Rebuilding and Reshoring: TCO, A Deeper Dive (Part 1)
Category: ReBuilding and ReShoring • May 13, 2021
By Harry Moser, Founder/President, Reshoring Initiative®
Localization, producing near the consumer, often reduces total cost due to shortened supply chains that contribute to a lean and agile strategy. The savings on non-manufacturing costs as a result of producing in the market in which the products will be sold can often overcome a 15-20% manufacturing cost gap caused by an 80% wage gap. Using the Total Cost of Ownership Estimator® (TCO) instead of manufacturing cost or Free on Board (FOB) price when companies make siting and sourcing decisions is the best way to recognize these savings. This is part one of a two-part series on the benefits and use of TCO.
The Reshoring Initiative’s TCO Estimator is a free online tool that helps companies account for all relevant factors to compare the true total cost of domestic and offshore sourcing and siting. These factors include overhead, balance sheet, risks, corporate strategy, and other external and internal business considerations. Using this information, companies can better evaluate sourcing, identify alternatives, and even make a case when selling against offshore competitors.
The benefits of localization are driving companies like fitness giant Peloton to reevaluate offshoring decisions and reshore. In December 2020, Peloton Interactive Inc. acquired Seattle-based Precor to reshore some manufacturing to Precor’s 625,000 square feet of U.S. facilities, to foster research and development and to accelerate market share. “By combining our talented and committed R&D and supply chain teams with the incredibly capable Precor team and their decades of experience, we believe we will be able to lead the global connected fitness market in both innovation and scale,” said Peloton President William Lynch.
Companies are finding that shortened supply chains and locating manufacturing closer to customers improves quality control, flexibility, and time to market while diminishing the costs and risks associated with offshore production, especially during a pandemic.
Offshoring multiplies waste
Reshoring lowers total cost by reducing waste. The Toyota Production System (TPS) is a popular and effective lean tool for identifying and eliminating waste. Figure 1 lists each of the seven wastes (Muda) in the Toyota Production System and shows how each is made worse by offshoring.
When manufacturing is moved in close proximity to where the engineering is done, companies can more easily improve design, eliminate waste, improve quality, and increase productivity. Often the result is a better product at a lower total cost.
This was the case when a group of entrepreneurs, engineers, and executives collaborated closely to work on an emergency ventilator to help with hospital shortages during the first viral wave of the COVID-19 pandemic. Newlab, 10XBeta, and Boyce Technologies joined forces to develop the Spiro Wave ventilator in under a month as global supply chains failed. Government incentives, lead time/time to market, manufacturing, and engineering joint innovation (R&D) were key to building the prototype and getting FDA emergency use authorization for a new ventilator to help with NYC hospital shortages at the epicenter of the U.S. epidemic.
TCO helps justify domestic investments
When companies make decisions based on a small TCO gap instead of a large price gap, the ROI on domestic investment rises. Companies then can often justify making investments in equipment and personnel. The resulting productivity improvements further reduce or eliminate the manufacturing cost gap with foreign production while improving product quality, delivery, and a product’s time to market. Such investment can thus further increase the percentage of work that is reshorable.
Many companies will say they have something like TCO in place but when pressed, they admit that the reward system in procurement and upper management is based on purchase price. Many shop sales professionals have told me that they tell procurement about warranty issues with imported components. The response: “Those costs are not in my budget.” Companies should eliminate such silos throughout the organization, including in procurement.
The metrics of TCO
About 60% of companies make sourcing import decisions based on price instead of TCO. Through the use of the more comprehensive TCO metric, companies can uncover the easily ignored hidden costs and risks of offshoring, shrinking the apparent competitiveness gap. Reducing costs with sustainable lean strategies, product optimization, and automation further closes the gap, enabling companies to unleash the power of “local for local.” Through localization, i.e. reshoring, overhead costs are reduced, keeping factories competitive in the key U.S. market against products from low-labor-cost countries. Part two of this topic looks at the fundamentals of TCO and use of the TCO Estimator.