Next-shoring: A CEO’s guide

NextShoringHere is a brief excerpt from an article co-authored by Katy George, Sree Ramaswamy, and Lou Rassey for the McKinsey Quarterly, published by McKinsey & Company. They explain why proximity to demand and innovative supply ecosystems will trump labor costs as technology transforms operations in the years ahead.

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When offshoring entered the popular lexicon, in the 1990s, it became shorthand for efforts to arbitrage labor costs by using lower-wage workers in developing nations. But savvy manufacturing leaders saw it as more: a decisive change in globalization, made possible by a wave of liberalization in countries such as China and India, a steady improvement in the capabilities of emerging-market suppliers and workers, a growing ability to transfer proven management processes to new locales, and increasingly favorable transportation and communications economics.

Something of equal moment is occurring today. As we settle into a “new normal” catalyzed by the global financial crisis, the ensuing recession, and an uneven global recovery, traditional arbitrage models seem increasingly outmoded. For some products, low labor costs still furnish a decisive competitive edge, of course. But as wages and purchasing power rise in emerging markets, their relative importance as centers of demand, not just supply, is growing.

Global energy dynamics too are evolving—not just the now-familiar shale-gas revolution in the United States, but also rising levels of innovation in areas such as battery storage and renewables — potentially reframing manufacturers’ strategic options. Simultaneously, advances stemming from the expanding Internet of Things, the next wave of robotics, and other disruptive technologies are enabling radical operational innovations while boosting the importance of new workforce skills.

Rather than focus on offshoring or even “reshoring” — a term used to describe the return of manufacturing to developed markets as wages rise in emerging ones—today’s manufacturing strategies need to concentrate on what’s coming next. A next-shoring perspective emphasizes proximity to demand and proximity to innovation. Both are crucial in a world where evolving demand from new markets places a premium on the ability to adapt products to different regions and where emerging technologies that could disrupt costs and processes are making new supply ecosystems a differentiator. Next-shoring strategies encompass elements such as a diverse and agile set of production locations, a rich network of innovation-oriented partnerships, and a strong focus on technical skills.

In this article, we’ll describe the economic forces sweeping across the manufacturing landscape and examine technologies coming to the fore. Then we’ll suggest some principles for executives operating in this new world. The picture we’re painting is of necessity impressionistic: next-shoring is still taking shape and no doubt will evolve in unexpected ways. What’s increasingly clear, though, is that the assumptions underlying its predecessor, offshoring, are giving way to something new.

Economic fundamentals

The case for next-shoring starts with the economic fundamentals of demand (since the importance of local factors is growing) and supply (as the dynamics of labor and energy costs evolve).

The importance of local demand factors

More than two-thirds of global manufacturing activity takes place in industries that tend to locate close to demand. This simple fact helps explain why manufacturing output and employment have recently risen—not only in Europe and North America, but also in emerging markets, such as China—since demand bottomed out during the recession following the financial crisis of 2008.

Regional demand looms large in sectors such as automobiles, machinery, food and beverages, and fabricated metals. In the United States, about 85 percent of the industrial rebound (half a million jobs since 2010) can be explained just by output growth in automobiles, machinery, and oil and gas—along with the linkages between these sectors and locally oriented suppliers of fabricated metals, rubber, and plastics (Exhibit 1). The automotive, machinery, and oil and gas industries consume nearly 80 percent of US metals output, for example.

In the recent US industrial rebound, about 85 percent of the job growth in manufacturing occurred in automobiles, machinery, and regional-supplier industries.

In China too, locally oriented manufacturers have contributed significantly to rising regional investment and employment. The country has, for example, emerged as the world’s largest market and producer for the automotive industry, and many rapidly growing manufacturing sectors there have deep ties to it. As automotive OEMs expand their capacity in emerging markets to serve regional demand, their suppliers have followed; the number of automotive-supplier plants in Asia has tripled in just the past decade.

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Here is a direct link to the article.

Katy George is a director in McKinsey’s New Jersey office; Sree Ramaswamy is a fellow of the McKinsey Global Institute and is based in the Washington, DC, office; and Lou Rassey is a principal in the Chicago office.

The authors would like to thank Michael Chui, James Manyika, and Venu Nagali for their contributions to this article.

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