Rebuilding and Reshoring: TCO, A Deeper Dive (Part 2)
Category: Supply Chain • May 13, 2021
By Harry Moser, Founder/President, Reshoring Initiative®
As reshoring becomes an increasingly attractive manufacturing strategy due to rising offshore wages, intellectual property (IP) risks, and loss of quality, control, and flexibility, companies are finding strategic ways to reshore or keep existing work here. In part 1 of our two-part Total Cost of Ownership (TCO) series, we discussed the benefits of using TCO for accurate sourcing decisions. Now we will discuss the relevant cost factors of TCO.
The fundamentals of TCO
The free online TCO Estimator software program guides companies through a comprehensive system for recognizing and summing all costs associated with offshore and domestic sourcing. The relevant cost factors must be accounted for in order to provide a complete picture of total cost. The user answers 36 questions about the U.S. and the offshore sources. Some factors such as price, weight, and quantity are easily quantified. Others are more subjective, such as IP and natural disaster risks. Once the user’s unique data is entered into the TCO Estimator, the system will calculate for each source:
- Twenty-five cost factors
- The current TCO
- Line charts showing current price, current TCO, and a five-year TCO forecast
- An accumulation of all costs into cost categories: hard/cash, risks, strategic
- Line charts showing the cumulative cost starting with the “hardest/firmest” cost, price, and progressively adding in more subjective costs. Purpose: To show how much of the hidden costs are not subjective.
TCO Estimator costs
CoGS (cost of goods sold):
- Free on Board (FOB) price
- Fees: percentage of price
- Fees: flat
- Routine surface freight, excluding local
- Routine air freight, excluding local
- Freight insurance at 0.5% on imported product
Other hard costs
- Carrying cost for in-transit offshored product if paid before shipment
- Carrying cost for inventory on-site
- Prototype cost
- End-of-life inventory
- Travel: start-up
- Travel: audit/maintain
- Pick/place into local inventory
- Purchasing cost excluding travel
- Emergency air freight
- Product liability non-recovery risk
- IP risk
- Opportunity costs: lost orders, slow response, lost customers
- Economic stability of the supplier
- Political stability of the supplier
- Distance from manufacturing’s impact on innovation
- Impact on product differentiation/mass customization
- Local warehouse
- Disposal of obsolete inventory
Figure 1 shows a typical example of the automatically generated TCO output. Based on FOB price, the company sees a current 30% advantage sourcing in China. However, using TCO, the current total cost gap is only 10% and will be closed within 3 years if wages continue to rise in China. The company may find it is most profitable to keep any new work here and plan to bring offshore work back by investing in automation, equipment, lean manufacturing, and training or finding a local supplier.
The advantages of using the TCO Estimator:
- Customized: calculations are based on your unique data.
- Flexible: users may skip values that they feel are not essential.
- User-friendly: automatic calculation of freight rates for 17 countries.
- Explanations and references for input factors.
- Transparent: cost calculation formulas are shown on the “results” page.
- Credible: recognized by the U.S. Commerce Department.
- Affordable: free to use.
Offshore vs. domestic production
Figures 2 and 3 compare the impact of using TCO instead of price in making sourcing decisions. Figure 2 shows the distribution of Chinese FOB price as a percentage of U.S. FOB price for 180 products analyzed by TCO Estimator users.
The mode or high point for the distribution shows China priced at about 72% of the U.S. price. U.S. manufacturers are not often going to win based on price alone. However, about a quarter of the products imported from China are within 20% of the U.S. FOB price, and using TCO will often balance a 20% or greater price difference. U.S. imports from China average about $500 billion/year. Twenty percent of $500B is $100B, enough to reshore about 600,000 manufacturing jobs. The key is to use TCO to identify the most accessible 20%. If used universally for all decisions on domestic vs. offshore production and sourcing, TCO could bring millions of jobs to the United States.
In Figure 3, the percentage of the cases that the U.S. wins increases from 8% based on price to 32% based on TCO to 46% if a 15% Section 301 tariff applies.
Chinese price & TCO as a percentage of U.S. price & TCO
Use of TCO is essential to reshoring. Various researchers have found that the hidden costs, the difference between price and total cost, average 15 to 25%, confirming the data from TCO Estimator users.
Use TCO for selling vs. imports
Use the TCO Estimator to make a strong case when selling against offshore competitors. Most companies make sourcing decisions based on rudimentary metrics such as wage rate, FOB price, or landed cost. As a result, they are offshoring work that could be produced domestically. By helping potential customers see the profitability improvement possible using TCO, you create sales opportunities and enable reshoring.
Buyers use TCO to assist them in their evaluation of sourcing options. Domestic suppliers use TCO as an objective sales tool to help the buyers quantify the advantages of domestic sourcing.
For example, the Reshoring Initiative helped Morey Corp., an Illinois printed circuit board contract manufacturer, win a $60 million order vs. a Chinese competitor by showing the customer that the Illinois supplier provided the lower TCO even though it had the higher price.
When competing with a lower priced offshore product, offer to help the customer compare the TCO of your offer vs. the offshore offer. Start with the offshore sourced product(s) causing the customer problems such as delivery, quality, IP, inventory, lost orders, travel, etc. Push hardest especially when there has been a very public problem with offshore deliveries like the COVID-19 pandemic, West Coast dock strike, natural disasters or special tariffs.
Show your prospect that its competitors are reshoring. More than 5,000 companies have already successfully brought the manufacture of parts or products to the U.S. from offshore. The Reshoring Initiative website provides a slide file of 400 reshoring cases, a case studies file, and a library with “advanced search” where you can find a collection of real-world success stories in your industry.
Other tools available
The Reshoring Initiative’s resources can help companies make better sourcing decisions and win sales over offshore competitors. Visit www.reshorenow.org to get ideas and examples to help your customers reevaluate offshore vs. domestic sourcing.