Time to rethink offshoring?

Last Updated Aug 16, 2010 5:42 PM EDT

McKinsey Changing economic conditions may have undermined some of the benefits of offshoring. For managers of global supply chains, this could be the time to reevaluate.

The production of high-tech goods has moved steadily from the United States to Asia over the last decade. The reasons are familiar: lower wages, a stable global economy, and rapidly growing local markets. These factors combined to make nations such as China and Malaysia favored manufacturing locations. In the last two years, however, the favorable economic winds that carried offshoring forward have turned turbulent. The new conditions are undermining some of the factors that made manufacturers of every stripe, including those in high tech, move production offshore.

For executives managing global supply networks, the question now is whether or not conditions are moving toward a tipping point. Is this the moment to consider sharply scaling back offshore production plans and bringing manufacturing back or close to the United States? Is there a more measured response that better suits the new circumstances? Before executives change their strategies, however, they must determine the total landed cost of each product produced offshore and better understand the shifting trade-offs between cost savings from offshoring (such as lower wages) and rising logistics charges.

Oil prices, and consequently the cost of shipping, have risen to heights few foresaw even just several years ago. Since 2003, crude oil has soared from $28 to more than $100 a barrel. The economics research institution CIBC World Markets estimates that in 2000, when oil prices were near $20 a barrel, the costs embedded in shipping were equivalent to a 3 percent tariff on imports. Today, that figure is 11 percent—meaning that the cost of shipping a standard 40-foot container has tripled since 2000.

To develop a clearer picture of the changing environment, we analyzed a number of products manufactured for the US market and mapped the optimal region to manufacture them by straightforwardly comparing the wage savings from offshoring with the cost of logistics. Exhibit 2 shows the optimal regions for products with a range of different unit manufacturing costs (all related to the transformation of raw materials into one unit of finished goods in US dollars) and various product weights (which affect logistics costs). We have chosen breakeven curves for China, a traditional low-cost manufacturing location, and for Mexico, a near-shore location.

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Additonal writing by Nazgol Moussavi, and Vats N. Srivatsan