2008-06-05 Relocalization of Business - shift from Low Cost Countries to "Medium Cost Countries"

The one-country-fits-all model predominant a few years back is dead. Long-life to localized, distributed Supply Chain !!! Many Purchasing and Supply Chain leaders that shifted enthusiastically their Supply Chains to Low Cost Countries now realize that the cost of operating stretched supply chains far outweighs the benefits.

It's about time. Some company leaders in all industries realize that the flexibility they need to operate at their Customer's expected levels of performance doesn't work very well with a supply chain that spans the globe. And the theoretical Cost benefit is no longer there. "Le roi est nu". It has taken just 8 years from the trauma of tech bubble explosion for the Industry to realize it was operating an unsustainable manufacturing model. We cannot talk about an industry explosion this time, but the consequences are potentially just as big.

Operations will start their migrations, once again.
Early adopters will move their business to "local" regional manufacturing areas - like Mexico for North America, Eastern Europe or North Africa for Europe, China/Vietnam for Asia.
On their way to these locations, they will leave room for the late adopters of the previous trend: industries for which Cost Reductions was not THAT critical in early 2000's, or for which the move was not yet possible (no suitable supply base, etc).

Of course there are exceptions, and industrial execution here is key. Careful localization as well. After all where would you build products that Chinese Customers would buy, if not in China ? Frugal companies with tight controls in place survive better than the rest of the herd. But in general the financial model that led to Low Cost Countries localisation of manufacturing and supply chains is increasingly beaten up by the rising costs of shipping.

There will be again winners and losers - let's see where it leads us.

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Shipping costs are changing business models
2 June 2008
By Assif Shameen, The Edge Singapore
Some weeks ago, an Australian friend whom I have known for years relocated back to Sydney after nearly six years in Singapore. The family was moving because they could no longer afford the rents here. Moreover, with their toddler growing up, they thought they would be better placed to find a school back in their hometown than paying through their noses for a place in one of the international schools here. As I talked to them on what was their last weekend here, the conversation turned not to escalating costs in Singapore but the expensive relocation.
When they moved here lock, stock and barrel with a container full of belongings, it cost them not much more than the equivalent of $2,500 including insurance and other charges. That included packaging, unpacking and door-to-door delivery within five weeks. After a quick moving out sale in their apartment, they reckoned they had almost as much stuff to take back home as they had brought with them. Yet the relocation was costing them about four times as much. The removal company that finally agreed to take their stuff charged them over $9,800 including insurance and quarantine charges.
Why? Soaring shipping and transportation costs. Over the past six years, oil prices have gone from about US$25 a barrel to over US$130. Cost of sea freight has also more than quintupled over the same time. More so on some routes like Australia-Singapore than others. If they were merely hurting a bunch of returning expatriates, the soaring container costs wouldn’t be much of an issue. The problem is that it is starting to bite where it really matters. Small- and medium-sized exporters in Asia are now feeling the pain. Indeed, if anecdotal evidence is anything to go by, the next big surge in oil prices to US$200 or US$250 per barrel over the next few years will not only push transportation costs to stratospheric levels, it could also dramatically change the industrial landscape of Asia.
Gas guzzlers
Shipping industry insiders tell me that a decade or so ago, oil prices or rather fuel costs made up about 20% or so of the total freight costs. So, a 10% increase in fuel costs would only mean about a 2% increase in freight costs. Or a doubling of fuel costs would only mean a 20% increase in freight costs. Today, fuel costs are between 50% to 60% of the total freight costs - and rising. Moreover, with higher prices of steel and ships, higher financing costs due to the credit crunch, higher cost of labour and increasing charges at ports, freight costs are rising faster than anyone could have imagined. According to some estimates, every $1 increase in fuel costs these days translates to over 1% increase in freight costs. Moreover, the new and speedier container ships that have come on stream in recent years are gas guzzlers that use a lot more fuel than ships of yesteryears.
Port congestions and infrastructure bottlenecks mean containerships are at sea longer, which adds to freight costs.
A recent study by Jeff Rubin and Jeffrey Tal, two economists who work for Canadian bank CIBC, shows that high transportation costs might even be reversing the course of globalisation. How so? Shipping a standard 40ft steel container from Shanghaito the US eastern seaboard now costs over US$8,000 ($10,902). Just eight years ago, when oil prices were around US$20 per barrel, it cost only US$3,000 to ship the same container. Rubin and Tal have calculated that if oil were to soar to US$200 per barrel, it could soon cost nearly US$15,000 in freight charges to ship a container from China to the US eastern seaboard.
If you were shipping a containerload of diamonds or a power turbine or jet engine from Singapore to Baltimore, the US$20,000 freight costs would just be a rounding error for you. But if you were shipping Nike sneakers that cost US$10 to manufacture with a retail price of around US$40 in a suburban mall, it will soon make no sense to manufacture them in China or Vietnam or Indonesia or even in sub-Saharan Africa if the end market is North America. Sure, it may make sense to make Nike shoes for the Chinese in China or in Bangladesh for Indians but the manufacturing would have to be closer to end markets for stuff that takes a lot of space and doesn’t fetch a huge premium.
Giant contract manufacturers like Flextronics and Hon Hai have built plants around the world even as China has emerged as the factory to the world. Flextronics, for example, is buying a plant in Russia to assemble brand name TV sets. Contract manufacturing these days is all about economies of scale, vertical integration and, wait for this, logistics. The reason why the likes of Flextronics build X-Box game consoles in Guadalajara, Mexico, isn’t that their Chinese factories can’t make them cheaper or faster but because the cost of shipping the latest game consoles from China or Apple iPods from Shenzen especially around peak times like the few weeks before Christmas far outweighs any savings that might accrue from slightly better economies of scale or marginally higher productivity.
Noticeable changes
CIBC economist Rubin in his study points out that there are already some noticeable changes in capital-intensive manufacturing - like steel - whose products carry a high ratio of freight costs to final selling prices. The high cost of shipping ore from Brazil to China and then shipping hot-rolled steel to North America means that suddenly, US steel plants can supply steel bars cheaper than Chinese plants. Indeed, China steel exports to US are down 20% y-o-y in recent months while US steel production has risen 10% y-o-y in the same period.
Exactly how much trade soaring transport costs will divert from China or for that matter anywhere else to big markets like North America, notes Rubin, will depend on how important those costs are as part of the total cost. “Goods that have a high value to freight ratio carry small transport costs, while goods with low value to freight ratios typically carry significant moving costs,” he says. If oil prices remain at current levels or surge higher and freight costs stay high, he says, a big beneficiary will be manufacturing facilities in Mexico as well as central and South America. As suppliers to western Europe, emerging manufacturing centres in Eastern Europe will benefit at the expense of countries like China, Vietnam and Malaysia.
Here’s a reality check. It is unlikely that oil will go to US$200 anytime soon and with an eventual glut in container shipping capacity, freight rates will likely fall faster than fuel prices. Still, high freight costs will more likely than not impact on where and how manufacturing is done over the next decade or so, whether it is sneakers or game consoles. As for expatriates looking to relocate like my friend from Sydney, the future might be in moving with just a suitcase rather than a steel container full of belongings.