Outsourcing and the U.S. Manufacturers

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The Short Tale.
Gordon, Benjamin
Rutt, Karen
World Trade; Nov2008, Vol. 21 Issue 11, p22-30, 5p
Article
*MANUFACTURING industries
*COST control
*SUPPLY chain management
*BUSINESS logistics management
UNITED States
The article explores the reason behind the move of manufacturing industries in the
U.S. to implement near-sourcing and discusses its implications for the supply chain
industry. It also offers ideas to supply chain that business owners could use to
ensure their success amidst change. Near-sourcing which is also called reverse
globalization or shortening the supply chain, describes the return of American
manufacturing in order to decrease shipping expenses.
1973
10548637
35370687
Business Source Complete
The Short Tale
Near-sourcing trends create new winners and losers in the supply chain.
Benjamin Gordon is founder and Managing Director or BG Strategic Advisors, www.BGSA.com,
and
can be reached at Ben@BGSA.com. Karen Rutt is an Associate for BG Strategic Advisors.
In the 1970s, deregulation spawned a new era of growth in transportation. Nimble trucking
companies
like Schneider and J.B. Hunt capitalized on this opening to become multi-billion-dollar giants. In
the
1990s, the demand for outsourcing produced a new category of winners, known as 3PLs.
Logistics
firms like CH Robinson and Expeditors became major beneficiaries. Today, we are on the
precipice of
the third major change to sweep through the supply chain. Like its predecessors, it has the
potential to
create new classes of winners and losers. The name of this powerful new trend? Near-sourcing.
The move toward near-sourcing is underway. Car manufacturer Tesla Motors just canceled
plans to
manufacture its 1,000-pound batteries in Thailand as previously planned. By manufacturing
them closer
to Tesla's home base in California, it will decrease the shipping distance of each battery
approximately
5,000 miles. Other major manufacturers are following suit.
Also called "reverse globalization" or "shortening the supply chain," near-sourcing describes the
return
of American manufacturing in order to decrease shipping expenses. As freight costs remain
high,
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globalization has become less competitive and is expected to remain so for the foreseeable
future. We
will share why near-sourcing is happening, discuss implications for the supply chain industry,
and
conclude by offering ideas to supply chain business owners to ensure their success amidst
change.
Near-Sourcing: Requiem for Globalization?
Historically, cheap gas fueled globalization. It enabled companies from all over the world to
shop
globally for cost-saving business solutions. However, fuel costs have nearly doubled since
January of
2006, and have shot up by nearly six times in the past six years (see Chart One). In a recent
CIBC
World Markets Report, analyst Jeff Rubin estimates that the cost of transporting imported goods
into
the United States is now equivalent to a 9% tariff on imports. Companies will recalculate the
costs and
benefits of global outsourcing as the cost of energy is expected to remain high indefinitely.
Supply chain businesses are feeling the pinch. Industry bellwether Expeditors International, a
Fortune
500 outsourced logistics company offering freight forwarding and customs brokerage services,
confirms in its recent 8-K, "The cost of fuel is a serious issue. Historically, fuel has been 15% of
carrier
operating costs. Today, it is estimated to be substantially over 40%."
The devaluation of the dollar has further added to the blight of global business. Between
September
2006 and September 2008, the dollar has lost an average of 11% of its conversion value
against the
yuan, yen, and euro (see Chart Two). As the U.S. dollar has decreased in value, the cost of
purchasing
goods and services in countries with stronger currencies (such as China and Japan) has
increased,
causing outsourcing to be even less competitive.
WINNERS
As skyrocketing fuel and plummeting dollars shake the foundations of global trade, who will be
the
winners and losers?
U.S.-Mexico Trade Lane 3PLs
One winner will be the U.S.-Mexico trade lane, and the supply chain companies that serve it.
U.S.
imports from Mexico are increasing as fuel costs climb (see Chart Three). The U.S. Department
of
Commerce reports an 8.7% increase from year-to-date imports through Mexico compared to the
year
before. Mexico is able to offer an alternative to expensive overseas outsourcing destinations. As
a
result, we expect increased demand for transportation, customs brokerage, import/export
services, and
regional warehousing companies in the U.S.- Mexico trade lane.
U.S. Exporters
A second winner will be those supply chain firms that target U.S. exports. The Port of Long
Beach,
California, a major West Coast trade port, reports a 13.5% increase in loaded outbound
containers for
2008 year-to-date versus the same time period in the prior year. Container movement trends
confirm a
shift in U.S. outbound volume. Increasing export activity suggests growing demand for all U.S.
export-based service providers, including freight forwarding, customs brokerage, and other
export
services.
Rail Service Providers
A third winner will be low-cost providers in the rail, intermodal, and drayage arena. As trucking
costs
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have increased due to fuel, driver shortages, insurance, and other variables, rail is becoming
more
cost-competitive with trucking. Pacer Stacktrain, an intermodal service provider and a division of
Pacer
International, recently expanded intermodal services with the BNSF Railway. Pacer CEO
Michael
Uremovich credited much of their recent success and financial improvements on the expansion
and
success of the intermodal segment. Their intermodal operating income increased $7.5 million
compared to the second quarter 2007, representing a year-over-year increase of 30%. Other
3PL
companies are also experiencing increases in their rail-related services. J.B. Hunt Transport
Services
reported a 17% year-over-year increase in load counts with their JBI segment, which offers
intermodal
and drayage services. Due to the increasingly competitive rail business, supply chain
companies
offering rail transport, intermodal, drayage, and short haul trucking are well positioned.
Regional 3PLs
A fourth winner will be regional contract logistics and supply chain providers, such as
warehousing and
value-added service providers and contract packagers. Each year, the International Warehouse
Logistics Association (IWLA) surveys its members, comprised of over 500 3PL and warehousing
companies, and shares data in its Annual Business Outlook. In its 2008 survey, over one-third
of the
respondents said they expect to experience growth of over 10% in 2008, and approximately
13%
expect to see sales increases of 20% or more. 28 % expected solid growth for value-added
services,
including packaging, pick and pack, and labeling. The IWLA report affirms that the outlook is
bright for
warehousing 3PLs despite a slowdown in other sectors.
BGSA anticipates that the contract packaging industry will also expand from increasing
domestic supply
chain activities. Our analysis indicates that contract packaging is an approximately $20 billion
market
exhibiting 10+% annual growth. Increasing fuel prices could potentially stoke the need to couple
packaging capabilities with warehousing and distribution. In a weak economy, companies often
prefer
to focus on core competencies, such as marketing and branding, as opposed to non-core
competencies, including manufacturing and outsourcing. This is more good news for regional
providers
of contract logistics and contract packagers.
Other Geographies
In addition to Mexico and the U.S., other countries are expected to better compete with China's
increasing manufacturing costs. As China develops, other markets are becoming lower-cost
competitors, such as Mexico, Thailand, and Vietnam. The performance of industry bellwether
Expeditors is again reflective of this trend. The company reported that revenue increased 28%
in
Mexico, 11% in Canada, and 51% in Latin America, which was attributed to "strengthening
export
volume growth." Domestic freight forwarding and customs brokerage companies that expand in
these
low-cost and/or North American markets will reap rewards.
LOSERS
Some supply chain businesses will experience weakened demand as a result of traffic changes
due to
near-sourcing.
Companies Dependent on One-Way Asia-U.S. Imports
West Coast import-based supply chain service providers are reporting a softening of the Asia-
U.S.
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trade lane. As Mexican imports are strengthening, conversely Asian imports are softening. For
instance, the Port of Long Beach is receiving fewer loaded containers. In its July 2008 monthly
tonnage
report, Long Beach reports an 18.1% decrease in loaded inbound containers to approximately
272,000,
down from approximately 332,000 over the prior year. For the three month period ending June
30,
2008, Expeditors reports that airfreight (tonnage) out of Asia decreased 4%. This was the first
time that
a negative industry airfreight tonnage was reported for the ex-Asia trade lane.
Long Haul Trucking
Long haul trucking has also suffered due to increasing energy costs. Pacer reported in its recent
quarterly report that increasing fuel costs caused a $3.4 million decline in income from its
logistics
segment, partly due to the effect of fuel costs on the Company's trucking units. Similarly, J.B.
Hunt's
DCI (trucking) Segment reported a 17% reduction in its second quarter of 2008. Both Pacer and
J.B.
Hunt's intermodal operations helped to offset declines in their trucking business. Overall, long
haul
trucking will continue to face pressure, due to expensive fuel and inexpensive rail among other
factors.
Others
The dislocation brought about by near-sourcing may create other losers. For instance, smaller
companies that are tied to the fates of less attractive markets may be unable to adapt as
quickly. As
near-sourcing causes international manufacturers to change locations, companies that lack a
full global
footprint may find their network value shrink precipitously. Freight forwarders that lack a
complete set of
locations in the U.S., Asia and Europe may be particularly vulnerable.
Options for Supply Chain Business Owners
Amidst the challenging market demands of near-sourcing, how should you respond?
Supply chain business owners have several options for growth amidst these major pressures.
First, smart leaders should consider adding services that respond to near-sourcing. Now is a
great time
for trucking and shipping companies to pursue opportunities in logistics. This move can enable
asset-based firms to enjoy growth in asset-light segments. In addition, logistics services can
provide
some insulation from the fuel shocks and cyclical capacity problems that plague much of the
asset-based markets. Lastly, logistics services can enable asset-based firms to increase touch
points
and cross-selling opportunities with both current and future customers. For example, the
refrigerated
trucking leader C.R. England pursued an acquisition strategy to gain access to non-asset
transportation
management and freight forwarding. By acquiring Trans-Man Logistics and Dynalink, C.R.
England was
able to capitalize on increasing U.S. exports and increasing domestic 3PL service demand.
Second, companies in the segments of warehousing and packaging can consider combining.
This
convergence play can allow firms to cross-sell their capabilities, and can also reduce
transportation
costs. In a high-fuel era, customers are increasingly interested in finding ways to cut
transportation
expenses. The mergers of firms like Wilpak-Jacobson and Power-Exel create opportunities to
pursue
network cost savings.
Third, supply chain firms can target customer segments that are poised to benefit from near-
sourcing.
Domestic raw materials and manufacturing, for instance, are likely to benefit. Logistics providers
to
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these domestic industrial segments could be winners.
The bottom line is that near-sourcing will create major dislocations in the supply chain market.
Some
companies will make aggressive investments in growth. For instance, C.R. England's
acquisitions have
the potential to reshape their business. Conversely, many other companies face the risk of rapid
decline. After a growth period from 2002-2006, we are seeing a sudden reversal of fortune for
many.
Two thousand eight has brought the fastest rate of trucking bankruptcies in seven years. Will
others
succumb to the cataclysmic change brought about by near-sourcing?
In sum, we may be at the precipice of a new era. The cheap fuel and long supply chains of the
past 20
years may be over. In its place, the winners and losers of near-sourcing are yet to emerge. In
the
1970s, deregulation enabled a few companies to thrive (e.g. Schneider and J.B. Hunt), while
putting
thousands of truckers out of business. In the 1990s, the shift to outsourcing enabled a few more
companies to enjoy success (e.g. CH Robinson and Expeditors), while squeezing many of the
small
Mom-and-Pop operators. In this new age of near-sourcing, who will become the defining leaders
of this
generation?
As fuel prices soar, supply chains shorten, and the landscape changes, what will you do? Are
you the
category leader in your field? More importantly, is what you do likely to be vital amidst the age of
near-sourcing? What resources will you commit to ensure success? Are you a buyer or seller?
Whatever your decisions, now is an ideal time to rethink your strategy.
GRAPH: Crude Oil Prices Skyrocket Per Barrel)
GRAPH: U.S. Currency Decline (% Change from 2 Years Ago)
GRAPH: Imports from Mexico
PHOTO (COLOR): As trucking costs have increased doe to fuel, driver shortages, insurance,
and other
variables, rail is becoming more cost-competitive.
~~~~~~~~
By Benjamin Gordon and Karen Rutt
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