Wave of Restructuring Global Supply Chain Strategies

For the past 25 years, the dominant strategy for Western companies has been to manufacture outside the United States in low-cost locations like China, resulting in a significant reduction of manufacturing jobs in developed economies.

However, more recently many corporations, such as General Electric, have reported plans to move at least a part of their global production volume to developed countries. At the same time, while there seems to be an emerging trend to bring back production to the United States, companies like General Motors are continuing to invest in new plants overseas.

As part of a global business initiative, seven business schools from around the world, including Georgetown University’s McDonough School of Business, the Wharton School at the University of Pennsylvania, and the Graduate School of Business at Stanford University, executed a multi-year research effort focusing on current practices and strategies associated with the sourcing of production and trends in a global supply chain.

“Off-, On-, or Re-shoring: Benchmarking of Current Manufacturing Location Decisions,” co-authored by Ricardo Ernst, professor of operations and director of the Global Business Initiative at Georgetown’s McDonough School of Business; Shiliang Cui, assistant professor of operations and information management at Georgetown McDonough; and seven other leading global supply chain experts conducted a survey of 85 top manufacturing companies predominately from North America, Europe, and Japan, shedding light on what production sourcing decisions are currently being made, what drives these decisions, and what happens as a result.

The study is the first empirical research to take an in-depth look at corporate executives’ decision-making processes at the product decision level and the drivers behind their manufacturing-related choices. It suggests that there is a significant wave of restructuring of global supply chains in progress across all industries. The researchers found decision-making has evolved from simple cost comparisons to more complex trade-offs between a magnitude of factors that are deemed important, such as quality, market access, and risk.

“We see a shift in production not only to China, but also to Eastern Europe and the Association of Southeast Asian Nations being used as nearshore sources of production for Western Europe and Chinese markets respectfully,” Ernst said. “Manufacturing in Eastern Europe is a cost-effective option and is performing for Western Europe like Mexico does for the United States.”

The new research also found more companies are reporting a shift in production volume to North America due to market access and innovation, a pattern not consistent with what many business and political commentators are currently saying.

“The movement is not driven by American corporations bringing back manufacturing to the United States, but rather by European and Asian firms looking to move their production to the United States, as they see the country as a very appealing market destination and source of knowledge,” Cui said. “These firms account for 60 percent of the production volume increase in North America.”

The researchers found recent business decisions seem to be driven by changing cost competitiveness and more advanced decision making. For many years, cost of production has been the dominant driver in making decisions to move manufacturing to other countries, especially from North America to China and other Asian countries. Cost differentials between developed and developing economies were so high that moving production outside the United States had become the default choice for many companies. That is no longer necessarily the case.

The researchers cite various reasons for the change in cost competiveness, including:

• Labor costs in many developing nations have risen in tandem with the industrialization of these countries. For instance, Chinese labor wages have tripled over the past 10 years, and in the same time, the Chinese Yuan has appreciated by 36 percent, making it less favorable to export out of China.
• While the cost of industrial energy has risen in many developing economies, it has stayed flat or has even decreased in some developed economies due to technological advances such as fracking.
• Rising oil prices have increased the cost of transportation, making long supply chains with production in far offshore locations less favorable.

In addition to the changes in cost of production, many companies report that other considerations have gained in importance for making today’s manufacturing location decisions, such as:

• Risk factors are being taken into account – e.g. the flood in Thailand a few years ago that disrupted entire industries – and mitigating such risks has become much more important for today’s supply chain design considerations.
• With rapidly changing demand, exchange rates, and commodity prices, many corporations invest heavily in making their supply chains more agile.

“As part of the global business initiative research, Ricardo Ernst, myself and the seven other business school professors wanted to shed light on the current trends in global manufacturing location decisions and the drivers behind those decisions,” Cui said. “Through our study, we confirm anecdotal evidence that across all industries and firm sizes, companies indeed are restructuring their supply chains by investing and divesting in production capacity, automation, and research and development.”

The researchers saw a collection of key factors in decision making which included cost, quality, delivery, and market access. Although, cost has lost its dominant position as a driver and has been replaced by more complex decision making that is trading off various factors.

The study has found five over-arching trends that provide a better understanding of current global production sourcing decisions. Those trends include:

1. China’s role in global manufacturing is changing: market-seeking firms invest while cost chasing companies divest (Cambodia and Vietnam are capitalizing on China’s increasing production costs).
2. Eastern Europe and Russia are becoming a low-cost and geographically convenient production source for Western Europe.
3. Western European manufacturing is on a decline.
4. Japanese manufacturing seems to be suffering from the repercussions of Fukushima.
5. No reshoring to North America is observed: this region may still be at the cusp of a manufacturing renaissance based on shifts from other regions in the world.

The researchers discovered European and non-Chinese companies are moving to China for market reasons, as the region is fast-approaching the United States as the largest market in the world. However, the research also found companies in particular industries, such as apparel, are relocating from China due to high cost to South Asia countries like Vietnam and Bangladesh.

Much of the public attention about the restructuring of supply chains centers around impacts on employment in the manufacturing sector. The researchers discovered the decisions outlined in their report had surprisingly little impact on employment. Divestments in Western Europe as well as investment decisions in China or Eastern Europe and Russia hardly impact employment at all. Only for North America and Japan did the researchers see that individual large-scale investments yield a high number of manufacturing jobs raising the average above the level of other regions.

“High-level corporation decision makers should use the insights presented in our study as a starting point to critically review their own supply chain, the way production sourcing decisions are being made, and whether they are taking the most effective approach,” Ernst said. “For the policy maker, understanding the driving forces of today’s manufacturing location decisions should inform the ongoing debate about manufacturing policy making that is directed to retain and attract manufacturing jobs. We believe our findings provide important insights into the nature of current production sourcing decisions on a global scale and across a wide range of industries.”

Photo: Kasra Ferdows, McDonough School of Business, Georgetown University; Hirofumi Matsuo, Graduate School of Business Administration, Kobe University, Japan; Shiliang Cui, McDonough School of Business, Georgetown University; Andy Tsay, Leavey School of Business, Santa Clara University; Hau Lee, Graduate School of Business, Stanford University; Panos Kouvelis, Olin Business School, Washington University St. Louis; Ricardo Ernst, McDonough School of Business, Georgetown University; Morris Cohen, The Wharton School, University of Pennsylvania; Marc Steuber and Arnd Huchzermeier, WHU – Otto Beisheim School of Management, Germany