If you own a shirt or a basic appliance, chances are it was made in China. For decades, China has been the largest source of manufacturing for companies, but the supply market could be headed for a major shift with a chance to bring significant manufacturing prowess back to the United States. Such a shift would have massive implications for manufacturing firms' profits and for some it might even require a complete revision of their business model.
What rising costs in China mean for investors
Data from the U.S. Bureau of Labor Statistics indicates an exponential rise in sourcing costs in China relative to other countries. The growth in wage inflation in China is depicted below.
Figure 1:
Source: U.S. Bureau of Labor Statistics.
The attraction to Chinese production has always been cheap labor, but the rapid currency and wage inflation makes it increasingly difficult for companies to maintain consistent profit margins with Chinese labor. Despite this, there are significant barriers to change that prevent most companies from uprooting production in China in favor of lower-cost countries.
One of the major barriers to making swift changes to supply chains is the fact that many corporations have well-established networks that cannot be moved to other countries without great cost. But as production costs in China continue to rise, there will be greater pressure on businesses to look elsewhere for manufacturing labor. In shifting markets, mobility is especially advantageous. Smaller firms with less established supplier networks may have a competitive advantage if production costs reach unsustainable levels. But as costs continue to rise, even large firms will have to consider an exit strategy.
There are other factors driving production away from China. High oil prices mean high shipping costs, and it doesn't take a degree in cartography to realize that goods produced in China have a greater distance to travel than goods produced at home. Furthermore, the natural gas boom in the U.S. means an abundance of supply and lower prices as a result. With natural gas prices falling, it becomes increasingly cheaper to run a U.S.-based factory.
The revolution is in America (again)
For some, the shift has already begun. It has been widely reported that Apple (AAPL +1.50%) and GE (GE 0.87%) have already begun the transition back to the U.S. for manufacturing. In an interview last year, Apple CEO Tim Cook made headlines with the announcement that he would begin efforts in 2013 to bring manufacturing stateside. For years, Apple's business model has been in line with the offshoring trend, but the model only works as long as labor is cheap and evidence continues to mount that outsourcing to China is becoming less and less viable.
The Atlantic Magazine reports that GE has discovered more than just cost benefits from its renewal of Appliance Park, the company's mammoth industrial park. In fact, the discoveries at GE have led some to question whether the offshoring model was ever the best solution. China may have offered cheap labor, but cheap labor is not skilled labor and there are hidden costs to less skilled labor such as decreases in quality and innovation. Furthermore, skilled laborers in the U.S. contribute valuable insight as they work that can lead to product redesign. GE has already seen the benefits of this in Appliance Park, with some newly designed units being made with fewer parts of higher quality in faster time. These small innovations in product design discovered on site lead to a better bottom line overall, something not foreseen in the rush offshore in search of cheap labor.
A rise in U.S. manufacturing would benefit more than just companies in the industry itself. As factories reopen on U.S. soil, there will be an ever-growing demand for the energy to run them. Producers of natural gas such as ExxonMobil, Chesapeake Energy, and Devon Energy may be well-positioned to profit from a domestic manufacturing boom.
Finally, significant innovations in manufacturing technology have perhaps the greatest chance to disrupt the offshoring model. 3D Systems (DDD +2.89%) is one company with the potential to dramatically alter the manufacturing landscape. The 3-D printing revolution offers untold benefits. The technology allows manufacturers to develop prototypes at an accelerated rate, increasing speed to market. As the industry grows and the technology improves, manufacturing costs will fall with benefits for producers and consumers alike. And the best part is, the revolution looks to be a domestic one.
