP by somewhere between $400
billion and $700 billion. But do they presage a dramatic rebalancing of global
manufacturing activity? Electricity costs were already lower in the United
States than in many countries, including China—which, along with others, also
has opportunities to boost its own energy output through hydraulic fracturing.
And fossil fuels aren’t the only area where the energy-supply picture is
morphing.
Consider, for example, the potential
impact of energy-storage technologies, especially lithium-ion batteries and
fuel cells, which are becoming more capable and less costly. At the same time,
the improving economics of renewable-energy production—particularly solar and
wind power—offers manufacturers an expanding range of future supply options. In
some developing regions where power grids are unreliable or nonexistent,
factory complexes served by distributed solar power may be feasible.
Distributed generation is also growing in combined heat–power (CHP) plants,
which use heat created in the production process to run steam turbines and
generate electricity locally.
None of these is a silver bullet
today. But as advances continue over time, more and more companies may become
able to ask themselves where they would place major strategic bets if the
availability and price of energy were lesser concerns. That too will probably
lead back to a focus on local demand patterns. Interestingly, the country
representing the greatest source of future demand growth—China—also is actively
stimulating the development of a range of new energy sources and storage
technologies through a focus on new strategic industries in its five-year
plans.
Technology
disruption ahead
Technology is affecting far more
than energy dynamics. Advanced robotics, 3-D printers, and the large-scale
digitization of operations are poised to alter fundamental assumptions about
manufacturing costs and footprints. To derive value from these shifts,
companies will have to make significant investments and ensure access to hubs
of innovation, capable suppliers, and highly skilled workers.
Advanced
robotics
Investments in industrial robots
have increased by nearly 50 percent since 2008—even in emerging nations such as
China—as a new generation of advanced systems develops, with greater dexterity
and ability to process information. These robots can perform an expanding array
of factory tasks—for instance, manipulating small electronic parts, and picking
and packing individual products. They can work side by side with humans and be
trained by factory-floor operators rather than programmed by teams of highly
paid engineers. Improved economics and capabilities eventually may yield
productivity gains that are unforeseen today, as well as better products and
faster speed to market. As that happens, companies will be able to retool their
manufacturing systems to provide new roles for these mechanical “workers.”
Cheaper, more proficient robots that
can substitute for a wider variety of human tasks are another reason companies
may locate more manufacturing closer to major demand markets, even where wage
rates are higher. In developing nations, robots could speed up rates of
automation and help bridge shortages of some production skills. MGI research
suggests that 15 to 25 percent of the tasks of industrial workers in developed
countries and 5 to 15 percent of those in developing countries could be
automated by 2025.
Further out, highly robotized
factories also equipped with other information technologies might shift
competition to areas such as the ownership of customer networks, which should
become increasingly valuable as information embedded in them starts guiding
production priorities and flows. Flexible, intelligent assembly robots also
should enable contract manufacturers to serve an increasingly diverse range of
customers, creating new opportunities for attackers to target attractive
microsegments.
3-D
printing
The economics of 3-D printing are
improving rapidly, as well. While still only a sliver of value in the
manufacturing sector (0.02 percent), sales of 3-D printers are set to double,
to $4 billion, by 2015, and prices for the equipment are declining swiftly.
Also, 3-D printers open up the possibility of more distributed production
networks and radical customization. In early manufacturing applications, some
companies are using the devices to accelerate product development, since they
eliminate wait times for prototyping by faraway specialists. Companies will be
able to consider new supply-chain models and, in some cases, replace
traditional suppliers of parts with targeted usage of in-house printers.
These printers won’t replace
traditional high-volume modes of production, such as die casting and stamping.
For more specialized goods, though, it’s easy to imagine the emergence of
service businesses—the equivalent of copy or print shops—that would manufacture
items based on design specifications provided by B2B or B2C customers.
Crowdsourcing networks for new-product ideas could one day complement
traditional R&D activities for some manufacturers.
Digitized
operations
Significant as advanced robotics and
3-D printers are, they represent just two plot lines in a much bigger story
about the digitization of operations. Cloud computing, mobile communications,
and the Internet of Things are beginning to combine with advanced analytics to
create threads of intelligent data that link assets and stakeholders as never
before. Increasingly, products will communicate with each other, with robots
and advanced machines inside factories, and with customers and suppliers.
Digital “DNA” for parts (including the materials, equipment, and time required
to make them) will also be increasingly available.
The implication is that we are
approaching a day when manufacturers will have unprecedented global visibility
into who makes what, where, and how well. They’ll be able to run virtual
operations “war rooms” on their phones. They’ll have new opportunities to solve
plant-floor optimization problems as intelligent machines interface with each
other and with people on the line. In the near future, manufacturers also will exploit
opportunities for crowdsourced design and on-demand production. These
opportunities will extend well beyond goods made by 3-D printers; manufacturers
will pursue the buying and selling of previously underutilized production lines
“by the hour” and will rely on dynamic databases to determine what every part
should cost. And new forms of technology-enabled collaboration, such as the
three-dimensional virtual assembly and testing of vehicles, will redefine what
it means to be proximate to innovation—which may be locally generated or
accessed via broadband.
Digital operations aren’t a far-off
fantasy. GE already has a 400-person industrial Internet software team and its
employees use iPads to run an advanced battery factory in New York State.
Amazon.com is employing growing numbers of smart warehouse robots. Fiat has
reduced the number of physical prototypes needed to introduce a new product;
Alcoa has compressed prototyping time and costs for some products; and an auto
supplier recently slashed an eight-month prototyping process to one week.
Next-shoring
Although these forces are still
gathering strength, they’re already pointing toward two defining priorities for
manufacturing strategy in the era of next-shoring: proximity to demand
and proximity to innovation, particularly an innovative base of
suppliers. In developed and emerging markets alike, both ingredients will be
critical. Next-shoring isn’t about the shift of manufacturing from one
place to another but about adapting to, and preparing for, the changing
nature of manufacturing everywhere.
Optimizing
location decisions
Being close to demand is
particularly important at a time when consumption in emerging markets is
growing rapidly, boosting with it the diversity of the regional preferences
that manufacturers must contend with. In a 2012 interview with McKinsey, Timken
CEO James Griffith explained his company’s approach: “Over the last ten years,
we’ve added a very strong Eastern European, Indian, and Chinese manufacturing
base,” not because wages are low there “but because those were the markets that
were growing.” This expansion has been accompanied by a strategic shift away
from a focus on automotive parts—“we could make a car last for a million miles,
but nobody cares.” The new emphasis is on fast-growing mining, trucking,
steelmaking, and cement-making customers in emerging markets. For them,
Timken’s reliability is a decisive asset.
Locating manufacturing close to
demand makes it easier to identify and meet local needs. It’s a delicate
balancing act, though, to create an efficient global manufacturing footprint
that embraces a wide range of local tastes, since economies of scale still
matter in many industries. Volkswagen has coped by moving from vehicle
platforms to more modular architectures that provide greater flexibility for
manufacturing several product variants or derivatives.
New products, market segments, and
consumer preferences are combining with perennial risks (such as seasonal variations
in demand and fluctuations in wages and currency rates) to boost uncertainty in
manufacturing and supply networks. That uncertainty places a premium on
operational agility—the ability to adapt design, production, and supply chains
rapidly to fluctuating conditions. This too may play into location decisions.
Take the experience of a
consumer-products company that had relied on one plant to supply its major
market. When the company began experiencing unaccustomed spikes in regional and
seasonal purchasing patterns, shortages and lost sales ensued. To accommodate
rising variations in demand, the company built a second plant, with similar
cost characteristics, in a different region. This additional capacity helped
ensure supplies to the prime market, where the problems were most acute, while
also allowing the company to meet growing demand opportunistically in several
new markets close to the new plant. Although the investment was considerable,
it lowered the company’s risk exposure, eliminated damaging stockouts, and
improved the bottom line.
Building
supplier ecosystems
New combinations of technical
expertise and local domain knowledge will become the basis for powerful new
product strategies. Responsive, collaborative, and tech-savvy supplier ecosystems
will therefore be increasingly important competitive assets in a growing number
of regional markets. To keep up with the opportunities afforded by
technological change, for example, a major manufacturer that until recently had
relied on a low-cost supplier in Mexico for parts has begun working with a new
supplier that has cutting-edge 3-D printing capabilities. The new relationship
has lowered stocking costs (since parts are made on demand), while providing
avenues for developing prototypes more quickly.
Examples like this are just a start.
As information flows among partners become more robust, they will usher in a
range of improvements, from surer logistics to better payment systems. These
will create a virtuous cycle of collaborative benefits. The supply bases of
many manufacturers thus may soon need significant upgrades and capital
investments to create joint competencies in areas such as robotics.
Collaboration and management investment in skill-development programs could be
necessary as well. In some cases, it may be valuable to collaborate with local
or national governments to create the conditions in which the manufacturing
ecosystems of the future can flourish. Tighter supply networks also will foster
production systems that reduce the need for virgin natural resources. A failure
to develop innovative supply ecosystems will have growing competitive
implications for countries as well as companies. The competitive challenges
facing the United States sometimes look more like a system failure than an economic
one. US investment in advanced robotics, for example, often lags behind that of
other developed economies, with trade deficits prevailing even in sectors where
wage-rate differentials aren’t a big influence on location decisions.
Developing
people and skills
All this will place a premium on
manufacturing talent, creating a range of regional challenges. In Europe and
the United States, educational institutions aren’t producing workers with the
technical skills advanced manufacturers need. In developing economies, such as
China, the millions of lower-cost production associates who are well adapted to
routine manufacturing may find it difficult to climb to the next level. Line
supervisors—often fresh out of regional universities—struggle to manage
baseline operations and to coordinate teams. Organizations will need to invest
more in formal training and on-the-job coaching to bridge the gaps. They must
also cast a wider net, supporting local community colleges and technical
institutes to shape curricula and gain access to new talent streams.
A related challenge is the need for
new management muscle. As it gets harder to hide behind labor-cost arbitrage,
regional manufacturing executives and midlevel managers will need to become
both better at running a tight operational ship and more versatile. They should
be able to grasp the productivity potential of a range of new technologies and
have enough ground-level knowledge of local markets to influence product
strategies and investment trade-offs. The ability to build external
relationships—with suppliers, education partners, and local-government
officials who can influence the development of vibrant, sophisticated supply
ecosystems—will also be a source of competitive advantage.
Next-shoring will look different in
different locales, of course. Europe and the United States have impressive
advantages in areas such as biopharmaceuticals, automotive engineering, and
advanced materials. China, meanwhile, is quickly climbing the expertise curve,
with increasingly sophisticated corporate and university research facilities
and growing experience in advanced processes and emerging industries. In the
world we’re entering, the question won’t be whether to produce in one market
for another but how to tailor product strategies for each and how to match
local needs with the latest veins of manufacturing know-how and digital
expertise. While the road map for every company, industry, and location will be
different, we believe that the principles we’ve laid out here should be useful
for all.
byKaty George, Sree Ramaswamy, and Lou Rassey
http://www.mckinsey.com/insights/manufacturing/next-shoring_a_ceos_guide?cid=other-eml-nsl-mip-mck-oth-1402
No comments:
Post a Comment