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Labor Costs: The Number-One Site Selection Factor

In the current economy, it is not surprising that labor costs - a major operational cost component - are ranked as the most important site selection factor by corporate executives.

Feb/Mar 10
As we look at the top-10 site selection factors ranked by executives in the 2009 Area Development Corporate Survey, it is not surprising that almost all factors are related to operational costs and cost control, especially given the state of the U.S. economy throughout this past year. These days, companies and corporate executives are under an extreme amount of pressure to reduce costs as everyone is tightening their proverbial belts. This is no different when it comes to site selection decision-making; therefore, it seems logical that labor costs - one of the biggest operating cost components - was ranked the most important site selection factor in the recent survey of corporate executives.

Narrowing Profit Margins and Cost Control
Increasing consumer demand for lower-priced products is driving companies to find ways to lower manufacturing costs. Companies have been forced to look at ways to control and reduce operating costs such as labor costs, inbound/outbound shipping costs, utility costs, corporate tax rates, occupancy costs, and other factors - most of which were also listed as top-10 factors in the Area Development Corporate survey. Tax exemptions and state and local incentives, other top-ranked factors, are means to help offset operational costs as well. The cost of labor though, which can make up anywhere from 30 percent to 60 percent or more of total operating costs depending on the type of operation, continues to be one of the most analyzed and important factors when it comes to site selection.

A 2009 report on manufacturing trends conducted by IDC Manufacturing Insights, a leading global market intelligence firm, predicted that "modern supply chain organizations will scrutinize expenditure budgets even more, and new investments will focus on cost savings, requiring shorter payback periods. Expenditures will be made through the lens of cost/value."

The focus on cost savings and shorter payback periods can also be applied to location selection projects for expanding or relocating manufacturing operations. Some recent Austin Consulting projects have involved relocation of operations from high-cost operating environments (such as metropolitan areas) to lower-cost areas (such as more suburban or rural regions) in an attempt to achieve cost savings. The Austin analyses incorporate a "benchmark" for current operating costs versus "alternative" options in other regions to compare cost savings or penalties that could be expected based on operating requirements. A major focus for these projects is labor costs and the return on investment that a new location with reduced labor costs could bring.

Global Competition
Driven by competition to find lowest-cost wages, some industries have considered moving operations offshore, but this is not a new trend. In 1977, the municipality of Sioux City, Iowa, decided to save their taxpayers less than $300 on a nearly $79,000 purchase by selecting a Japanese-made escalator over an American-made one for their new City Hall building. The irony, however, came shortly thereafter, when the local Zenith television production plant - pressured by competition from foreign-made models - announced it would be closing and laying off 800 workers. The jobs were transferred to Mexico and Taiwan where wages were $5 less than the $6.32 per hour the company was paying to American workers. Sioux City quickly found out how decisions like theirs impacted the U.S. manufacturing sector and American jobs, but - at the same time - city officials, like other businesses and consumers, had their own budgets to be concerned about.

During the 1970s and even prior, companies began to move operations to low-cost regions in the southern United States as well as abroad, largely driven by competition to find the lowest-wage locations. This was especially the case for low-cost, low-margin products that required low-skilled manufacturing. The trend for moving operations to foreign countries continued to grow for more industries in the mid-1980s and leading up to a major shift in the mid-1990s following passage of NAFTA legislation. Industries such as computers and other electronics, clothing and textiles, and toys and other consumer products have been largely impacted by this shift.

Labor in the New Economy
Although the exodus of manufacturing from the United States to offshore locations that became more pronounced during the past 20 years was devastating to many communities, it can be argued that the loss of these lower-skilled production operations made room for the next generation of manufacturing and production that is still occurring today. New industries such as biotechnology and advanced manufacturing require higher-skilled workers and flexible labor forces that many less-developed nations do not offer.

It is also more cost-effective to produce regionally and locally consumed products, such as food and beverages, in the United States rather than abroad, and shelf life and food safety considerations are also critical to these products. Some types of packaging and building materials are also produced locally to serve local markets. Although the manufacturing of these types of products is destined to remain in the United States, consumers are still demanding lower-priced products, and companies are constantly striving to offer competitive prices by lowering costs, especially labor costs.

In today's economic recession, the United States is facing a national unemployment rate of 10 percent with some states showing much higher rates, such as Michigan (14.7 percent) and California (12.3 percent). In addition, the level of underemployment, i.e., people employed in jobs that they may be overqualified for, is also at an historic high. This means the availability of workers - including some who may possess high skill levels that are required for "new" manufacturing - is at an all-time high in most areas. The surplus of available of workers has benefited companies, however, by allowing wages to remain relatively stable over the past several years, while still allowing businesses to attract quality workers. Based on the forecast for the coming years, a slow economic turnaround means that this trend should continue to benefit companies.

Other Labor-Related Cost Factors
Today, while the dollar per hour figure is still very important, there are other cost components that factor into total labor costs as well. Most notably, these include the employee benefit package and other mandated indirect costs that are the responsibility of the employer such as:

• Life and health insurance
• Retirement and savings plans
• Workers' compensation
• Unemployment insurance
• Social Security
Typically, fringe benefits like life and health insurance and retirement and savings plans are a percentage of total payroll costs that may or may not vary by region or state. In order to be competitive, a company will generally want to be sure that their fringe benefit package is competitive with other operations in the area in order to attract quality workers. A large multi-operation company may have a corporate-wide fringe benefit package that is standard and offered to all employees at all locations.

Mandated costs that can vary from state to state include workers' compensation and unemployment insurance. Workers' compensation insurance provides compensation for medical care for employees who are injured on the job. Unemployment insurance provides unemployment benefits to workers who become unemployed through no fault of their own. Currently, Indiana and North Dakota have some of the lowest workers' compensation rates, and Vermont and Nebraska offer some of the lowest unemployment insurance rates. Conversely, Alaska and Montana are on the high end for workers' compensation, and Washington and Minnesota rank on the high end for unemployment insurance.

Social Security is a federally mandated program in the United States that is funded through payroll taxes, which are based on total earnings per employee. Although it is a mandated program for all U.S. employers, a location that can offer a low total payroll cost will also help to keep payroll taxes at a minimum. This may also factor into location decisions for operations that are considering foreign countries that do not require such a tax.

Labor / Management Relations
In addition, labor/management relations and unionization rates can also factor into labor costs. According to Bureau of Labor Statistics, the average worker not represented by a union commanded a wage that was nearly 20 percent less per week than one represented by a union. For this reason, it is less attractive to a company to locate an operation in a highly unionized environment. Especially with the high U.S. unemployment rates, most companies feel they can find quality and skilled workers to meet their operational needs at a lower cost in areas with lower overall percentages of organized labor.

This is also why an increasing number of companies are selecting locations in right-to-work states, or states that prohibit employers from having agreements with trade unions that require membership in a union as a condition of employment. In most right-to-work states, the unionization rate is low and the threat of the work force unionizing is minimal. There are 22 right-to-work states, primarily in the southern and western United States (see map). Since the right-to-work laws went into effect, many states in the South have succeeded in attracting business from highly unionized regions in the North.

Future Labor Cost Trends
As more jobs are lost or relocated due to the recession, it can be expected that average labor wages will remain constant or even decrease in areas of high unemployment. For emerging industries, such as renewable energy, that are working on minimizing operating costs in order to offer products that are at parity with those of their competitors, low-labor-cost regions may be selected for new operations, provided that they also meet other important requirements.

Going forward, it can be expected that the cost of labor will continue to be an important location decision factor for new investment. Even as the U.S. economy slowly improves, companies will continue to be mindful of operating budgets and cost factors as operations are evaluated for efficiency and cost-effectiveness. Since labor costs will continue to be a major operational cost component, it can be expected that this factor will remain one of the top site selection priorities in the Area Development Corporate Survey for a long time to come.

Michelle Comerford is the managing director and Frank Spano is the director of Austin Consulting, a leading consulting firm specializing in location strategy, logistics analysis, property selection, due diligence, and incentives negotiation. The authors can be contacted via email at michelle.comerford@theaustin.com or frank.spano@theaustin.com.

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