18 January 2012

Chinese whispers

Is production really coming back to the UK from low-cost countries? Annie Gregory attempts to sift evidence from rumour

As long ago as 2003, some observers were warning that the slow boat to China might also turn out to have leaks. Professor Peter Nolan of Cambridge Judge Business School told a US Congressional committee that a herd mentality was developing among giant corporations for sharing in the Chinese miracle. And in 2004, US research consultancy Stone and Associates warned of the myth that migration to China is always cost effective: "When all the hidden costs and risks are factored in, China doesn't always look favourable. It depends, in part, on what you count in the analysis, and the answer may change since some of China's advantages may not be sustainable."

Move on nearly a decade and there's evidence that some boats have turned round and won't be setting sail again. For example, General Electric is moving production of a new, high-tech, energy-efficient water heater from China to Louisville, Kentucky. After a year making it offshore, GE wanted the control and faster cycle time that comes from having designers, engineers and production under the same roof. It's not just China either; last year Ford announced by 2012 it would have brought back nearly 2,000 jobs to its US plants from Japan, Mexico and India.

There are some good examples in the UK, too, although it isn't yet happening on the same scale. After years processing almost all of its products outside Britain, specialist yarn maker Laxtons has invested in new facilities and brought all its manufacturing back to Guiseley, West Yorkshire. MD James Laxton says UK production means improved service with reduced lead times, better management, and a greater control of raw materials and quality. It also has big environmental benefits, with a new emphasis on local sourcing reducing shipping costs and the business's overall carbon footprint. The business has seen resurgence in interest from both existing and new customers as consumer interest in UK-manufactured products grows.

GlaxoSmithKline is planning to build its first new UK factory for 30 years, although it's probably as attributable to new tax breaks as any rejection of offshore capabilities. Reports that GSK's plant in Montrose – one of four sites in the running for the new factory – is taking over the manufacture of steroidal products from India are more significant. A decade ago, this plant was scheduled for the axe; today, the local newspaper reports comments from GSK chief Andrew Witty that Montrose wins the business because of its "globally competitive position" and "extraordinary emphasis on efficiency".

Does this auger well for other UK plants that have shown major improvements? It's true that British manufacturing productivity has more than doubled between 1985 and 2009. Its rate of improvement outstrips both the service sector and the UK economy as a whole. So any company that quit through frustration at poor performances might rethink, especially as Chinese labour productivity is very low by western standards. The average western worker produces 12 times as much as a Chinese one. That means any company returning could theoretically equal its offshore output with a much smaller workforce. But even that couldn't iron out the difference in labour costs. Wages are certainly going up in China, but although the annual average of $2,250 (IMF figures) may drive some OEMs to Cambodia (a pitiful $672 per head), it certainly isn't an incentive for a return to Britain.

There are clearly other things going wrong offshore. If there is a discernible trend to reshoring – by no means proven – the reasons are far more complex than "because we're worth it". Let's take a look.

Simon Howes, MD of MAS-SW says the advisory service is receiving a growing number of requests for advice and support from local companies looking to repatriate production. "Businesses are learning it's not just about the direct cost of production," he says. "There are many other important factors to weigh up when developing strategies for the future." He cites – but does not name – a Devon company winning supply work due to increasing labour and logistics costs; a Bristol business which has taken vital component production back in-house due to quality issues and an inflexible, protracted supply chain; and a Gloucester manufacturer bringing back production of its injection moulding tools for greater control, improved quality and shorter lead times.

Horrendous stories about quality failures offshore abound – like the good prototype that turns into a totally different part in production. Or the contractor who subs the job out after a successful first order to someone who makes the next run in a different material. But it's hard to sort the objective from the vindictive.

Mark Davies, operations director of the contract electronics Exception Group, produces concrete evidence of the reverse flow of manufacturing. "We have just had our best month since 2007 and we are experiencing a real trend in both new customers and business coming back from overseas." In the last 12 months, he has noticed a discernible difference in the language that mainstream customers are using in the tendering process. Whereas once the emphasis would have been on 'low-cost country', now they are stipulating 'best-cost country'. In his view it marks a strategic change where the costs of engineering, logistics and quality have become as important as price as a result of recently-burned fingers: "The choice of low-cost geography was driven largely by labour rates and the hidden costs of the other things weren't questioned. Now the impact on the bottom line has become clearer."

He believes consumer electronics, like most volume products, have gone forever – "they are not safety critical nor is quality so vital." Instead, Exception is scoring by handling smaller volumes of more complex printed circuit board assemblies. "In China they would consider 1,000 boards a month as low volume. To us that's medium mix, medium volume and high tech – it's what we are good at and there's plenty of that work around. We can't ignore cost – but today it's definitely more about value: ease of doing business, engineering support, quality and on-time delivery. If you can guarantee that, you'll do well."

Davies is seeing reshoring opportunities in sectors like oil, gas, energy and transport where reliability is key and the cost of engineering is high. He says currently the engineering presence – particularly in China – is lacking and keeping a company's own staff there long term is expensive, both in direct costs and in management and support.

Recent natural disasters – earthquakes and the tsunami in Japan and appalling floods in Thailand – have obviously caused huge disruption to volume supply chains and have caused many OEMs to rethink their sourcing strategies. These players are, however, more likely to strengthen their future resilience by splitting production between several geographies rather than returning to home base. It's supply problems of a different kind that cause discernible tactical changes.

"The slow boat from China is not necessarily a problem if you plan for it. It does mean you carry more material but once you have filled your pipeline, it's easy – until something goes wrong," explains Davies. Some time ago, Exception helped a customer transfer the manufacture of a product to China: "Their strategy was offshore; their biggest market sector was the Far East and so it made sense." His team designed and built an efficient production cell and helped the customer to replicate it overseas. Then the customer introduced a new version and the problems started. There was an oversight in the design and changes were needed to fix it. The offshore facility was geared up for volume production – not modifications like this. With 20,000 already made to fill the pipeline and customers waiting, the simplest thing was to ship the whole lot back to Exception for rapid rework.

As GE obviously found with its new water heater, innovative product development is an iterative process and it's not easy to maintain momentum and agility with 6,000 miles between design, test and production facilities. Davies says manufacturers are discovering what a nightmare new product introduction (NPI) and prototyping can be offshore. "Service and speed is vital and volume producers are just not geared up for it. And when there are expensive test strategies like stress chambers involved, offshoring just doesn't work." His solution, obviously, is to do all the demanding, skilled work close to home, offshoring only the non-value added work using intermediaries, like his own organisation with branches in the Far East, to handle the interface. It's not too different to what most trade and government bodies have been saying for some time.

The obvious solution is not, however, always achievable. For example, according to the Department for Business, GM Vauxhall has repatriated £200 million of supply chain work back to the UK since July 2010. Yet Vauxhall's boss, Nick Reilly is on record as saying that he and other auto-manufacturers struggle to find UK producers capable of making components at scale. Supply chains once broken can be difficult to mend.

On the other hand, ask any pundit what products are never going to come back to the UK and footwear will be near the top. Oh yes? New Balance makes innovative athletic shoes and it is totally committed to keeping its UK manufacturing right where it is, at Flimby on the Cumbrian coast. Although its process is based on highly skilled but still largely manual assembly, it still competes and wins on cost against the Far East.

Factory manager Andy Okolowicz makes no bones about where China fits. "For our more demanding products, we source as much of our material from the UK and Europe as possible. European leathers are the best in the world and make a real difference to our product. And there are huge advantages – it brings uniqueness, you build relationships, there are smaller minimum orders and you can deal in smaller quantities at the retail end. Nonetheless, it would be very difficult for us to source everything we get from Asia anywhere else. For example, it's just not practical for us to make soles in the UK – we don't have the technology here and we certainly couldn't do it at the right cost given our volumes."

The reason that New Balance and Laxton will keep as much as they can close to home is not just greater control. "I think the made in England label is important, particularly at the high end," says Okolowicz. "Some people still have money and they want goods that are at a premium. Some of ours sell at 200 euros in Italy."

He senses a definite mood that production is coming back. Davies goes further: "I firmly believe there is a genuine resurgence in demand for UK manufacturing. The challenge is making sure we don't allow our skill base or our capabililities to be diluted so – when it comes back – we are ready to support it."

should we stay or should we go?

"... companies often don't consider all of the costs involved in sending their manufacturing offshore, such as inventory carrying costs, travelling costs to check on suppliers, intellectual property risks and opportunity costs from product pipelines being too long."
Harry Moser, The Reshoring Initiative, USA

"Recent economic and natural shocks such as the ash clouds, tsunami and Japanese earthquake have shown the fragility of long distance and single source supply chains. I want to seize on the increased preference that big global companies are showing for co-locating key elements of their supply chains with their UK manufacturing operations."
Vince Cable, business secretary

"… reshoring will not happen … in China 34 million urban factory workers are paid an average of $2 an hour. A further 65 million in town and village enterprises average 64 cents. They would be delighted to work for $2 … Chinese wages will rise but the potential supply of low-cost Chinese labour remains elastic."
Tim Leunig, economic historian at LSE writing in the Financial Times

Annie Gregory

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