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The year-over-year U.S. inflation rate through February 2022 hit a 40-year high of 7.9%, eroding purchasing power especially for gas, food and rent. U.S. manufacturers have already been struggling with the impact of geopolitical uncertainty and pandemic-induced strains that are unlikely to cease in 2022. Offshoring of U.S. manufacturing to low-cost countries has made many of these problems worse
President Biden says making more goods, like cars and semiconductor chips, in the U.S. will lower inflation. Complex, extended offshore supply chains were not configured for risk exposure, transparency or resilience.
“Making it in America is one of the ways we can address our cost and supply-chain challenges. When we build products we need, we don’t have to wait, we reduce shipping costs and we can get goods moving faster,” Biden said.
A 2020 McKinsey Global Institute report found that companies will likely experience supply-chain disruptions lasting a month or longer every 3.7 years, increasing costs and cutting into profits. Reshoring can reduce disruptions.
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While the idea of reshoring reducing inflation may seem counterintuitive, consider the total cost. Higher labor costs and component FOB prices should drive up product consumer prices. However, a broad range of costs and risks not now considered by most companies can offset differences in labor rate and FOB price. Our TCO Estimator user data shows that about 20-30% of product now sourced in China can be reshored while holding or reducing customer prices. Similar percentages apply to other countries.
Transpacific ocean freight costs have skyrocketed, and delivery times have been long and unpredictable due to soaring demand for ocean and air freight from Asia to the U.S. Ballooning demand and tight capacity are fueling inflation. In ocean freight, rates in some cases are as much as 8-9 times higher than the pre-pandemic norm. Some sea freight has shifted to even more expensive air freight to achieve needed delivery commitments. Domestically, rail and trucking costs are up about 23% in 2021 from 2020.
In addition to the freight rate increases, new challenges arose in 2022 as empty containers pile up amid continued shutdowns in China, and the Russian invasion of Ukraine blocks the ability to ship containers back to Asia. A lack of capacity is keeping ocean rates elevated, and lead times continue to be unpredictable. The freight cost of imports is primarily trans-ocean. Therefore, ocean-freight cost is up much more for imports than for domestic products. Conclusion: Inflation is worse due to offshoring.
There are key advantages to moving production to the U.S. Manufacturers would benefit from a local, just-in-time production model where goods are made as orders are received and can be delivered to consumers more rapidly. That helps drive down the costs of holding and storing unsold inventory. Producers also would avoid hefty shipping fees and tariffs on imports. Some manufacturers also have moved operations to the U.S. to ensure higher-quality products with fewer errors, which is another benefit that holds down total cost.
Connecticut-based FCP Euro, a midsize automotive parts retailer, typically imports and sells parts from the European Union. Due to an expected four- to six-month pandemic-induced delay from Europe, the company is shifting some of its supply chain to domestic suppliers. Scott Drozd, CEO of FCP Euro, said he shifted 40% of his higher-margin stock-and-ship supply chain to a more flexible and reliable just-in-time local model.
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Ongoing pandemic-induced factory closures and delays, input shortages, strong consumer demand and shrinking inventories coupled with geopolitical uncertainty complicate supply-chain problems. The resulting inventory squeeze is driving more reshoring to balance inventories. Companies have seen shortages in PPE and other essential products and in a broad range of components. They ordered more, and deliveries stretched. Companies are now deciding to reshore or nearshore to regulate inventories.
Reshoring can solve inventory volatility and result in lower inflation. When orders drop, inventory of imported products rises faster than domestic products and takes longer to get back in balance (Table 1). When orders rise, domestic suppliers deliver faster and inventory rises to desired levels, avoiding stock-outs. By not stocking out or overstocking, profitability is enhanced without raising prices.
Richmond, Va.-based pharmaceutical startup Phlow is helping shore up the nation’s generic drug supply. Approximately $6 million in government funding will help “secure a supply of medicines and Active Pharmaceutical Ingredients (API) at risk of shortage during the current coronavirus pandemic.” Phlow will use “different manufacturing methods that allow the U.S. to not rely on importing foreign medicines.”
To support health, safety and emergency response workers during the COVID-19 surge, Honeywell added manufacturing capabilities to produce N95 facemasks. The company’s Phoenix and Rhode Island facilities are able to produce upwards of 20 million masks per month and create more than 1,000 new U.S. jobs.
The pandemic revealed the vulnerabilities of hyper-connected global supply chains. Companies with local supply chains fared better against the disruption. For example, toolmaker Stanley Black & Decker recently shifted production of its Craftsman tools from China to Texas. It reported no increase in costs and “much less impact from the coronavirus than would have been the case if it had remained in China.”
Unilever has more than 200 factories worldwide and kept running at about 85% capacity throughout the pandemic. Unilever CFO Graeme Pitkethly said, “Most of our supply chain is local. It’s very flexible, and generally speaking the vast majority of the products we sell in a country we supply in that country.”
Now is an especially good time for companies to re-evaluate the choice of domestic versus offshore production. The Reshoring Initiative’s website provides tools to help companies decide objectively for which products their overhead will come down more than their manufacturing cost goes up when sourcing locally.
The online Total Cost of Ownership Estimator® will more accurately determine the real profit and loss impact of reshoring or offshoring. After doing the math, most companies will decide to bring some work back. See if reshoring makes economic sense for your company. The Reshoring Initiative’s resources can be found at www.ReshoreNow.org.