Daily Archives: January 3, 2024

There is a Price of Relocating to “Friendly Countries”, but There Are also Corresponding Cost Reductions

A recent article in El Pais on the price of relocating factories to ‘friendly countries’ noted that according to the European Central Bank (ECB), 42% of the large companies in the Old Continent that it has recently surveyed have resolved to produce in allied countries as a means of reducing risks. However, this relocation carries economic consequences, and international institutions — such as the IMF and the ECB — warn of its impact on growth and soaring prices.

The article is right. Some prices will go up as countries move out of countries in, or likely to engage in conflict, both of the physical (war) and the economic (closed borders, significant tariff increases, rolling lockdowns, etc.) variety, and move to more “friendly” countries. (As far as SI is concerned, it shouldn’t just be “friendly” countries, it should be “friendly countries close to home”. At least companies are realizing that China and/or the lowest cost country is not always the answer when that answer comes with risks that, when they materialize, could lead to skyrocketing costs and losses that dwarf five years of “savings”.

Furthermore, even though 60% of those contacted said that changes in the location of production and/or cross-border sourcing of supplies had push up their average prices over the past five years, this hasn’t been true across the board, it doesn’t have to be true, and some of those could still see savings as they optimize their new processes, methodologies, and supply chain network. (Changes don’t reach full efficiency overnight, and sometimes it is two or three years before you can optimize a supply chain network due to existing contracts, infrastructure, etc.)

Why are costs (initially) going up for many companies?

  • wages: many of the “friendly” countries are more economically mature, or advantaged, with a higher standard of living buffered up by higher wages / better social systems
  • utility charges: in “friendly” countries that are using newer, cleaner, sources of energy or limiting energy production from burning (coal, oil, natural gas) have energy costs that are often higher as the initial infrastructure investment has not been amortized, water costs could be higher if more processing inbound or outbound is required, and so on
  • production overhead: chances are that the factories are newer, required a large investment that isn’t anywhere close to being paid off yet by the owner, and you’re paying a portion of the large interest payment to the investors/banks as part of the overhead

However, it’s important to note that:

  • productivity: will go up when you move to a locale where the workforce is more educated and skilled and is better able to employ automation and modern practices, and thus gets more efficient over time, countering the initial wage increase
  • energy costs: will reduce over time as a solar farm or wind farm can produce renewable energy for decades, with the initial investment often being paid back within one third to one quarter of that time; as a result, energy prices should remain flat(ter) over time than in the locales where they are still burning dwindling fossil fuels (which rise every year in cost) and have not yet invested in renewables
  • overhead: will decrease once the investments are paid back (and the interest payments are gone), which means it can stay flat as other production related costs rise (compared to older plants which will eventually reach a point where the revitalization investment becomes significant on a regular basis)

In addition to:

  • logistics costs: will reduce when you choose a friendly country closer to your target markets (since most freight is ocean freight on fossil fuel burning cargo ships)
  • disruption costs: will reduce as less risk translates into less (costly) disruptions over time

So while costs may go up a bit at first, at least relatively speaking, they will go down over time, especially as network and process optimizations are introduced and obtained from experience with the new network, suppliers, and technologies.