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|Carlton Delfeld, President of the global investment advisory firm ChartwellAdvisor.com, believes that the United States and Europe can learn lessons from Japan's moves to bring manufacturing capabilities back into that country.
Delfeld states that Corporate America is in serious need of a 'portfolio review' of its manufacturing base. He believes that outsourcing makes sense only if the proper balance is achieved between domestic and offshore manufacturing. During the last decade, a hot topic in both Japan and America has been the 'hollowing out' of their respective industrial bases. The share of Japanese-owned productive capacity located abroad has grown from 8% in 1994 to 40% in 2005. The United States currently has about 50% of its manufacturing base located offshore.
For both Japan and America, the large outflows of direct investment, especially to China, have caused an uneasy feeling that both countries have bleak futures as manufacturing centers.
Surprisingly, the pendulum is now moving back in Japan as large Japanese multinationals are busy investing in manufacturing plants at home. For example, Canon is building a large digital camera facility and plans to spend 80% of its $7.2 billion capital budget in Japan over the next three years. This is a reversal from the past ten years when 80% of its capital budget was spent overseas. Toshiba is building a $2 billion semiconductor facility. Sharp, Matsushita and Nippon Steel are also building major plants in Japan. Overall, spending on plants and equipment in Japan is rising at a 10% rate.
Delfeld notes that this trend runs counter to the fact that Japan has been investing heavily in China. China has passed the US to become Japan's largest export market. In addition, Japan needs a strong presence in China to tap its rapidly growing consumer market, as well as a low cost base to manufacture lower tech products. For certain products like cars it is also likely to keep large manufacturing bases in countries like America. For example, Toyota produces more than 1 million cars annually at eight manufacturing plants in America and has two plants under construction in Texas and Tennessee. But for the more advanced capital-intensive products, Japanese companies are building plants in Japan.
How can we account for this surprising turnaround and what are the lessons for America and Europe? First, Japanese firms have learned the drawbacks of outsourcing. Supply bottlenecks, poor infrastructure, power shortages, uneven quality, difficult inventory management and high employee turnover are just some of the problems.
Secondly, even though China's wages are about 5% of Japan's, its increasingly sophisticated factory automation has lessened the importance of labor costs. For advanced high tech products it accounts for only 10-15% of total costs. Having manufacturing closer to home also shortens new product lead times and increases cooperation between R&D and production teams, leading to a crucial edge in staying ahead of nimble competitors. Supply lines of 1,000 km or more can become a major source of problems..
Lastly, and perhaps most importantly according to Delfeld, there is the critical issue of protecting intellectual capital. Having research, development and production closer to headquarters better protects proprietary technologies.
In America, the signs that corporate outsourcing is at a tipping point are numerous:
- the last time that the US recorded even a one-month trade surplus was in the 1970s.
- the US imports $1 million of Chinese goods each minute.
- if Wal-Mart were a country, it would be China's fifth largest export market.
However, in America the outsourcing trend does not appear to be reversing even in capital-intensive products. Many of the new high tech jobs are for managers to manage the outsourcing process. Microsoft, Intel, IBM and Motorola all have large and growing R&D centers in China to take advantage of that country's cheaper pool of talent.
Given China's lack of intellectual property rights enforcement, Delfeld suggests that senior executives should pause and reconsider the long-term costs of expanding outsourcing programs. He believes that their offshore R&D staff may very well walk off with proprietary knowledge and a company's future.
One example of a balanced approach to outsourcing is the US-based New Balance shoes. While market leaders Nike and Reebok manufacture virtually all of their shoes offshore, New Balance has taken the approach of keeping five domestic factories that are equipped with high tech robotics, leading to making a shoe in 25 minutes versus four hours in Asia. New Balance employees earn an average of $12 per hour versus 40 cents an hour in China. But the new technology coupled with cutting production cycles from 8 days to 8 hours and cost savings from shipping directly to US retailers make up the difference.
Delfeld argues that this is not a call for isolationism or rolling back globalization, just a reminder that outsourcing has its risks and downside. He suggests a little common sense and balancing short-term cost savings against the long-term strategic risks.
Delfeld concludes by saying that instead of just taking the comparatively easy step of lowering labor costs by outsourcing, executives should follow Japan's examples and improve manufacturing techniques in order to reap the returns and lower risks through a more balanced 'portfolio' approach to outsourcing.
(Carlton Delfeld is President of ChartwellAdvisor.com, a global investment advisory firm. He is the author of a new book,The New Global Investor, and was a Japanese Government Scholar at Keio University's School of Commerce and also served on the Board of Directors of the Asian Development Bank.)