The Pros and Cons of Onshoring
Companies relocate operations to other countries largely for financial reasons. Has the global economic downturn created opportunities to move those operations back to the United States?
Defining the Different "Shorings"
Offshoring is defined as the relocation of a whole process, piece of a process, a function, or a discrete piece of work outside the boundaries of the United States, either within or outside the boundaries of the company. This means work performed either as an affiliate or work "outsourced" to another firm (known as outsourcing). Onshoring frequently refers to an overseas investment by a domestic company (or overseas affiliate) that is subsequently reinvested back into the domestic marketplace; this is what is meant by bringing jobs back home. In reality, onshoring has a broader definition and is actually defined as any direct investment into the domestic marketplace by a domestic company.
"Nearshoring" is a domestic company investing outside the country, but into a neighboring or "near" country. For example, nearshoring to the United States would be a U.S. investment in Mexico or Canada - part of the Americas as a whole when considering the entire world. "Inshoring" is a new term that refers to an investment by a foreign company into the United States. This is also called an inbound foreign direct investment.
Background of Offshoring and Onshoring
Countries were historically held back from trading by limitations of excess shipping and difficult, costly communications. The advent of the Internet, together with the development of highly efficient and inexpensive transportation of goods on a global basis, has fueled worldwide economic growth and subsequently led to globalization. The transformation has been swift. In manufacturing, investment went from a "trade-then-invest" model to an "invest-then-trade" model. This has now become a model of "invest to optimize the value chain." Competition has become fierce and global, forcing survivors to seek out locations that minimize costs and maximize efficiencies. In services, offshoring allows companies to compete on a global basis for lower costs and better efficiencies for their information technology (IT), business process outsourcing (BPO), call centers, and the like.
Most successful, smart investors will tell you that an investment needs to be a "win-win" situation for both sides. Offshoring has done this in a significant way. On the investor's end, offshoring has enabled significant market growth and return on investment (ROI). On the recipient's end, international investment and trade have brought millions out of poverty on a global basis by creating new jobs and new markets - often at the expense of the developed countries and their own domestic jobs and marketshare.
The playing field is becoming global and is quickly leveling out as gaps in price and quality parities are starting to narrow. The third gap, that of time, is also closing as transportation and communications continue to improve. Although the parity gap is closing, we will never reach parity. In fact, the countries against which parity is measured may well change. The growing parity being witnessed today is only being measured between the world's present Tier I cities that have attracted the majority of offshore investment, a small percentage of the total global population.
Tomorrow's population will be very urban, living in new cities with new infrastructures and new competitiveness. Most of the population growth in the next few decades will be outside the United States. Our present world of over 6 billion people will grow to 9 billion by 2050; 98 percent of these new inhabitants will be born in developing countries - with over one-half living below the poverty line of making $2 a day. There will always be a cheaper place to invest.
The Current Economic Crisis
The current economic crisis has grown to global proportions and is greatly affecting both offshoring and the possibilities of onshoring. The financial crisis began in the third quarter of 2007 and became much more serious a year later during the third quarter of 2008. By year's end, falling consumer demand for goods and services caused greenfield investments, both in the United States and U.S. investments overseas, to be put on hold or outright canceled.
Companies have had to undertake two main objectives both at home and at their overseas affiliates: curtail expenditures and take measures to reduce debt. Curtailing expenditures has resulted in operational reductions, including massive layoffs that have prolonged the downturn. Many companies have been forced to divest back to their core businesses or to sell parts of the company in order to generate cashflow. Declining profits and sales have led to significant overcapacity, declining equity, decline in reinvested earnings, and declines in capital cash flow. Several have simply gone out of business.
From a financial standpoint, the crisis has greatly reduced access to finance both domestically and overseas. The capacity to invest and the propensity to invest have been greatly reduced. The financial markets have tightened to the point of making external financing impossible for some. Tighter credit has made syndicated bank loans and money for arranging leveraged buyouts (LBOs) much tougher to find - especially as hundreds of financial institutions are closing doors. This has all resulted in higher prices, especially the spreads in corporate bonds. In the meantime, many companies are losing their creditworthiness.
The picture does not look so bright in the future, either. Although the stock market is recovering, double-digit unemployment continues, with gloomy economic and market forecasts. The results of the huge federal stimulus package are still unknown months later, and government spending is increasing substantially. There is a real fear of inflation on the horizon with the erosion of the U.S. dollar and creeping price of oil. The International Monetary Fund (IMF) projects an actual decline in total world output in 2009, the first time in 60 years. This does not bode well for either offshore or onshore investment by U.S. companies.
Onshoring by U.S. manufacturers will be very limited. This is due to several factors, with the cost of labor being the main obstacle, as this makes up the largest portion of production costs. Taxation in the U.S. and heavy regulations are also major factors forcing companies offshore. Manufacturing skills are being lost in America and our education system is not meeting future demand. Absent a large, qualified manufacturing work force with globally competitive labor costs, manufacturing per se will not return. That isn't to say a few companies will not onshore back to the United States; some will, and they will grab headlines.
Most U.S. manufacturers considering onshoring back to the United States will most likely instead nearshore back to other North American or Central American locations to remain globally competitive. Certainly, new U.S. market-driven manufacturing investment will return - especially when the economy improves as there is pent-up demand by consumers. However, most manufacturers are experiencing all-time low capacity utilization rates and it will take some time for this capacity to be taken up by the market before new greenfield projects take place.
The services sector will be better positioned for some onshoring activity. This is because investments in this sector are much more flexible than manufacturing. Overseas inflation rates, all-in labor costs, labor quality, high churn rates, high benefits costs, training costs, waste, corruption, and increasing domestic and foreign competition will all be factored in to any offshore/onshore investment decision.
Although the price advantage has typically decreased over the years from 30 percent of the U.S. costs to 40 percent of the U.S. costs to today's estimated 50 percent of U.S. costs, the differential is still significant. Keep in mind that these costs are typically compared to U.S. Tier I cities. Rural onshoring to Tier III cities can save an additional 30 percent; however, quality and risk may offset these cost concerns.
Certainly, the economic downturn has made the United States more competitive in attracting onshoring. A much larger pool of available labor, including a lot of people willing to work even if underemployed, exists in many locations throughout the country. Lower real estate costs and a greatly expanded broadband network to rural areas are other key attractors. In addition, states are willing to provide incentives to attract most investments in the service sector; training incentives are especially useful.
Offshoring from the United States needs to be understood in terms of its purpose. If the purpose was to enter new markets, the prospect for onshoring back is minimal - only done in a survival mode and resulting in a consolidation or divestment. However, if the purpose of offshoring is to fine-tune the value chain of an operation, the question then becomes: What does onshoring to the U.S. bring to the overall value chain?
Bill Luttrell is a global site selection specialist with more than 20 years experience in the corporate real estate and economic development industries. His areas of expertise include cross-border international location solutions and foreign direct investment consulting.
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