By: Phil Kernen
Over the last several decades, globalization took root, delivering the affordable goods we demanded when and where we wanted. COVID-19 turned that efficient system upside down, forcing supply chains to become water cooler chatter. A shift away from globalization was already underway, and COVID accelerated it. Where do we expect companies to go next?
Offshoring arrived in the 1960s. Primarily pursued to reduce personnel costs, geography was irrelevant. Most offshoring projects for U.S. companies pushed production to Asia, called farshoring, because of the extreme distance and time differences. Offshoring allowed industries like automotive, retail, and others to operate more affordably and competitively.
Dramatically lower costs more than compensated for the time, culture, and technical proficiency differences. As skill sets improved and labor demands for increased compensation, costs rose – Chinese labor costs reportedly grew 30% from 2016 to 2020 – slowly eroding the cost benefits. At the same time a trade war with China prompted many companies to consider transitioning their sourcing from China. Some had already begun the process. When COVID arrived, leading to the inability for companies to timely obtain required inputs, sourcing managers realized production needed to diversify to reduce supply chain risks.
Enter nearshoring, which we expect to play a more prominent role going forward. Still considered offshoring, nearshoring moves operations to the closest country with a qualified workforce and lower cost of living, minus the time and cultural differences. It means increased collaboration through real-time communication within similar time zones and more opportunity for onsite visits. For U.S. companies, this often means Mexico – where labor costs increased by only 7% from 2016 to 2020 – but it includes other Latin American countries too. A 2021 survey of 260 executives with manufacturing plants in China acknowledged growing interest in Mexico to supply the U.S. market. For European companies, this often means Eastern Europe.
Supply chain disruptions due to COVID and shifting economics forced many companies to move from the just-in-time principle of inventory management to just-in-case. Just-in-case is more expensive due to higher inventory costs, partially offsetting the diminishing cost differentials in personnel remaining from the original decision to offshore production in the first place. The closer suppliers are to final production, the greater the ability to retain a just-in-time inventory method.
Nearshoring isn’t limited to physical production. It applies to knowledge work too. Latin American universities in Brazil, Argentina, Mexico, and Columbia have produced thousands of software developers available at lesser costs than in the U.S, usually without language barriers. Latin America saw a 150% increase in companies hiring in the region, particularly software engineers.
Shifting supply chains is costly and will take years to implement. Relocating even a small percentage of production from China to another smaller option could require a capacity buildup by many multiples. However, companies that remain exclusively or primarily exposed to Chinese production risk an era of higher labor costs, political trade wars, and continued supply chain breakdowns as globalization retreats.
Not every nearshoring candidate has the infrastructure to handle home office wish lists. Nearshoring may be combined with reshoring, or bringing production back to the U.S. Either way, long-term changes such as these require patience and commitment, but companies who do it may enjoy cost advantages and develop a more secure and long-term supply chain, something investors will reward.
Disclosure: This is for informational purposes only and any reference to a specific type of security does not constitute a recommendation to buy or sell that security. The reader should not assume that an investment in the security identified or described, was or will, be profitable. For a complete list of disclosures, please click https://mitchcap.com/disclosure/
