Right-Shoring: The Regionalization of the High-Tech Supply Chain
Technology companies are bringing product manufacturing and assembly closer to the customer and — more importantly — to R&D.
Steve Stackhouse-Kaelble (Q3 / Summer 2013)
The pace of technology innovation seems to grow continuously, as high-tech products get ever-more powerful yet increasingly affordable. And in recent years, it has been getting ever-more difficult to find tech products made somewhere near home — if your home is not in Asia, that is. In that respect, times certainly changed over the past few decades.
Now, it seems, times are starting to change back. Consider the announcement from Apple last December. As one of the world’s most admired tech companies, Apple turned heads when it pledged to begin making some of its Mac computers in the United States, and said it would pump $100 million into the effort. It’s a relatively small splash, considering the fact that Macs are far from the biggest part of Apple’s business these days, but the symbolism was powerful.
Greg Matter, vice president at Jones Lang LaSalle, who advises technology firms on their real estate needs, also points to the example of Motorola Mobility. The company announced in May that it would make its Moto X smartphone in Texas, creating some 2,000 jobs. “That’s something that 12 years ago you would never have seen,” he comments. And a smartphone assembled in the United States? Unheard of, until now, despite the fact that the U.S. is one of the world’s biggest smartphone markets.
Indeed, a May 2013 report from Jones Lang LaSalle called “Perspectives on Technology Manufacturing” proclaims “American high-tech manufacturing is on the rebound.” A slow rebound, to be sure, with a growth rate averaging just 0.7 percent over the next five years, but any growth is a big deal, considering what’s been happening during the past decade or two.
Shuffling the Supply Chain
Does that mean technology companies will be shutting down big facilities in lower-cost countries and bringing all their business to America? Not necessarily. “What we’re seeing is a regionalization of the technology supply chain,” Matter says. “It’s not necessarily re-shoring of the supply chain, but right-shoring. That entails having production in close proximity to consumers.”
“It’s less about companies leaving China and Asia; it’s that the markets continue to evolve,” agrees Raj Vohra, manager in Deloitte Consulting’s Real Estate and Location Strategy practice. Tech companies, he says, “have an infrastructure set up throughout the world. How can they refine it to better serve the markets they’re in?”
That means some of the production in China, for example, will serve China itself and other Asian markets, and more of the work in Brazil will be destined for nearby locations. Facilities in Central and Eastern Europe will potentially serve that region in this kind of supply chain, and North America might be served by an increasing amount of manufacturing in Mexico — and the United States.
If you’re feeling a bit of déjà vu, you’re not alone. “If you look at the historical transition of global supply chains, we’re looking more like we did in 1950 than we did in 2000,” Matter observes. Not the same, by any means, but increasingly similar.
There are a number of reasons for this noteworthy shift. A significant factor is the cost differential — it has been shrinking, thanks to rapid wage inflation in China. Back in 2000, U.S. labor costs were 23 times what they were in China, according to Jones Lang LaSalle, but they’re now just eight times higher and the narrowing continues. At the height of the migration of technology manufacturing toward China, wages there were about 60 cents an hour, but they’re now $3 or even $6 an hour in some places.
“Labor rates along the coast of China have reached closer to parity with labor costs in some other parts of the world,” says Clarence Chen, principal at PricewaterhouseCoopers. “China isn’t the default simple answer anymore. In the grand scheme of things, things aren’t that clear anymore.”
It doesn’t help that transportation costs are skyrocketing. According to Jones Lang LaSalle’s report, back in 2005, Chinese-produced parts arrived at U.S. ports costing 22 percent less than comparable parts made in America. By 2008, that gap had closed to less than 6 percent — but even that’s just part of the story.
Manufacturing Near Development
As tech products get increasingly complex, it becomes more important that production not be so far away from R&D — or, that at least some production takes place closer to where the product was developed. “Firms are looking at having their R&D closer to their production lines and pilot lines,” Matter observes.
Indeed, a November 2012 report titled “Manufacturing the Future: The Next Era of Global Growth and Innovation” — from the McKinsey Global Institute and McKinsey Operations Practice — found that industries with simple processes and fairly low-intensity R&D can separate production from development fairly easily. However, “the complexity of the production process and the degree of innovation required in the industry dictate strong links between R&D and production,” the report states.
That doesn’t necessarily mean all production needs to take place near R&D. McKinsey notes that many companies have established a “lead factory” model, so that process development can happen in the same vicinity as product development. Once production processes are perfected, they can then be spread to manufacturing operations around the world, closer to the end markets and in keeping with the regionalization model.
Bringing manufacturing closer to R&D is causing some counterintuitive things to happen, according to Matter. “Silicon Valley has seen a resurgence of technology manufacturing, and this is contrary to people’s belief system of where manufacturing will land because it has such a high cost of operation.”
But the idea can work both ways. “I think another trend is reverse innovation, and that’s not helpful for North America,” Vohra says. The traditional model, he observes, has involved conducting R&D in the company’s established big market in North America or Europe, then pushing the product out to the world. “But a lot of companies are [developing products] in the local market to meet the local market’s characteristics,” he explains. In this situation, a locally developed product can then go global. One company, Vohra says, was having trouble selling its x-ray equipment in China. “They locally developed a smaller portable machine to serve that market better, and that product has gotten a lot of global traction as well.”
“One thing has become very clear,” says Alex Blanter, principal at PricewaterhouseCoopers. “Deciding where to locate an R&D facility is more complex than it was five or 10 years ago. The last several years, as in manufacturing, the cost comparison has shifted, not just because of direct costs but training.”
Vohra says the traditional U.S. hot spots for technology R&D will continue to be strong. That, of course, includes Silicon Valley and the Boston area, and Austin also is a strong contender, he says. “These have critical mass and have had good success,” according to Vohra, who also cites Atlanta as being on the move.
The Jones Lang LaSalle report notes, “When a strong supply of college-trained workers is critical to a company’s success, nobody provides more than the U.S. This American intellectual capital advantage makes it easier to develop prototypes and test models of products here.” Though the United States has just 5 percent of the world’s population, it has a third of the high-tech researchers, who together perform 40 percent of the world’s R&D, the report states, citing economist Richard Freeman.
Factors to Consider
The volume of American R&D is a real key to future technology prosperity, according to Dr. William Harris, the president and CEO of Science Foundation Arizona, who formerly helped appropriate federal grants through the U.S. National Science Foundation. In his view, it’s not so much that technology manufacturing is returning to the United States. “However, the next generation of high value-added production and manufacturing will develop here,” he says. “Intellectual property issues trump any labor cost savings, and as technology development costs increase as a share of total product cost, the benefits of remote, low-labor-cost production diminish.”
Labor quality will increasingly become more important than labor cost, according to Matter. The challenge, adds Harris, is providing that quality labor. “The quality of the available work force is driven by quality of the K-12 education and community college systems, especially in the STEM disciplines,” he says, referring to science, technology, engineering, and mathematics.
That’s why training incentives can be a vital factor in a location decision, according to Matter. So can such considerations as taxes. “The factor of sales and use taxes is something people are definitely focusing on because of the capital investment required to develop these facilities,” he says. “Many are very automated and require significant capital investment.”
“It is important for states to be truly business-friendly,” Harris says, “Excessive or unreasonable business regulations are poisonous to establishing new manufacturing operations.” On the other hand, “increasingly, successful states are going to establish independent entities that can help build successful university-industry research partnerships, particularly in the engineering and computer science areas,” Harris explains. An example is his organization, Science Foundation Arizona, which connects industry with university research and focuses on helping the state’s education system build the kind of work force required to succeed in the future.
“All locations will offer state and location incentives in support of a new manufacturing operation,” the Jones Lang LaSalle report notes, “and in today’s competitive climate, areas newer to high-tech manufacturing often offer the best package of incentives that can include tax concessions, economic grants, reimbursements, and training partnerships through local institutions.”