The Area Development 2009 Corporate Survey again illustrated the importance corporations place on labor when making location decisions. Of the 26 factors measured by Area Development, labor costs were rated the single most important consideration and skilled labor availability was ranked sixth in importance.
Such ratings are consistent with Jones Lang LaSalle's experience when helping guide companies to location decisions. Labor is typically rated highly for a number of reasons, including the significance of labor as one of the largest geographically variable costs, the impact of labor quality on plant productivity and output, and the constraints imposed on operations should labor not be available in appropriate volume and/or skill. These and other considerations are discussed below.
Composition of Operating Costs
Labor is often one of the more notable operating costs for manufacturing operations and, as stated, one of the most significant geographically variable costs. While the contribution to the total cost of operations varies by industry and type of manufacturing operation (i.e., capital/process-intensive versus labor-intensive), labor often represents the second-largest geographically variable cost. The variable nature of labor costs makes it a key consideration when determining where to locate facilities.
As a general rule, the financial dimension of location optimization can commonly be reduced to a trade-off between labor and supply-chain costs, where a company often seeks to achieve significantly reduced labor costs for nominally incremental supply-chain costs. This paradigm can be seen in North America, where companies install operations in Mexico to serve the U.S. market, and in Europe, where the candidacy of Eastern European countries for direct investment is tied to the tolerance of the supply chain in supporting the revenue markets in Western Europe.
Figure 1 illustrates the contribution of labor to the before-tax (before "income" tax) operating cost of a manufacturing facility for hypothetical companies in the chemicals and in the medical device industries. (It should be noted that income tax has a notable bearing on the selection of locations in the medical device industry and has a notable impact on the overall cost profile when viewed from an after-tax perspective.) The importance of labor to the ongoing cost of operations is evident in both examples, with labor representing 21 percent of before-tax operating costs for the chemical company and 44 percent for the medical device company.
Labor Cost Differentials
Despite escalations in the cost of labor in some of the world's emerging economies, there remains a notable difference in the cost of labor between the U.S. and emerging economies. At a country level, differentials can be attributed to the level of development and industrialization, labor regulations, and prevailing employee benefits practices. Within a country, the differences are often attributed to city size, composition of the economic base, and prevalence of unions. These factors combine to create a highly variable labor environment across political borders at the country, state/provincial, and municipal levels.
Within the United States, the difference in the cost of labor between high- and low-cost locations can easily range from 10 percent to 25 percent, a figure of relevance to a location decision. Labor differentials, however, are best highlighted when comparing high- and low-cost countries. Figure 2 illustrates the difference in fully loaded labor costs for skilled (two-plus years experience) and unskilled (less than six months experience) labor between the United States and Thailand and China - two of the leading destinations for foreign direct investment in Asia. Such a comparison indicates that costs in the United States are 10 to 15 times higher than in the Asian countries.
The impact of the difference can be seen in the number of companies with products represented by high labor content electing to install manufacturing capacity in such low-cost Asian locations. In an era of significant margin and cost containment pressures, the case for considering locations with low-cost foreign labor is compelling and will likely remain so until fuel costs increase to such a level that the costs of transporting materials and finished product erode the desirability of manufacturing locations that are geographically distant from where sales are generated.
Costs for direct labor are particularly important to location decisions and typically receive a lot of attention from manufacturing companies when seeking sites for new or expanded operations. This is because direct labor categories (i.e., unskilled, semi-skilled, and skilled labor) typically comprise the largest number of workers in a manufacturing facility. While the exact composition of an operation varies by industry, most headcount is represented in the direct labor groups, with the number of employees declining sharply with climbing skill grade to the maintenance, engineering, and professional-level employee.
Figure 3 provides an illustration of headcount composition for a sample group of manufacturing operations that cross industry verticals. The data illustrates that direct labor represents more than 80 percent of the total headcount found in most operations.
The availability of labor is also a significant consideration in a location decision. If the growth, concentration, and volume of labor skills and target work force are not sufficient to support the scale of a new operation, a location that might otherwise demonstrate merit as a candidate for a facility might in reality prove to be an incorrect choice. The size of an operation must be aligned with the market's ability to provide talent (supply) and competition for the talent (demand).
Another key consideration when locating a facility is finding management-level talent to run operations. Sometimes an investigation of management availability does not receive a comparable level of effort as expended on the investigation of the direct-labor categories because the number of management positions that need to be filled is notably lower. Figure 4 illustrates an organization's typical management structure.
Management talent, however, can be very difficult to source and companies tend to have significant difficulties finding qualified production, quality-control, and supply-chain professionals. If a company also requires that candidates possess an industry specialization, the number of individuals able to meet job requirements can quickly decline.
Labor Investigative Process
Accurate data on labor costs, availability, and quality is challenging to acquire and calibrate when making comparisons across geographic areas. During the location selection effort, the assessment of labor considerations evolves and becomes more focused on micro-market considerations as the investigation moves through each phase of the analytical process.
As illustrated in Figure 5, companies and consultants often adopt an increasingly fine-tuned, three-step process for the assessment of labor after project objectives are established:
1. Identification: Locations are subjected to a filtering exercise to identify a list of candidates that appear to align with the broader objectives of the investment. In this step, labor analysis would likely be conducted on the desktop using published and survey data with a focus on measurements of cost and supply.
2. Validation: Locations are commonly subjected to primary in-market research to obtain a detailed understanding of labor supply and demand characteristics, competitive compensation strategy, and market-entry strategy.
3. Negotiation: The investigation migrates to developing an under standing for how labor conditions might be influenced by utilizing economic development incentive programs. The investigation will focus on how statutory or discretionary incentive programs can support the relocation, recruitment, and training of potential employees.
A successful outcome of the process can be summarized as finding a location with the appropriate costs, labor supply, skills, government support, and the ability to successfully sustain operations for an extended period.
Given the importance of labor to the cost of operations - and its position as one of the most significant geographically variable costs - labor costs will likely remain one of the most important considerations when selecting a location for new manufacturing operations. The geographic variability in costs, skills, supply, and regulation further support the need for robust labor analytics.
When analyzing a location for direct investment, it is important to get beyond desktop analysis and obtain market intelligence using field research interviewing techniques in efforts to obtain the insight necessary to confidently support decisions. In doing so, human resources strategies can be developed, risks mitigated, and confidence applied to communications concerning the merits of a location to support investment.
Matt Jackson, Matt Highfield, and Scott Redabaugh are executives in the Strategic Consulting practice of Jones Lang LaSalle. Contact information for each contributor is as follows:
• Matt Jackson, 571-215-5118 or email@example.com
• Matt Highfield, 612-308-5765 or firstname.lastname@example.org
• Scott Redabaugh, 703-608-3240 or email@example.com