One of the predictions (or purported trends) we heard a lot about in the last few years is “nearshoring”. Google has 78,000 references to the term. Supposedly, trans-Pacific supply chains are so unreliable and complicated that US businesses are leaving their Chinese suppliers and moving to closer areas such as Mexico. If that were happening, I expect we would be seeing Mexican imports to the US being an increasing percentage of Chinese imports. Here’s the data. See for yourself. There was a surge in early 2008 but it went away. The data source is the U.S. International Trade Commission.
value of US imports from Mexico as a percent of imports from China
Here’s why I think many predictors are going astray:
First, they don’t differentiate between goods that usually travel by air and goods that travel by ocean. If your goods travel by air, an 8000 mile supply chain is only 12 hours longer than a 2000 mile supply chain. I agree that trying to have a long flexible supply chain is only possible if air freight is economically feasible. The economics work for laptop computers but not for clothing.
Second, the predictors overlook the main reason companies buy from a given country … that’s where the best suppliers are. You shouldn’t just say “I’m moving from country X to country Y” unless country Y has equal or better suppliers. (“Best” here means best against criteria that include landed cost.)
Economics Professor Michael Porter wrote a book called The Competitive Advantage of Nations. It has a great chapter on how countries become centers of excellence in building things. He says it requires four conditions:
- High degree of domestic competition
- Related and supporting industries
- Demanding customers
- Adequate factor conditions
Too many predictors focus on condition four, factor conditions. That includes labor, overhead and material costs, infrastructure efficiency and overall business environment. The other three conditions are also necessary. If factor conditions were the only criterion, Japan never would have become excellent in building cars.
I’m not saying that nearshoring will never happen. It will happen first in purchasing products that can’t be shipped by air and require supply flexibility. For any product, today’s best countries will not be best forever. Some external shocks to the system can speed up the process. If China allows the yuan to float, costs for the Chinese content of China’s exports will go up with respect to the US dollar. If energy costs soar or emissions from aircraft or ships are tightly controlled, the “best” countries could change. Both of these changes are likely to happen sometime.
The typical purchasing company cannot solve these problems. You can’t generate a nearby supply base for the parts needed to manufacture your supplier’s products if it doesn’t exist already. Because of that, “insourcing” may often be a better solution than nearshoring. If starting to manufacture something you are now buying isn’t practical, the company best positioned to solve the problem is your current supplier. I suggest you start probing your Chinese supply base about what they would do if the yuan increases in value. Farsighted Chinese companies are already looking in Africa and Latin America for both sourcing and manufacturing.