Commentary – The Right Place at the Right Time: Bucking the Onshoring Trend

How Smaller Companies Could Benefit by Bucking the Onshoring Trend

Earlier this year, Baird Capital examined the recent trend of onshoring, whereby primarily larger Western companies are increasingly bringing home full-scale manufacturing processes and jobs previously sent overseas – mostly to China.

Roberto Ferranti
Vice President,
Portfolio Operations
The relative cost of labor in China, where wages continue to rise, is a large driver of this trend for U.S. and European companies. According to the U.S. Bureau of Labor Statistics, the ratio of an average Chinese factory worker’s wages to those of a factory worker in the United States increased from 3% in 2000 to 9% in 2010. Chinese wages are expected to reach 17% of U.S. wages by 2015.

Factor in the logistical issues of maintaining offshore operations – including language and cultural differences – and fluctuating transportation costs, and it becomes easier to understand why some companies would opt to make the goods they sell in locations closer to their largely Western consumer bases. Recent examples include General Electric, Wal-Mart and Apple, whose size and scale give them some negotiating leverage in a U.S. market where labor costs are already comparatively lower than they’ve historically been. However, what works for larger, more-established companies may not be the right course for smaller companies still establishing a brand identity, particularly in a global marketplace where emerging markets are creating new consumers as their economies grow.

The Growth of the Spending Class
The demand for manufacturing labor and associated wage growth has already given rise to a fast-growing middle class in China. At the end of 2012, the Chinese middle class was estimated to number 230 million people. A 2013 study by the China-United States Exchange Foundation predicts that by 2022 China's middle class population will be 630 million. Other projections by the U.N. Population Division estimate that number could reach 1.4 billion by the year 2030.

India is experiencing a similar trend, fueled initially by growth in its service sector and more recently in manufacturing. According to the McKinsey Global Institute, India’s middle class could be larger than 583 million people by the year 2025, and other estimates suggest it could number more than 1 billion within 20 years.

In these and other emerging markets, where Western companies have sourced manufacturing operations, it’s clear that the newly financially empowered are spending. A 2013 study by Standard & Poor’s noted that total sales of consumer goods in China grew 14.3% in 2012 to about $3.29 trillion. By comparison, U.S. retail sales totaled $4.35 trillion, representing growth of 4.8%. The same study predicts China will surpass the United States to become the world’s largest consumer economy within five years.

Opportunities and Their Costs
The potential for new customers in emerging markets presents an opportunity for manufacturing companies with global growth ambitions, but a surgical approach that carefully evaluates benefits and potential hurdles should be taken when evaluating those opportunities.

Not all emerging markets are created equally. Each has characteristics that can make it a better or less optimal fit, depending on your bottom line requirements. For example:

  • The cost of labor is generally higher in China than in Vietnam, but the infrastructure – particularly in the coastal areas of China, where manufacturing operations have been up and running for decades – is much better. Having paved roads can make a real difference in timing and cost when it comes to transporting your products.
  • If transportation time and cost are primary concerns, Mexico can be a convenient option for U.S. companies. However, the skill of the labor force is typically not on par with China or India.
  • Both China and India have highly skilled workforces, and operations typically have senior people in place who are used to working with Western companies and entrepreneurs. However, that expertise comes at a premium compared to the very low cost of having things made in Vietnam and even lower cost labor in Indonesia.
  • Indian manufacturers have demonstrated a passion for best practices that could have a positive impact on your processes and bottom line, but the bureaucracy inherent in India’s government can be an impediment to establishing operations, especially when compared to China’s very accommodative policies.
Even if a company ultimately decides to handle final assembly of its products in a facility closer to home, the different skills and specialties associated with various emerging markets can help level the playing field between smaller and larger companies by enabling the former to more affordably chase the specific expertise necessary to manufacture individual components for their products. For example, electronics are generally less expensive to manufacture in China than in the United States, and electronic components are cheaper and easier to ship than, say, fully assembled medical imaging devices.

Knowing Your Market
When thinking longer-term about the implications for potential top-line revenues in these markets, there are additional, more forward-looking considerations. The size of the population and projected middle-class growth will be important to know because – despite recent gains in China – average wages in emerging markets considerably lag those in the United States and Europe. So companies looking to establish a foothold for their brands will likely need to compromise on unit price.

Knowing what local competition may exist in your product space and what local customers might be able and willing to spend on similar products is also important when trying to sync up bottom- and top-line growth objectives in emerging markets.

Recently Apple surprised many analysts by releasing a slightly less expensive plastic version of its iPhone at a price point that most agree is not low enough to appeal to the average Chinese consumer. Apple sells its iPhone 5 for about $860 (U.S. dollars) in China, while local smartphone manufacturer Xiaomi offers its new topline model at about $330. As a larger company with a well-established customer base in a very competitive smartphone field, Apple may well have prioritized brand integrity in making that decision. But it’s worth noting that, for the first time, Xiaomi captured more of China’s smartphone market share (5%) than Apple (4.8%) in the second quarter of 2013 according to a September report in The Economist.

A Strategic Partner
Baird Capital believes smaller Western companies with global growth ambitions might realize long-term benefits by bucking the onshoring trend and maintaining or establishing offshore production operations – as long as they strategically select a market with an understanding of not only its economic evolutionary trajectory but also its culture.

With private equity partners and operating professionals on three continents – including our Asia investment and operations team located in Shanghai, China – Baird Capital has extensive operating experience in emerging markets as well as a broad network of government and industry relationships. We’ve helped portfolio companies develop and implement global strategies, including:
  • Building global supply chains
  • Developing sourcing relationships
  • Establishing operations
  • Market entry strategies and local distribution
Baird Capital makes venture capital, growth equity and buyout investments in smaller, high-potential companies in the Business Services, Healthcare, and Industrial and Consumer Products sectors. Since inception, we have invested in more than 265 companies globally.

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