A Manufacturing Strategy
Built for Trade Instability
February 18, 2020
As they scramble to adapt to a global business landscape thrown into disarray by trade wars and renegotiated treaties, many manufacturers face a quandary. Companies that have been relying on Chinese factories to supply the US market, for example, must choose from among several strategic options. Should they shift production to North America, where costs may be slightly higher but where they can reduce their risk of exposure to fallout from geopolitical intrigue? Should they hunt for other low-cost offshore locations? Or is the wisest course over the long haul simply to stay put and see how the new world trade rules play out?
Whether manufacturers pick one of these options or a combination of all three, cost will likely be a key factor in their decision. Manufacturers should look beyond tariff rates and factory wages to take into account less obvious factors—such as worker productivity and energy expenses—that also help determine the underlying cost competitiveness of manufacturing economies.
An analysis of the most recent BCG Global Manufacturing Cost Competitiveness Index reveals some interesting shifts in cost structures that may be useful both to executives who are deciding where to locate production and to economic policymakers who are developing strategies to boost their manufacturing sectors. The index tracks changes in relative factory wages, productivity growth, currency exchange rates, and energy costs. (See Exhibit 1.)
Production cost, of course, isn’t the only factor to consider when deciding where to manufacture. Logistics, proximity to key markets, and competitors’ strategic moves are increasingly important, too. And as explained below, a number of factors beyond cost will continue to keep China globally competitive across a range of industries. BCG has long taken the position that, rather than locating production in a handful of low-cost developing economies to serve markets worldwide, companies should adopt a regional strategic approach that provides the flexibility necessary to respond to the shifting economics of global manufacturing.
Productivity as a Differentiator
The strong showing of the US in the 2019 BCG index illustrates the power of productivity. US gains in cost competitiveness against 18 other economies come after several years in which the country had lost ground. This was due in large part to three factors: factory wages that rose faster than productivity, a strong dollar, and a decline in the US’s energy-cost advantage as global prices for natural gas converged. From 2015 to 2017, the US had registered losses in competitiveness against 31 of the 34 countries tracked in the index.
The US’s manufacturing productivity growth rate of 4% in 2018—an acceleration from an average of only 0.5% from 2013 through 2017—was twice as high as the overall US productivity improvement in that year. As a result of the gain, manufacturing’s contribution to gross value added in the US economy increased from 11.1% in 2016 to 11.4% in 2018, even though the nation’s manufacturing workforce remained roughly flat, at 10.7 million, over that time.
Manufacturers must also, of course, factor in recent tariff hikes—such as those on steel, aluminum, and machinery in the US—that are not captured in the BCG Global Manufacturing Cost Competitiveness Index. The impact—if any—of tariff costs varies dramatically from one product category to the next, however, and rates continue to fluctuate. So the BCG index, which serves as a broad gauge of cost competitiveness across all manufacturing sectors, does not consider them. Even with somewhat higher costs due to tariffs on inputs, moreover, many US companies are opting to keep production in the US in order to be closer to customers and to hedge against geopolitical risk to their supply chains.
Productivity growth has also bolstered the competitiveness of other major export economies. (See Exhibit 2.) Although wages have been rising in Germany, for example, an average 2.4% annual increase in the value of output per worker from 2015 through 2018 has offset that cost. Over that period, Germany’s cost disadvantage versus the US shrank from 26% to 17%. In Finland, average productivity growth of 4.2% from 2015 through 2018 enabled the country’s economy to hold its ground over that period.
Navigating Through Volatility with a Steady Hand
Executives need to keep a steady hand on the wheel while navigating a world of constantly shifting manufacturing costs and trade policies. We see several key actions that global manufacturers should take. First they should evaluate the current geographic footprints of their customers—and then they should move boldly to optimize manufacturing and supply-chain capabilities to ensure that their companies are globally balanced, flexible, and resilient to future changes in trade regimes.
Manufacturers must recognize that productivity—not just labor rates—will be a primary battleground for determining cost competitiveness in the future. They must continue to aggressively pursue lean practices and continuous improvement, and invest in advanced manufacturing systems such as autonomous robots and digital “virtual” factories to cut costs and boost productivity.
Companies can accomplish only so much by improving productivity in their own factories, however. To make a greater impact, they must also drive improvement in their underlying supply base. As the business-to-business world increasingly migrates to globe-spanning digital platforms, for example, manufacturers should partner with their vendors and with consortia of other manufacturers to digitize supply chains.
Given ongoing trade tensions and geopolitical volatility, companies should also consider undertaking a comprehensive, country-by-country review of their supply chains’ risk exposure. For example, they should assess whether the IT systems of foreign companies within their ecosystem pose a potential security risk.
The findings of the latest BCG Global Manufacturing Cost Competitiveness Index underscore an argument we have been making for nearly a decade, long before the recent trade wars began: companies should adopt a regional approach to their manufacturing and supply chain footprints, rather than locating all of their production in a handful of low-cost countries.
For companies that have built manufacturing footprints and supply chains on the assumption that a global environment of free trade will continue, adapting to sharp swings in trade policy can be disruptive. But executives should regard the current trade instability as the new normal. By going beyond short-term tactical moves and beginning to build flexible, regionally focused supply chains informed by a better understanding of the cost dynamics of different locations, companies can turn the current climate of adversity into a source of competitive advantage.