Does Outsourcing to China (Still) Make Sense?

Last Updated Jul 29, 2008 3:00 PM EDT

Container shipI've long wondered about the fascination with outsourcing manufacturing work overseas, particularly to China. The premise is simple: Low wages and lack of regulation combined with a proven interest in economic growth meant that products were cheaper to make, and those savings dropped to the bottom line. It seems like solid business logic, but the analysis has been incomplete:
  • The actual percentage of cost that goes to labor is tiny -- on the order of a few percent. Better to focus on where the bigger bucks are. (Or is that too close to admitting that high tech marketing and sales is often wasteful and inept?)
  • Industries spent a good 15 to 20 years trying to gain control of bloated inventories. Manufacturing in China usually means sending products back on boat, which is a two month voyage. That means two extra months of inventory are floating around at any point, and you have a two month delay in getting products to actual western markets.
  • I've heard enough complaints about poor workmanship and loss of intellectual property for so many years that it makes me wonder whether management teams are looking at those costs and calculating them in as a figured amortized per manufactured item.
Given that conversations on the topic generally focus on marginal costs, I have wondered whether companies mistakenly look at the cost of manufacturing as completely divorced from every other business decision. You'd think that only by taking everything into consideration could you find the true cost of making a given product in a specific country.

But now is the time to make the calculations, because the underlying dynamics are quickly changing. Start with the shipping costs. A container ship can bring over a great deal of cargo, but the cost of shipping a 40-foot container from east Asia to the eastern coast of the U.S. has already doubled since 2000. If oil prices move to $200 a barrel, then shipping would again double.

Unless that container is chock full of diamonds, shipping costs have suddenly inflated the cost of whatever is inside. And those inflated costs get passed onto the Consumer Price Index when you buy that good at your local retailer. As oil prices keep rising, pretty soon those transport costs start canceling out the East Asian wage advantage. They already have in steel. Soaring transport costs, first on importing iron to China and then exporting finished steel overseas, have already more than eroded the wage advantage and suddenly rendered Chinese-made steel uncompetitive in the US market.
Or, "[T]he cost of moving goods, not the cost of tariffs, is the largest barrier to global trade today."

Next stage of the new calculations is wage conditions. China has told Wal-Mart that its workers there will be unionized, with eight percent pay raises this year and next. And that's with a company employing 48,000 workers. Labor costs are rising generally in China:

In interviews, factory executives across the country complained of being forced to give double-digit raises in order to find and keep young workers at all skill levels. Three or four years ago, said Zhong Yi, vice general manager of a leather-jacket manufacturer in Hangzhou in east-central China, 800 to 1,100 yuan a month ($105 to $145) "was a good salary.""Now," he said, "1,500 is the bottom" ($198).
The possible third strike for the ballgame is the falling value of the dollar, greatly compounding the oil and labor costs. Add them all up, and a smart managerial move would be to calculate what outsourced manufacturing really costs and see if there is still a savings.

Container ship image courtesy of Erik Sherman, all rights reserved.

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    Erik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.