Dramatic Shifts in Manufacturing Costs Are Driving Companies to Change Their Global Production Strategies

by Carol Miller, MHI VP of Marketing and Communications

Dramatic shifts in cost competitiveness around the world over the past decade are changing global sourcing and manufacturing investment strategies, according to a new report titled The Shifting Economics of Global Manufacturing: How Cost Competitiveness Is Changing Worldwide by The Boston Consulting Group (BCG). The new report finds that improved cost competitiveness is leading to new factory investment in countries such as the UK and Mexico, where productivity has largely offset wage increases.

Mexico’s Manufacturing Boom
Imports of U.S. shale gas have reduced energy costs for companies in Mexico by 37% over the past decade. Manufacturing costs are now estimated to be lower in Mexico than in China. In 2004, China’s average manufacturing costs were estimated to be six percent higher than Mexico’s, according to the BCG index. Mexico is currently around four percent lower on average. Chinese manufacturing wages have nearly quintupled since 2004, while Mexican wages have risen by less than 50 percent in U.S. dollar terms. Adjusted for productivity, Mexican labor costs are now estimated to be 13 percent lower than those of China. As a result, automakers and Asian electronics manufacturers are expanding production.

Mexican exports of electronics more than tripled from 2006 to 2013, to $78 billion. Asian companies account for one-third of investment in Mexican manufacturing. Foxconn, China’s largest single investor, says it now exports 8 million PCs a year from its 5,500-worker facility in Chihuahua state, and a major expansion is planned.

Mexico now makes a quarter of all vehicles imported into the United States. Last year, Daimler AG and Nissan Motor ADR announced plans to invest $1.4 billion to build compact luxury cars in Mexico. In the past six months, BMW, Renault, Audi, Honda, and Mazda have either begun manufacturing vehicles in Mexico or announced plans to do so. Kia Motors Corporation just announced a plan to build a $1 billion plant there. Nissan opened a $2 billion plant there in 2012.

UK’S Emerges as Low Cost Manufacturing Location in Western Europe
Global automakers are also expanding production in the UK, as it emerges as one of Western Europe’s lowest-cost manufacturing locations. In the UK—where the direct-manufacturing cost structure has improved by up to an estimated 10 percentage points in the index over other leading Western European exporters since 2004—automobile output has increased by around 50 percent since 2009. According to the Financial Times, auto production is projected to grow by another one-third by 2017 to 2 million units annually, thanks to around $17 billion in new investment by automakers such as Jaguar Land Rover, Nissan, Honda, and the BMW Group’s MINI.

Contrast the UK with Australia, the country whose global cost competitiveness deteriorated the most from 2004 to 2014, according to the BCG index. Australian auto production has contracted by half since 2004, and Ford Australia, Toyota, and General Motors’ Holden subsidiary plan to shut their factories by 2017. Overall investment in Australian manufacturing fell by 6 percent between 2004 and 2012. A major reason is that Australia’s booming natural resources sector helped push manufacturing wages up by about 48 percent over the past decade and Australia’s currency up by 21 percent against the U.S. dollar. Overall manufacturing labor productivity, however, fell by 1 percent over the same ten-year period.

“Many companies are beginning to see the world in a new light,” said Harold L. Sirkin, a BCG senior partner and coauthor of the report. “They are finding that many old perceptions of low-cost and high-cost countries are out of date, and they are starting to realign their global sourcing and production networks accordingly.”

“Improving the productivity of each worker is becoming an increasingly important factor in manufacturing competitiveness across the globe,” said Michael Zinser, a BCG partner who is coleader of the firm’s Manufacturing practice. “This is especially true as the once-considerable wage gaps between developed and developing economies continue to shrink.”

Not all countries are taking full advantage of their low-cost advantages, however. The report found that global competitiveness in manufacturing is undermined in nations such as India and Indonesia by several factors, including logistics, the overall ease of doing business, and inflexible labor markets. “A lot of factors other than wages and exchange rates weigh heavily on corporate decisions about where to locate production,” said Justin Rose, a BCG partner and coauthor. “These challenges must be overcome before they can translate low costs into a surge of investment and exports across a broad range of industries.”

Rather than seeing the globe in terms of low cost versus high cost, the report recommends that companies base manufacturing decisions on “a more current and sophisticated understanding of competitiveness” within regions. Companies should reassess their manufacturing footprints and explore investments that can improve productivity. They should fully account for logistics and obstacles to efficiently conducting business that can add hidden costs and risk. Companies should also understand the implications of changing manufacturing locations on their entire supply chains to avoid surprises, such as unforeseen shipping and import duty costs.

Companies should also expect that volatility will continue and that relative cost competitiveness around the world will remain dynamic. “The winners are likely to be companies that align their operations with the shifting economics of global manufacturing—and build in the flexibility to shift gears as those economies continue to evolve,” said Sirkin.

Click here to download a copy of the report.