Episode 36 – Manufacturing Re-shoring: Post-COVID 19 Tipping Point
Rick Weddle: Welcome to Site Selection Matters, where we take a close look at the art and science of site selection decision-making. I’m your host, Rick Weddle, president of the Site Selectors Guild. In each episode, we introduce you to leaders in the world of corporate site selection and economic development. We speak with members of the Site Selectors Guild, our economic development partners and corporate decision-makers to provide you with deep insight into the best and next practices in our profession.
In this episode, we have as our guest, Greg Burkart, managing director and practice leader for Site Selection and Incentives Advisory Services with Duff & Phelps. Today, Greg will talk with us about manufacturing reshoring. More specifically, we’ll talk with Greg about how the COVID pandemic is changing the dynamics of manufacturing location activity around the world. Join me as we welcome Greg Burkart to Site Selection Matters.
Greg, a lot has changed and continues to change in response to the COVID-19 pandemic. Global supply chains are being reexamined as we speak. I’ve even heard you suggest that companies are maybe nearing a tipping point to bring manufacturing operations back to the U.S. Take a minute or two, if you will, to help our listeners understand your views on reshoring and what you mean by companies reaching a tipping point.
Greg Burkart: Thanks, Rick. So, since the passage of NAFTA in ’93, the trend for companies has been to shift the manufacturing of goods from the U.S. to low labor costs. And in 1992, the U.S. trade deficit for goods production was about $85 billion. Last year, the trade deficit had multiplied 10 fold to $854 billion. So over this time period, what we were also seeing what all the shifts of production to China, the labor costs in China rose about 2,000% and that caused companies to start analyzing their manufacturing operations because the U.S.-China labor deferential shrunk from about 31X to about 4X.
Initially, companies as these labor costs started to rise, what they did is they moved from the coastline in China to the further interior parts of China. Once the pandemic hit, companies realized that, you know, they couldn’t reliably get their goods out of the Western Province. And so, as a result of that, the goods just stopped flowing almost overnight. And what was kind of this slowly simmering pot really started to boil over in April. The C-suite was also facing the possibility that the current administration would designate their company as a critical business. And for them, that was the tipping point where they would be forced to relocate operations back to the U.S. So instead of having this, you know, far-flung supply chain, companies started looking more closely at manufacturing for the U.S. market in the U.S. or asking some of their critical suppliers to relocate back in the U.S. So that’s what we mean by the tipping point. The pandemic caused companies to kind of reach that tipping point.
Rick: So, Greg, let me ask a question, the critical business designation that the federal government could make would actually be a regulatory matter where they might say to industry A or industry B or company A, or company B your business is critical, therefore you have to realign your supply chain. So, they were actually faced with possibly having to do it for non-business reasons. Is that right?
Greg: Correct. So, Department of Homeland Security has identified, I think there’s 13 or 14 industry segments that they view as being critical to national security. So, it’s a designation that could come from Department of Homeland Security, or Peter Navarro has an office in the White House. And he would be the, you know, the U.S…what they’re calling the, I guess the U.S. productions czar. So, it could come from either the agency or from the White House.
Rick: That’s interesting. So, you know, as we’ve dealt with the pandemic, we…back home, we have operations and employees that are considered essential employees, that that’s a designation. And then now you also have critical businesses and critical industries that have an implication there. So that’s very interesting. Greg, with companies reassessing their supply chains, are there specific considerations that are now being weighed as heavily or more heavily than costs alone? Are there other non-cost factors that are starting to come into play?
Greg: So as strategic factors, as risk factors entered the equation, executives started asking us to quantify other variables that would help them minimize some of these risks in their siting decision. So, our firm undertook a census study of the 28 identified production sectors, and we created an index that ranked the various industries that identified those that were most likely to ensure their operations. And in our analysis, we plotted the current data for all those major production categories. And we began that analysis by identifying and measuring and weighting some of these key [inaudible 00:05:50] which include…we sort of refreshed the analysis on costs you know, with the huge increase in Chinese labor rates. We took a fresh look at what those labor rates were in China versus here in the United States. And we did that as a percentage of production hours to factor out currency fluctuations in the effect that exchange rates would have on the overall dollar value of production.
In addition, we took a look at logistics costs, you know, what was the cost to hold and ship those products to the United States. It’s another factor that has risen quite substantially in China here in recent years. But then in addition to cost, we took a look at five other variables, and those were the level of automation in making the product. How amenable was the improvement in the manufacturing process with automation? So essentially, we took a look at the effect of labor productivity on the manufacturing of the good. The second one was the level of innovation and intellectual property that’s embedded not only in the product itself, but also in the manufacturing of the product. The third variable that we took a look at is product quality and manufacturing safety. So how important was product quality to the customer’s buying decision? You know, for example, was it a part that was under the hood in an automobile that would not be visible to the driver, but then also, you know, how safely could the product be made? You know, there’s a number of manufacturing operations that are just, you know, inherently dangerous. So, what is the overall level of safety in the manufacturing of that product? We also took a look at, we just talked about, you know, whether or not the business would be considered as essential or critical to U.S. national security. And then finally, we took a look at environmental regulations and what were the incremental costs of the environmental controls that were required to manufacture the product in the United States? So those were the six. So, we had cost plus automation innovation, intellectual property, product quality, manufacturing safety, central business designations, and then also environmental regulations. Those were all of the things that we considered when we created our index.
Rick: You know, Greg, it strikes me that all those factors were there before. It’s just now that some are more important than others that as you said, you reweight them or…and figure out how to measure them. I’m curious, what really does [inaudible 00:08:43] see this? What does it mean for location advisory services? Does this level of non-cost related analysis make reassuring more important to some industries? And if so, which I think obviously it does, what would you consider the priority industries to consider for reshoring to the U.S. now?
Greg: Well, for site selection, risk minimization has become just as important as cost. So, in our analysis of the six primary criteria, we did an even weighting of the variables that relate to cost and those that relate to risk. And, you know, we see, for example, the essential business designation or the probability of being designated as a critical industry as a risk for a company, much like the incremental cost of environmental controls as a cost element. So, we did an equal weighting of these costs and risks. And after we analyzed all of those criteria across the 28 production sectors, we identified 8 as being the most probable candidates to reshore to the United States. And when we look at those eight industries, they share a few common characteristics. So first, they’re relatively low labor and high transportation costs. The manufacturing process tends to implement some of the most advanced robotics and automation techniques for the manufacturing of those goods. The manufacturing process also is more conducive to U.S. environmental and OSHA regulation. And then a couple other items is that we found that the innovativeness or the value of the IP is a big percentage of the overall product value. And then finally, a lot of these products just tend to have higher profit margins and higher global demand, so that, you know, alleviates some of the concern associated with the additional investment costs to reshore the product. And so, the eight sectors that we identified are automobile parts and body manufacturing. We had other transportation equipment that we identified, for example, rail, and boats, probably the third one, which was…seems to be obvious for a lot of folks, but, you know, a lot of it was also being manufactured offshore is navigational, measuring, electromedical, and control instruments and devices. The other one is soaps and cleansers. You know, with the pandemic, we didn’t realize how much of our soaps and cleansers were actually made offshore. Semiconductor and electronic components, medical equipment and supplies, communication equipment. And then finally the eighth sector was aerospace products and parts. So those were the eight that we identified as being the most likely to reshore and come back to the United States.
Rick: You know, it seems interesting to me when you…listening to you walk through that list and the build up to that going through innovation and the cost of this and the cost of that, and the importance of this and the importance of that, that you initially would think, well, that’s gonna mean that this is…we’re all really high end kinds of things. And then we add soaps and cleansers, which is interesting to have that right there beside semiconductors as one of the priority candidates, but it’s for a different set of reasons, but probably equally important.
Greg: Right. Absolutely. Well, and I guess we didn’t realize how much profit margin is actually in soaps and cleansers too, so. But, you know, some of these, for example, soaps and cleansers are, you know, probably higher in terms of the probability being designated as a critical industry, much like, you know, medical equipment and supplies. Those two items, especially in the midst of the pandemic that we’re in are very, very critical to the overall national security in the U.S.
Rick: Well, and it strikes me that when the pandemic first hit and broke out, there was all of the stories on the evening news of, you know, distilleries and beer place…people converting alcohol production to hand sanitizer, which is, you know, because that was suddenly way more important than it was just a few weeks ago. And that whole process, as it had become very, very critical and as we go through that. As you shift all the strategic system analysis from cost and specific lower labor cost, doesn’t mean that labor goes away as important, but it’s relative importance shifts. But now that you’ve built this kind of matrix, how does this really help you determine the best candidates for reshoring? Or is there any thoughts you wanna share on that?
Greg: The best candidates for reshoring are really those that would be probably have the highest potential of being designated as a critical business. That’s the new risk in the equation that people really hadn’t fully considered up until the pandemic hit. You know, we’ve always talked about the importance of manufacturing safety and product quality and intellectual property protections and environmental regulations. But I think that the real new sort of factor that that is now on everybody’s radar screen is this essential business designation.
Rick: That’s very interesting. It’s a change. You know, Greg, I don’t wanna put you on the spot, but let me just go right ahead and do it and put you on the spot. If you had a crystal ball right now and could see the future, as much as all this change is happening, you know, what would it look like to you? How do you see COVID-19 pandemic changing the way you do business? How do you think this would impact the competitive position of cities and regions? And finally, if and when, if ever, will we return to normal?
Greg: Wow, those are all good questions. I guess that’s why you’re on that side of the mic. Those are very good questions. You know, we’re seeing right now two competing risks, really, or two competing events that are causing risk. One is COVID-19, the pandemic. The other one, which I think we talked about on one of the recent webcasts with Jay is, you know, the some of the unrest and protests and…that’s going on across the country. Now, in my view, the biggest economic disruption that we’re gonna face is with the pandemic, with COVID-19. And to respond to this uncertainty, we’re seeing a lot of our clients repatriating manufacturing to the U.S. or holding larger inventories in the U.S. until they can make this decision about whether or not they wanna repatriate. What’s common between these protests though and COVID-19 is both of these events seem to be occurring more in urban [inaudible 00:15:54]. So as these operations are repatriated back to the United States, what we’re seeing is more interest in rural areas, not necessarily urban areas. And that’s a switch from what was going on here just, you know, really almost a year ago or even six months ago. How that changes our profession a little bit is our challenges as site [inaudible 00:16:20] is finding reliable data for the rural areas. For example, you know, we have 392 MSAs. All the counties that are not part of an MSA are considered rural. Well, if you take a look at the last census, the non-metro counties contained about 46 million people in the U.S. and it covered about 72% of the land area of the country. So, if you focus solely on MSA level data, you’re gonna be missing a lot of the country’s land area and about 15% of the population. So, it seems like maybe kind of a innocuous decision at the front end of a site selection project can lead to large gaps in the data, and you could inadvertently, you know, eliminate hundreds of a very viable sites in the more rural areas.
Rick: Does it follow that suddenly now you’re having to look at areas that you previously didn’t have to look at, or didn’t…or weren’t being asked to look at and consider?
Greg: Well, that’s the old Pareto’s law, right? So, it’s always, you know, 80% of the projects always seem to go to 20% of the locations. So, it always seemed to be, you know, when you would look at announcements that, you know, a lot of the project announcements happened in, you know, the, you know, the top 75 to 85 metro areas or MSA. And I think now what’s gonna end up happening is companies are going to be actively exploring the other MSAs and non-metro communities. The biggest challenge was always getting the data for those non-metro counties, because so much of the publicly available data is organized around MSAs. And, you know, now I think our challenge is gonna be, you know, how do we get data to analyze these decisions and make recommendations to our clients? So, data gathering for these rural areas is really gonna be a critical skill I think for the foreseeable future for our profession.
Rick: Certainly, sounds like an opportunity for local economic development leaders to figure out how to help you get that data so they can be on the short list and maybe have an opportunity for some of these new opportunities.
Greg: Absolutely. They are certainly on the front lines of that data gathering and publicizing it. You know, the great thing about the internet is it really does make the long end of the…the long tail of the market much more visible. And so now, like no other time in our history, local economic developers can make a big impact just by gathering and publicizing the information about their communities on their websites.
Rick: Greg, you’ve given us a lot to think about today, a lot of opportunities for local economic developers. What a great conversation. But that’s really all the time we have. So let me begin to say thanks to Greg Burkart with Duff & Phelps for talking with us today on this episode of Site Selection Matters.
Greg: Thanks, Rick.
Rick: Thanks for listening to this episode of Site Selection Matters and a special thanks to Greg Burkart, managing director and practice leader with Duff & Phelps for helping us get inside and better understand manufacturing reshoring and how it will impact our country, our states, our regions and cities in the years ahead. What an informative discussion we’ve had today. Again, I’m Rick Weddle, president of Site Selectors Guild. This podcast episode presents my views and the views of my guests and they do not necessarily represent the views or opinions of the Site Selectors Guild or its membership. We hope you will subscribe to ”Site Selection Matters” podcast on Apple Podcasts, on Stitcher, on Spotify or wherever you get your podcasts. We look forward to bringing you some great discussions in the year ahead. Until next time, good day.