Douglas van den Berghe, Managing Director, Investment Consulting Associates (ICA) (Location USA 2012)
The flow of inward investment and, in particular, foreign direct investment (FDI) brings with it potential benefits for locations - they are able to differentially benefit from a strengthened technological base, enhanced supplier base, and improvements in both the quantity and quality of local employment opportunities. Investment also plays a key role in enhancing the capacity of a host location to respond to opportunities offered by global integration, investment, and production.
Traditionally the developed countries had the most inflow of foreign investments. However, the economic downturn that started in 2008 changed the global landscape. For the first time in history, developing countries and transition countries, i.e., those in transition from a centrally planned economy to a free-market economy, absorbed more than half of global FDI flows (UNCTAD Global Investment Trends Monitor: Global and Regional Trends 2010, No. 5, Jan. 17, 2011). Given the rise of emerging markets and the economic developments in the United States since the financial crisis - e.g., debt ceiling debates, increasing budget deficits, and high unemployment - the United States has been increasingly warned for its deteriorating investment climate.
However, in 2008, Investment Consulting Associates (ICA) challenged this widespread view by positing that the United States could be re-invented by investors as a favorable location for manufacturing processes and outsourcing activities. By means of our research study - presented at the IEDC 2011 annual event in Charlotte, North Carolina - ICA justified and validated our statements to a wider audience. The presence of a large internal market, highly educated employees, strategic infrastructure, and relatively decreasing international labor costs point toward a newly emerging trend in foreign direct investment, i.e., the revival of the United States as an economic powerhouse.
U.S. Global Competitiveness
The competitiveness of the United States versus emerging and low-cost markets has been assessed by a fact-based benchmark analysis using objective data from international organizations and national statistics sources. The criteria used in the competitiveness benchmark are comprised of:
- Business environment
- Labor costs
- Business risks
- Macro economy
The web-based benchmarking tool LocationSelector.com transforms the actual country values into a relative score between 10 and 100 (e.g., best-in-class country for a particular factor receives a relative score of 100) and calculates the overall country competitiveness scores.
The overall competitiveness ranking implies that the United States still offers a very competitive investment location compared to the selected emerging low-cost and high-growth markets. The United States consistently scores well in terms of business environment, business risks, infrastructure, and tax.
Needless to say, in terms of labor costs, the United States has a distinct cost disadvantage compared to its competitors. Yet, a new trend called "re-shoring" has been observed. Re-shoring involves re-migration of business activities back to the United States from overseas locations, as illustrated by Ford Motor Company and Wham-O (the makers of the Frisbee®), which have brought their overseas production back to the states. Also Presair, a manufacturer located north of New York City, is returning production of switches to the United States from China. Presair's reasons for moving production back to the states include the desire to cut long lead times for product and to free up capital that would have been needed for expansion in China.
Total Cost of Ownership (TCO)
In addition to a fact-based global competitiveness benchmark and real life examples from the corporate markets, ICA's research simulated a manufacturing business case located in the United States and in China.
Any financially based case analysis of the impact of offshoring manufacturing activities must take into account all the costs associated with an offshore initiative. In practice, corporate decision-makers often ignore important cost drivers and focus only on the labor cost differential between the United States and emerging economies such as China, i.e., a labor cost of US$2.80 per hour in China versus US$25 per hour in the United States. However, the manufacturing business case simulation highlights the hidden costs of relocating overseas and illustrates that the so-called Total Cost of Ownership (TCO) actually favors the United States as an investment location over China.
The Total Cost of Ownership approach (TCO) - based on the TCO model provided by Reshoringmfg.com - analyzes the entire cost a company incurs when producing or purchasing a particular manufactured part overseas and consists of the following key components:
- Raw material costs
- Packaging costs
- Transportation costs
- Customs and duties fees
- Inventory costs
- Lead times and local warehousing costs
- Quality control costs
- Travel costs
- Training and productivity
- IP risks
- Exchange rate fluctuations
- Inflation rates
Let's look at an example:
Company XYZ is active in the automotive industry and is a first-tier supplier to original equipment manufacturers (OEMs). It produces high-technology braking and gearing systems, for which it also uses its own software systems, fully integrated with its "hardware" products. For its supplies of specific steel products, XYZ is depending on several suppliers that are located globally. The board of directors is following a vertical integration strategy to allow for further growth of the company. The board must decide whether to source the steel from third parties or produce and process the steel for the company's products internally. Secondly, it must decide where to locate such a steel processing plant. Would it be more beneficial to locate the steel plant overseas and potentially benefit from lower cost levels, or does it make more sense to keep it close to the other U.S. facilities to minimize lead times and transport costs?
The business case analysis illustrated in detail the total costs associated with the production of steel. It appeared that off-shored production resulted in a "lower price per unit." When incorporating all costs associated with goods sold, risk, and strategy, a U.S. location had a TCO disadvantage of 11.3 percent as compared to China. Is this disadvantage in TCO reason enough to move production to China? Based on ICA's research and corporate location selection experience, we think otherwise and increasingly see executives reconsidering this option as well.
As foreign direct investments are generally long-term investments, a corporate location selection team should always incorporate future trends into financial modeling. National and international statistics show that skilled wages in low-labor-cost countries have been rising at about 10 percent per year versus 2 percent in the United States. In particular, China has recently experienced labor strikes that have resulted in wage increases of 24 percent to 100 percent annually. Transportation costs are also rising again as oil prices increase, and OEMs that have sourced work overseas continue to report problems with quality, counterfeiting, and intellectual property violations. In addition, China's currency is appreciating against the U.S. dollar (on average 5 percent), which will further increase local product prices denoted in U.S. dollars.
By forecasting the annual cost increases based on the yearly impact of wage inflation and the appreciation of the Chinese yuan, ICA has modeled the TCO for a period of five years. The results of the five-year forecast model show that the initial higher TCO in the United States will be eliminated in the medium to long run.
After adjustments are made to account for American workers' relatively higher productivity, wage rates in Chinese cities such as Shanghai and Tianjin are expected to be about only 30 percent cheaper than rates in low-cost U.S. states. And since wage rates account for 20 to 30 percent of a product's total cost, manufacturing in China will be only 10 to 15 percent cheaper than in the United States - even before inventory and shipping costs are considered. After those costs are factored in, the total cost advantage will drop to single digits or be erased entirely.
The global competitiveness benchmark, the "reshoring" trend, and the business case simulation explored in ICA's U.S. Competitiveness Report 2011 indicate that corporations should give - and are increasingly giving - more priority to the softer factors, as these embrace a lot of hidden costs. Also, as foreign investments are long-term commitments to a country, a "snapshot" of a country's investment climate alone is insufficient. Forecasting (inter)national trends adds significant perspective to the process of foreign investment decision-making. It is exactly this combination of the competitive and low-risk investment climate, with relatively stable wage inflation, increased productivity levels, and a skilled U.S. labor pool - compared to rapidly rising labor costs and seemingly overheating economies in Southeast Asia - that is shifting the global landscape of FDI.