When Europe’s largest automobile manufacturer, VW, announced in mid-July that it would start building cars in Chattanooga, TN, the move seemed to signal an end to the days when manufacturers would prioritize low-cost labour in the supply chain.
But while Wolfsburg, Germany-based VW was finalizing the deal in Tennessee, the world’s largest commercial aircraft maker, Toulouse, France-based Airbus, started shipping fuselages, wings, and other airplane segments to Tianjin, China, to begin its first-ever final assembly in that low-cost country.
From a supply chain perspective, observers had to stop and wonder what was going on. Are manufacturers for some reason forsaking the routine decision to head to low-cost labour countries in favor of higher-cost areas like the United States? Or are they carrying on with the pure low-cost labour economics that have led them to countries such as China and India over the past decade?
The simple answer is both, but low-cost labour no longer dominates as it has. And while both of these examples have significant idiosyncrasies, they help to illustrate that factors such as the surging costs of oil-based transportation, the green imperative, and the weak dollar are pushing manufacturers into a new era in which low-cost labour alone does not drive their sourcing decisions.
For VW, the weak dollar helped drive its decision to invest $1 billion and create 2,000 direct jobs in Tennessee. In a press release announcing the decision, the company said that the Tennessee facility “will help to permanently alleviate exchange-rate fluctuations.” In the same press release, VW CEO Martin Winterkorn called exchange rate relief “a prerequisite for the economic success of the company in the dollar region.” The company has been building North American cars in Mexico, using many euro-denominated parts that undermine its financial position.
A common thread in both the VW and Airbus moves is that both plants serve the countries where they are located. VW will build mid-sized sedans for U.S. consumers starting in 2011. Airbus is about to start snapping together A320s in Tianjin for China’s Sichuan Airlines.
Rising Shipping Costs
Many supply chain experts expect to see more manufacturers locate production in or near their major markets, as opposed to prioritizing low-cost labour areas. One of the biggest reasons: The surging price of oil-based transportation is wiping out the economic gains of producing in low-cost countries as companies spend a king’s ransom to ship goods around the world. Related to that, international shipping carries a big environmental cost.
In a recent report by IDC Manufacturing Insights, analysts Kimberly Knickle and Simon Ellis note that a pure, low-cost economic approach sometimes “just doesn’t make sense. Companies need to look at all options, including low-cost country outsourcing, near-sourcing, or even moving operations to locations of growing customer segments. Skyrocketing energy costs and the implications for transportation/logistics costs may change the dynamic for many categories.”
IDC even has a name for the move away from low-cost tunnel vision: profitable proximity. “The current myopic pursuit of ‘low-cost country sourcing’ is coming to an end,” Ellis says in a separate report, titled “Profitable Proximity: Product Sourcing Decisions in the Modern Supply Chain.” “A total supply chain cost perspective is far more sensible.”
Part of Ellis’ reasoning is that labour costs are already rising in today’s low-cost countries, such as China. And though China won’t remain low-cost, many European companies will still choose to manufacture there. Among other reasons, manufacturing partnerships with Chinese companies, such as the one formed by Airbus in Tianjin, are key to gaining access to the national market. Airbus operate its Tianjin facility in a joint venture with a group called the Chinese Consortium that consists of the Tianjin Free Trade Zone, and the two China Aviation Industry Corporations. Airbus and the Chinese group announced the venture last year in a ceremony in the Great Hall of the People in Beijing.
"With China's economic booming and the rapid development of the Chinese aviation industry, Airbus looks at China not only as one of the most important markets, but as a strategic partner,” Airbus China President Laurence Barron said in a statement when the A320 parts reached Tianjin in late July. “Airbus will closely work with the Chinese aviation enterprises and continue to deepen and expand our cooperation.”
This is not to say that manufacturers are turning their backs on low cost considerations. Douglas Kent, director and founder of supply chain consultancy eKNOWtion in London, says that the move to low-cost countries “is not going to reverse itself.” In fact, some manufacturing is moving from China to Vietnam. But Kent, who is also a European Leadership Team member for manufacturing organization the Supply Chain Council, adds, “The pace of the transition is going to lessen.” He echoes IDC, noting that the past decade’s low-cost labour thinking “is now getting turned on its head,” as environmental, transportation, and other factors rise in prominence.
For European manufacturers, the trend toward proximity means some factories will return closer to home. Within that context, Kent says, manufacturers will settle on countries where labour rates remain relatively low. “There will be a resurgence in Eastern Europe, in places like Romania and, I think, Russia,” he says.
Further fueling that trend: Manufacturers want to reduce the amount of carbon pollutants they emit through global transportation. Many manufacturers at least want to give a public relations image of doing so. As Kent says, “They want to be lean, green, and seen.”
As evidence of the PR campaigns feeding the carbon footprint reductions Kent points to U.K. supermarket giant Tesco. “They’ve started putting the number of miles traveled on a product. That plays into the emotions of the consumer.” The point: Consumers’ environmental sensitivities will further cause manufacturers to consider producing closer to the markets where they sell.
“Moving goods up and down continents has a huge environmental impact,” says Pierfranceso Manenti, a Milan-based analyst with IDC Manufacturing Insights. “Companies are starting to think about that.”
Other factors will also help keep manufacturing closer to home. For some, nationalism will play a role. For others, quality control will. Still others will cite risk management in keeping production nearby. For Europe’s manufacturers, the decision on where to source goods and locate production will not be quite as straightforward as in recent years. One thing for sure is that manufacturers will be rethinking their supply chains.