Tomorrow's game: Offshore production with robots
Execs must factor in shifting costs and tech when choosing Asia's next factory site
MAKOTO KAJIWARA, Nikkei commentator
TOKYO -- Cambodia's capital, Phnom Penh, has been at the forefront of offshoring in recent years, attracting foreign investors in droves as they scour the world for a low-cost alternative to production in China, where wages are rising.
But a recent visit to Phnom Penh offers intriguing signs that the offshoring trend is losing steam. Offshoring occurs when a company moves operations from one country to another to take advantage of lower labor costs or more favorable economic conditions. Typically, it involves manufacturing for export.
Labor and transport costs, along with access to markets, have always weighed heavily in decisions about where to put a factory. Now, technologies that allow products to be made in new ways pose additional challenges and opportunities for CEOs of manufacturers.
End of the boom?
In Cambodia, the outsourcing tide began to shift in 2016. Land sales have been falling sharply in the Phnom Penh Special Economic Zone, a private-sector industrial park where nearly 90 companies operate, including Japanese machinery parts maker Minebea Mitsumi and U.S. soft drinks producer Coca-Cola.
In particular, purchases of land for large, export-oriented factories ground to a halt. The operator of the Phnom Penh Special Economic Zone, which handles land sales in the park, saw its revenue plunge 43% from the previous year.
One reason is soaring labor costs. Wages for factory workers in Phnom Penh rose more than 70% in the three years through 2016.
In response the industrial park's operator has tweaked its marketing, focusing more on companies that sell to Cambodia's increasingly prosperous consumers. For export-oriented manufacturers, the operator now recommends a site in Poipet, a town on the border with Thailand where wages are lower.
Jeffrey Immelt, the former CEO of General Electric, caused a stir earlier this year when he called offshoring "yesterday's game." Rising wages in emerging countries are not the only reason for Immelt's verdict. The development of the internet of things, a network of web-enabled devices, promises significantly lower production costs, even in industrial nations, making offshoring much less attractive for manufacturers.
A growing number of economic commentators talk about "reshoring" -- bringing operations back home, and "local production for local consumption," which helps companies to insulate their businesses from protectionism.
But is offshoring really about to go the way of the dodo? One Samsung Electronics smartphone plant in the suburbs of Hanoi suggests otherwise. The factory employs around 110,000 workers and ships $40 billion worth of products annually, accounting for over a fifth of Vietnam's exports.
Otto Schulz, a partner at consultancy A.T. Kearney, who is well-versed in Samsung's business, scoffs at talk of the death of offshoring. "If your logistic cost proportionate to what the customer is willing to pay is rather small, if it's more mass than super customized, I think it's better to keep it offshore," he said. "I don't think Samsung's smartphone [production] will be reshored."
How do rising wages factor into the equation? In the case of Samsung's smartphones, labor costs account for only a few percent of the price, according to an industry executive in Vietnam. So rising wages are not an important cost factor for the company's operations in Vietnam.
And there is already a fair amount of automation at the Samsung plant. The factory uses a phalanx of robots for certain steps in the assembly process.
There were many factors that went into the South Korean manufacturer's decision to locate its smartphone operations in Vietnam. Myanmar was another candidate that eagerly courted Samsung. Among the things the company considered were roads, power and water supplies, the size of the working population and labor-management relations.
Having spent nearly $7 billion on the Vietnamese plant, Samsung is unlikely to pull the plug, absent a compelling case. Offshoring thus appears to be evolving rather than dying.
Weighing the options
The debate over offshoring underscores a simple point that is easy to overlook: Corporate executives must carefully consider all factors when deciding where to build their factories, including the characteristics of the products and the production environment. The wider range of options today poses a greater test of their strategic acumen.
Sysmex, a Kobe-based maker of medical equipment, has adopted a flexible location strategy. The company's plant in Kakogawa, in Japan's western Hyogo Prefecture, makes testing instruments.
At the plant, workers, mostly housewives working part time, assemble domestically procured parts into finished products. When the yen was at a historical high, Sysmex came under pressure from investors to shift production overseas to lower-cost countries. But it avoided offshoring to ensure supplies of high-quality parts.
On the other hand, the company has moved much of its production of reagents -- substances used to test for the presence of other substances -- overseas. Seven of its nine reagent plants are located outside Japan. Chemical reagents must be fresh. They are delivered daily to the laboratories that use them. Exporting them from Japan would shorten their shelf life, requiring price cuts.
Boston Consulting Group finds that various factors -- the cost of labor and transportation as a share of a product's price, for example -- are crucial in determining whether a product should be made offshore or locally.
Offshoring makes sense for labor-intensive goods that can be shipped cheaply, such as clothes. It usually pays to manufacture such products in low-cost countries and export them.
But the calculation changes for products that cost a lot to transport, such as furniture. If labor costs only make up a small share of the price, local manufacturing can pay off, even in expensive developed nations.
For products that fall in between, such as cars and machinery, exchange rates are a key factor in deciding where to locate production.
Reality, however, is more complicated than this simple model implies. The "local production for local consumption" formula only works if there is a sufficiently large domestic market and parts can be obtained locally.
But the biggest variable in location decisions may be innovation. The field of telerobotics, which allows semiautonomous robots to be operated from a distance, for instance, can change the meaning of local production.
Having robots manufacture near a large market in a developed nation appears at first glance to be a case of local production for local consumption. But if the robots making the widgets are operated remotely by workers in a low-cost country, the result is a hybrid system that combines offshoring and local production.
Pankaj Ghemawat, a professor at Spain's IESE Business School, asked some 6,000 senior executives in six countries, including the U.S. and China, whether technology would continue to drive globalization. Ninety-eight percent of them said that it would. To be successful in the current phase of globalization, manufacturing executives need to work out their own formulas for determining where to crank out their wares.