Techtonic Shift

Ever since the cold war era, a rough, bifurcated conception of the world has driven corporate manufacturing investment and sourcing decisions. Latin America, Eastern Europe and most of Asia have been viewed as low-cost regions, while the Triad region was traditionally considered a high-cost environment. But new research by the Boston Consulting Group (BCG) could now make that worldview obsolete.

The latest edition of the BCG Manufacturing Cost-Competitiveness Index has found that the map of global manufacturing cost competitiveness has to be dramatically redrawn to accurately reflect the world we live in today. “The new map would resemble a quilt-work pattern of low-cost economies, high-cost economies, and many that fall in between, spanning all regions,” says Harold Sirkin, a Senior Partner at BCG in Chicago, who compiled the report in association with Michael Zinser and Justin Rose, who also serve as Partners in the firm’s Chicago office.

To understand the shifting economics of global manufacturing, Sirkin and his team analysed manufacturing costs for the world’s 25 leading exporting economies along four key dimensions – manufacturing wages, labour productivity, energy costs and exchange rates. The resulting data should drive many a multi-national company to rethink decade-old assumptions about sourcing strategies and where to build future production capacity.

“In some cases, the shifts in relative costs are startling. Who would have thought a decade ago that Brazil would now be one of the highest cost countries for manufacturing – or that Mexico could be cheaper than China?” they conclude.

While London remains one of the priciest places in the world to live and visit, the UK has become the lowest-cost manufacturing base in Western Europe. Meanwhile, average costs in Russia and much of Eastern Europe have risen to near parity with the US. To understand just why the world of manufacturing has changed so dramatically, BCG identified four distinct ‘patterns of change’ in manufacturing cost competitiveness.

The first scenario, titled Under Pressure, encapsulates the erosion of cost advantages in areas traditionally known for low-cost manufacturing. For example, China’s estimated manufacturing-cost advantage over the US has shrunk to less than five per cent since 2014, and Brazil is now estimated to be more expensive than much of Western Europe. Poland, the Czech Republic and Russia have also seen their cost competitiveness deteriorate on a relative basis. They are now estimated to be at near parity with the US and only a few percentage points cheaper than the UK and Spain.

The second scenario is titled Losing Ground and describes how traditional high-cost countries that were already relatively expensive a decade ago have lost additional ground, resulting in 16 to 30 per cent cost gaps relative to the US. According to BCG, this is largely because of weak productivity growth and rising energy costs. The countries losing ground include Australia, Belgium, France, Italy, Sweden and Switzerland.

The third model, aptly named Holding Steady, describes those regions that have remained stable relative to the US – including countries as varied as India, Indonesia, the Netherlands and the UK. In India and Indonesia, rapid productivity growth and depreciating currencies have helped keep costs in check, even as wages have grown quickly. In contrast, the Netherlands and the UK have seen relative stability across all the cost drivers the consultancy examined. What connects all four economies is the fact that their performance has positioned them as potential future leaders in each of their respective regions, as Sirkin et al describe.

The fourth group comprises what the BCG has dubbed Rising Global Stars and includes the US and Mexico, where cost structures have improved more than in all of the other 25 largest exporting economies between 2004 and 2014. “Because of low wage growth, sustained productivity gains, stable exchange rates and a big energy-cost advantage, these two nations are the current rising stars of global manufacturing. We estimate that Mexico now has lower average manufacturing costs than China on a unit-cost basis,” the Chicago-based team says – adding that except for China and South Korea, the rest of the world’s top-ten goods exporters are 10 to 25 per cent more expensive than the US.

Sirkin et al argue that such dramatic changes in relative costs could drive a large shift in the global economy as companies are prompted to completely reassess their manufacturing footprint.

According to BCG, one implication is that global manufacturing could become increasingly regional. Because relatively low-cost manufacturing centres exist in all regions of the world, more goods consumed in Asia, Europe and the Americas will be made closer to home – a trend that has recently been described as Next-Shoring.

Naturally, BCG’s findings will also have implications for governments around the globe, whose leaders increasingly recognise the economic importance of a stable manufacturing base. To assist them in evaluating current and future economic performance, BCG tried to find out what exactly drives change in the field of manufacturing cost competitiveness.

The first factor is wage growth. According to BCG, the range of hourly pay differentials for manufacturing workers is still enormous, but what’s even more lopsided is the speed they change at. Nations such as China and Russia have experienced more than a decade of annual increases ranging from 10 to 20 per cent, for instance, while other economies saw wages rise by two to three per cent only.

The second key variable BCG uncovered is the strong influence exchange rates now have on manufacturing performance. “Changing currency values can make an economy’s exports either more expensive or cheaper in international markets,” the report says. “Currency shifts from 2004 to 2014 have ranged from a nearly 26 per cent devaluation of the Indian rupee against the US dollar, to a 35 per cent increase in the Chinese Yuan.” The result is a striking imbalance in manufacturing cost competitiveness.

A more obvious issue is labour productivity. Gains in output per manufacturing worker – or productivity – have varied widely around the world from 2004 to 2014 and explain some of the biggest shifts in total manufacturing costs we’ve seen. In Mexico, India and South Korea, for instance, manufacturing productivity rose by more than 50 per cent during that time, but it shrank in countries such as Italy and Japan. Sirkin et al also point out that some economies with low wage rates are, “not particularly competitive in terms of unit labour costs when wages are adjusted for productivity”.

A fourth reason why the balance of manufacturing power has changed so drastically over the past decade is the cost of energy. Take the price for natural gas – it has fallen by 25 to 35 per cent since 2004 in North America because of the country’s vast shale gas resources. In contrast, it has risen by 100 to 200 per cent in economies such as Poland, Russia, South Korea and Thailand. Likewise, the industrial price of electricity has risen sharply in manufacturing economies such as Australia, Brazil and Spain. As a result, overall energy costs in many countries outside of North America are now between 50 to 200 per cent higher than they were in 2004. Naturally, that development has caused major changes in competitiveness in energy-dependent industries steel manufacturing, which are directly linked to the transport equipment market.

For manufacturing businesses, the changing cost competitiveness landscape could therefore have profound implications going forward. According to BCG’s research team, improving the value added by each worker is one important area of improvement as once-enormous gaps between wages in developed and developing economies continue to shrink.

According to Sirkin and his team, it is crucial to take into account hidden cost advantages of operating shorter supply chains, such as speed to market, greater flexibility, and a better ability to customise products for specific markets. What’s more, “companies will need to understand the implications of their network decisions from an end-to-end, supply chain perspective to avoid any surprises.”

They add, “Many companies should consider adjustments in their products or business models to better meet the needs of that manufacturing environment. It may make sense to use different materials that are locally available, for example, or to take advantage of new manufacturing technologies such as robotics and 3D printing when capital is cheaper than labour.”
BCG’s comprehensive data sets shows that identifying and making such changes will allow companies to better meet the needs of the market they operate in – often at a better cost position than if they use the same materials or processes that they use elsewhere.

All it takes is approaching the world with a fresh mind-set: “Rather than seeing the globe in terms of low cost versus high cost, manufacturing investment and sourcing decisions should increasingly be based on a more current and sophisticated understanding of competitiveness within regions.”

As a result, manufacturing businesses that build production capacity based on out-dated concepts of cost competitiveness may risk placing themselves at a serious disadvantage. Meanwhile, those who are able to align their operations with the shifting economics of global manufacturing and are flexible enough to shift gears as those economics continue to evolve are likely to come out on top.