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There are multiple reasons for the reversal of outsourcing we refer to now as reshoring including but not limited to labor costs in China communication difficulties with overseas manufacturers a desire for more and faster product innovation and corrupt and inefficient supply chains

What Does Reshoring Mean for U.S. Metalcasters?

July 19, 2013
Fully satisfied? Survey, develop … create Out-sourcing in reverse Still ‘revolting’ Skilled/unskilled labor More yuan Under control?

Executives of efficient American foundries and diecasters who overcome organizational inertia and take the five steps needed to improve their competitiveness can meet the price and delivery requirements of casting buyers and take advantage of the “reshoring” trend — casting orders once assigned to cheaper foreign metalcasters, but now returning due to rising Far Eastern labor costs, fluctuating foreign exchange rates, and logistical difficulties.

As the president, CEO, chief marketing officer of a management consulting firm who spends much of his time meeting with clients to discuss how to improve their performance and organizational effectiveness, I know from experience that many metalcasting executives are their own worst enemies. I have heard innumerable variations on the theme of:

“We don’t need any help! We are on the top of our game,” …

“We’re not alone … it’s a down economy because of Washington,” …

“We are the best in our industry,”  …

“I can’t get my management team excited about a new program,”  …

“Business isn’t good now, but the whole industry is down,” etc.

In short, they act either as if they have a monopoly on wisdom or they are satisfied with their current profit level, however modest it may be. But, as Peter Drucker wrote, “Inertia in management is responsible for more loss of market share, more loss of competitive position, and more loss of business growth than any other factor.”

Inertia has captured them; good enough is good enough. Inertia can be identified when executives and owners send the message through their organizations by their action and inaction that good enough is good enough, despite below average results.

The most successful metalcasting executives I have met are never fully satisfied with current results. They have a gnawing sense that if they had only made an extra effort here, had asked their managers to execute faster there, had been less accepting of excuses, and had insisted on better performance rather than resting on dubious laurels of current profitability (which is often marginal), their firms would have lower per-unit costs, better delivery records, and more orders taken at profitable margins.

These executives don’t lose sleep fretting about their popularity because they spend too much time worrying that their companies could have produced better results …

“If we had not made this mistake …”

“If I had not waited to start … until our margins fell out of bed.”

“If only I had prepared for two of our major customers filing for Chapter 11…”

Executives dissatisfied with the status quo take five steps to rectify it, because experience has taught them that pop psychology approaches like “three quick steps to this, five fast shortcuts to that, or the seven secrets to whatever” are no substitute for insisting upon better organizational performance. They understand customers can be persuaded to purchase their cast products again from domestic foundries — from their foundry — not for patriotic reasons, but because they can make quick deliveries of quality products at reasonable prices.

Five steps to profiting by reshoring

Metalcasting executives can benefit from the reshoring trend by taking the following five steps to cut costs, improve their competitiveness, and boost profitability:

• The first step is to conduct an external market survey, assessing the strengths and weaknesses of competitors and the prospects of the industries they serve. This will show where their greatest opportunities lie and what is needed to take advantage of them.

• The second step is to conduct an internal survey of their own costs and productivity to identify what inefficiencies exist within their own organizations and what bottlenecks stifle throughput. This will tell them how to increase internal efficiencies in order to take advantage of the opportunities there.

• The third step is to conduct development programs for senior managers to teach them how to how focus their activities on meeting the long-term goals needed to take advantage of future opportunities. In special training sessions, senior managers can be shown how to focus their activities on major company goals, so they can concentrate on critical matters while delegating the hum-drum to the back-office.

Then, properly trained executives can use their time to coordinate the different disciplines within their companies — engineering, R&D, marketing, finance, production, and human resources — to cut cycle times for designing, engineering, and producing castings at ever lower costs, and to bring new patterns on-line faster. In short, to insist on rapid execution of short term goals.

• The fourth step to develop a cadre of first-line supervisors trained to understand the difference between busy-ness and effectiveness. This will teach them how to meet and beat the short-term efficiency objectives needed to meet the organization’s overall goals.

Rather than focusing on managing the behavior of their workers, first-line supervisors need to learn how to manage the work of their employees. Traditional supervisory training that advocates mere panaceas like “praise in public and criticize in private,” and similar simplicities, no longer suffices. Constraint Theory, real-time scheduling to coordinate the work from furnace to finishing, and lean manufacturing techniques, for example, will be required.

• The fifth step is to generate employee cooperation toward meeting company efficiency standards by developing and implementing motivation/compensation systems to reward workers for better day-to-day productivity and improved quality output.

By identifying and focusing on future markets with the greatest potential, by training managers and supervisors to be more effective and efficient, by using costing systems to identify and shed marginal products and customers, by cutting costs, and by motivating employees to improve productivity by rewarding them through motivation/compensation systems like Gainsharing (which can produce double-digit productivity improvements), metalcasters can take advantage of the “reshoring movement” and reestablish themselves as low-cost, domestic suppliers whose deliveries are quick and dependable.

What is reshoring?

Reshoring is the reverse of out-sourcing, which has a long history in its own right.  Outsourcing started in Detroit as General Motors, Ford, and Chrysler tried to escape their expensive United Auto Worker contracts by becoming mere assemblers of parts (brakes drums, exhaust manifolds, seat frames, etc.) made by lower-cost suppliers, rather than coordinating parts made in their own vertically integrated organizations.

All of the old Big Three spun off their parts subsidiaries into independent suppliers in the hope they might negotiate lower labor costs with the UAW. This practice soon spread to the off-highway construction and agricultural equipment industries, as well as consumer durable goods makers producing refrigerators and stoves. Manufacturers hoped they could reap savings by buying parts made by low-cost domestic suppliers not hobbled by restrictive union contracts… or even by unions at all.

When that didn’t work out the Big Three rationalized that since they sold cars globally, they should also search the globe for low-labor-cost suppliers of components to be assembled in their domestic plants. Other OEMs followed. Soon, a chase was on to find areas or countries with the lowest labor costs.

Jack Welsh, legendary chairman and CEO of General Electric, semi-humorously claimed the ideal location of an international company’s factories would be barges that could be floated anywhere to take advantage of favorable exchange rates and low-cost labor. But, because of rising foreign labor expenses, foreign currency value fluctuations, and logistical nightmares, many casting buyers are rethinking previous decisions to buy parts from low-labor-cost, off-shore suppliers.

When and where did “offshoring” start?

“Offshoring” started in the late ‘60s with Mexico’s maquiladora program. Factories built in those free-trade zones along the Mexican-American border could import American-made parts and components without tariffs, assemble them into finished products, and then ship them back to the U.S., paying duties only on the value added by inexpensive labor. Spurred by the 1994 North American Free Trade Agreement, maquiladora output now accounts for about 25% of Mexico’s GDP.

As wages rose in Mexico, American companies looked to Guatemala and other Central American nations for lower-labor costs so finished products could be made (e.g., apparel) or assembled (small consumer appliances) cheaply. This trend morphed into exporting the entire production of labor-intensive operations, like shoes, apparel, toys, small appliances, electronics, and all types of computers and peripherals, to foreign countries with cheap labor, and then shipping finished goods back for domestic customers.

Then, as Central American wages climbed due to higher demand for low-cost labor, American manufacturers looked overseas for low-labor-cost suppliers. They found them in Pacific Rim countries like South Korea, Taiwan, the Philippines, and finally, China.

China today

China still suffers from the Mao Zedong’s early efforts to consolidate Communist Party rule in the 1950s, his simplistic efforts to speed industrialization, and his desires to maintain the theoretical underpinnings of socialism. These included:

• Mao’s 1958 “Great Leap Forward”, which collectivized private farming in an effort to boost food supplies enough to feed industrial workers in urban areas. Like Stalin’s forced collectivization of Ukrainian agriculture in the 1930s, Mao’s leap stumbled, resulting in famine, and tens of millions of Chinese starved. The results were so clearly negative that they helped more moderate Communist party leaders like Deng Ziaoping and Liu Shaoqi to gain influence.

• Mao’s Cultural Revolution in 1965, which was an effort to eliminate “revisionism” and reinforce basic principles of Communism, to create a classless society in which peasants, workers, and educated classes would work together for the common good. Groups of Red Guard students banded together to denounce all whose thinking differed from Mao’s. They created such social chaos that Mao’s authority was challenged again by moderates Zhou Enlai and Deng, who used their influence to return to normal life in 1968.

• Mao’s hukou system, which was a way to control internal migration by household registration. Everyone was forced to register at their place of birth for a location certificate, on which were based social benefits like land distribution, school admittance, and medical insurance. Deng subsequently softened this effort in the 1980s, allowing more rural citizens to migrate from the interior to the Special Economic Areas, bringing a surfeit of cheap labor to the growing export industries in coastal areas. 

• Deng’s “one-child policy,” begun in 1979 to slow the rise of China’s population, which had grown to about 963 million in 1978 from 552 million in 1950. Each woman was allowed just one child; above-quota births were heavily fined, if not aborted by force. This policy led to a temporary “demographic dividend,” i.e., an extremely high percentage of the population in its prime working years. The working population (age 15-64) increased from 59.3% of the population in 1980 to 74.4% in 2011 as China urbanized.

Today, that population is aging, and the social safety net for the elderly is weak. Of the roughly 185 million Chinese over 60, some 22.9%, or 42 million, live in poverty, as compared to 8.7% of Americans over 65, where the safety net of Medicare and Social Security is much stronger.  To date China has made little effort to address this problem, and it will haunt the nation in the coming decades.

China’s economic scene gradually changed, starting in the late 1970s, due to four trends:

• The “household responsibility system” in rural provinces, where local governments allowed farmers to sell some of their produce at free-market prices. Since humans seem to be hard-wired to be acquisitive, this practice gradually spread nationwide in the early 1980s.

• The industrial reform at a local level, whereby enterprises owned by municipal and provincial governments were allowed to begin producing and marketing goods for sale at market-driven prices in local areas.

• The gradual transition from state-owned to private enterprises, as “hard-wired” individuals became entrepreneurs, making and selling a wide variety of goods nationwide. In short, this was the beginning of a national private economy operating sub rosa along with the state-owned enterprises.

• The establishment of Special Economic Zones in Guangdong and Fujian provinces, as well as Shanghai and other coastal cities, in which free-market was encouraged, as Communist Party leadership looked the other way.

Under the leadership of Deng Ziaoping in the 1980s, China gradually liberalized its economy, although political power remained a Communist Party monopoly. While relaxation of Party political control was the subject of much internal debate, hardliners finally won the argument when the Tiananmen Square demonstrations for political reform and an end to Party corruption erupted in May 1989. Martial law was declared in Beijing, followed by troops and tanks. The June 4 crackdown killed hundreds of demonstrators.

To this day, the Communist Party maintains political control and ideological purity at a national level while turning a blind eye to the market-driven, capitalistic economy based on exports functioning alongside large state-owned, woefully inefficient enterprises.

China’s leaders face a dilemma: how can a Communist central government, still so repressive that Lenin would admire it, maintain political control in an open (or at least, semi-open) market that has propelled much of the country’s industrial sector into the 21st century global economy. No repressive government in modern history has made that transition … and survived intact.

Wages and population

All this turmoil has created lasting, deleterious effects. Because of the still extant one-child rule, the temporary demographic dividend has ended and the growth of China’s prime-age labor force has slowed considerably, causing wage inflation, hurting exports, and threatening the rising standard of living that has kept the masses more or less satisfied and the repressive central government in power.

Until recently, an abundant supply of unskilled and semi-skilled labor from the China’s interior agricultural provinces, and the long working hours demanded of employees in coastal manufacturing areas have proved beneficial to economic growth. But today, labor shortages exist in some of those special economic areas, especially the Pearl and Yangtze River Deltas, as well as other industrial areas vital to export markets. This shortage also helps explain the current wage explosion in China.

As offshoring accelerated in the 1990s, Chinese officials chose to ignore citizens organizing profit-seeking companies in coastal Special Economic Areas, to make parts and components for export. These exports fueled a rising standard of living that enabled the Communist Party to consolidate control. Local and provincial Party leaders welcomed the chance to become “silent partners” in many of these companies, proving that greed, political payoffs, and bribery are a global phenomena.

Chinese wage levels in 1978 were about 3% of those in the U.S. at that time, and much lower than the pay in neighboring countries, like Thailand and the Philippines. Since labor costs in China were still a fraction of the U.S.   rates in the 1980s and ‘90s, American manufacturers dropped their domestic foundry suppliers and began importing castings and diecastings from China.

Since the law of supply and demand knows no boundaries, the rate of gray, ductile, Ni-hard and steel castings exports, as well as zinc and magnesium diecastings, outpaced the supply of skilled labor in China’s coastal “special enterprise” zones. Wages shot up far faster than in neighboring countries.

From 1998 to 2010, the average annual growth rate of wages was 13.8%, says the International Labor Organization. Region-wide real wages in low-cost Asian economiew have risen by 7.1% to 7.8% yearly between 2000 and 2008, while pay in advanced Western nations rose by just 0.5% to 0.9% during the same period. These narrowing differentials have made it increasingly difficult to justify importing cast products of most types from China.

Factory owners in the coastal zones made great efforts to bring in workers from the poverty-stricken inland, initiating a great internal migration, despite the hukou system. Since Chinese pay levels climbed faster than productivity, labor became more expensive for employers, decreasing the labor-cost differential between China and Western nations. Indeed, China’s labor-cost differential compared to those of South Korea and Malaysia will evaporate by 2018 and 2022, respectively. China’s factories face a difficult future, given their rising labor costs, the time and cost of trans-Pacific shipping, and the rising value of the currency, the yuan.

Currency valuation

While China doesn’t float like Welch’s barge, that nation’s government has a long history of manipulating the value of its currency in order to boost exports.

The appreciation of the yuan has created more difficulties for China’s export industries, now bedeviled by rising labor costs. China’s past economic success has been due not only to cheap labor, as we have seen, but also to an artificially low, fixed exchange rate for the yuan versus the dollar. Washington and the European Community have railed for years against the undervalued yuan, saying it causes the large trade imbalance and adds to high domestic unemployment rates in the U.S. and Europe.

At the start of economic liberalization in the late 1970s, the percentage of China’s GDP that was exported was about 5%. By 2006 it had grown to about 40%, generating a large trade surplus. That should have raised the international value of the yuan, but Chinese governmental intervention maintained its low value in the world’s financial markets, in order to promote exports.

Here’s how comparative purchasing power of the yuan versus the dollar works: Say an exhaust manifold costs 200 yuan to produce in China, and a similar one costs $50 to make in the U.S. Then, one dollar would be worth four yuan, at least in terms of manifolds. If the value of the yuan appreciates, rising say 25% to 3 yuan to a dollar, then a Chinese manifold would cost $62.50. Obviously, buyers at American automakers could purchase fewer Chinese manifolds with their dollars, and domestic foundries would not be so hard pressed to beat the “China price” their Detroit customers always cite. Fewer automakers would buy manifolds — or anything else — from Chinese suppliers and ship them to the U.S.

Due to international pressure, China has been forced to allow the value of the yuan to climb, causing the cost of China’s exports to increase for foreign purchasers. Because of the higher value of the yuan, goods produced there are more expensive than before when purchased in the U.S. with American dollars. Since so much of Chinese manufacturing is geared to exports, the rising value of the yuan is creating higher unemployment there. Eventually, this will threaten China’s standard of living, the rise of which has enabled the Communist Party to maintain political control. This raises the specter of the widespread social unrest so greatly feared by the Chinese government.

Social controls

China’s one-child rule reduced the supply of young, cheap labor while the demand for cheaply priced exports increased the demand for it. To contain the social unrest it fears, the Chinese government established a Great Firewall in the late 1990s to block access to foreign information, including websites like Facebook, Twitter and YouTube.  It allows domestic sites to flourish, like Taobao, Alibaba and Baidu, although under tight government scrutiny intensified by the 1998 creation of the Golden Shield for domestic surveillance. Comments and postings by civic-minded bloggers are filtered, letting them focus their attention only on local problems like pollution, food safety, and local industry, but suppressing critical comments about the central government that might foment widespread collective action, social unrest, protests, and public demonstrations.

With few rights, workers find themselves housed in giant company-owned dormitories in the Pearl River Delta near Shanghai and other coastal manufacturing megalopolises, where they work +80-hour weeks in unhealthy conditions. Industrial accidents killed more than 70,000 per year in 2011 and 2012. Growing prosperity has created an era of rising expectations that China’s repressive regime has been unable to throttle entirely.

Highly regimented factories, low wages, and long workweeks have spurred unrest, strikes, riots, and even waves of suicides. Moreover, adverse publicity about poor working conditions, child labor, and worker suicides is causing American companies selling branded consumer goods like Nike and Apple to insist that suppliers and subcontractors improve pay and working conditions.

Other causes of reshoring

Additional reasons for reshoring are growing are more difficult to quantify.

One reason “offshoring” has declined has been the difficulty of communicating typical business information — engineering change orders, invoices, shipping instructions, product specifications — half way around the world, across a dozen different time zones.

A second reason is that many American companies see innovation suffering when engineering and R&D facilities remained here but manufacturing was moved to the Far East.

Yet a third reason is corruption – the threat of losing intellectual property to counterfeit-goods makers in countries where respect for patents and contracts is nil. The volume of “knock-off” goods, from electronic consumer goods, drugs, luxury fashions, and toys; to industrial products like airplane and automobile parts coming from China, is enormous. The list is endless, ranging from one Chinese firm’s heavy cast steel train wheels that the U.S. International Trade Commission banned recently when it determined the producer used stolen U.S. trade secrets to make them; to the flood of lightweight fake Zippo cigarette lighters that according to Zippo Manufacturing Co. equals the 12-million-lighter annual output of its Bradford, PA, plant. 

China’s government is no bystander to this. One observer said, “stringent protection of foreigners’ intellectual property is at odds with China’s development strategy.”  Foreign firms operating in China complain that Beijing views the appropriation of foreign innovations as part of a policy mix aimed at developing domestic technology and production.

A final reason that reshoring is increasing is a political one. U.S. unemployment rates in the U.S. have not receded much from their peaks during the Great Recession of 2007-2008, making many manufacturers sensitive to the charge that they’re sending “American jobs” offshore. During the 2012 campaign, President Obama flayed Governor Romney for sending thousands of jobs overseas as the head of Bain Capital, a hedge fund, while Romney blamed Obama for allowing Chrysler, whose bankruptcy was fast-tracked by the government, to plan Jeep production in China.

In short, narrowing differentials in labor costs, communication difficulties, and dodgy business practices have reduced the appeal of “offshoring.” Even Chinese companies have joined American ones in a continued search for low-labor-cost sites in Malaysia, Indonesia, India, and other areas, but there they are finding that workers’ skills are low and infrastructures are inadequate.

The appreciating value of the yuan has increased the cost to American buyers of Chinese-made castings and diecastings of all types. But, rising labor costs in that country’s special economic zones, the theft of intellectual property, and the cost and time to ship heavy castings across the Pacific, all have contributed to the reshoring movement, too.

True, manufacturers like General Motors, and Caterpillar built factories in China, Brazil, and elsewhere to “homeshore” their products in those expanding markets, but the volume of  castings imported to the U.S. for assembly into finished products for domestic markets has fallen, and is predicted to continue declining, giving producers like Victaulic, Bradken Inc., and Sivyer Steel (all with Far Eastern foundries), and Pacific Steel Castings (which has “partners” in China) a chance to reclaim jobs for their domestic locations — if they can meet the demands of local buyers still looking for cheap castings.

Other metalcasters, like Grede Holdings, Waupaca Foundry, and Torrance Casting never left. These foundries focused their efforts in the domestic market, and no doubt continue to seek greater efficiencies.

For American metalcasters, reshoring does not mean they can relax, because OEMs still shop the world for low prices. It does mean that America’s domestic foundries and diecasters can take advantage of this trend by redoubling their efforts to become the low-cost producers of rapidly delivered, high-quality castings. Astute executives understand they must abandon notions of “good enough is good enough,” overcome internal inertia, and follow the five steps to success listed above to prevent mediocre profitability from turning into no profitability.

Forward-thinking executives also know the growth of free-market economies like those in Europe and North America has always been accompanied by political liberalization and the decline of autocratic rule. That day will come in China, either by evolution as in Great Britain in the 17th Century and Germany in the 19th Century, or revolution as in France and U.S. in the 18th Century and Russia at the end of 20th Century. 

Who knows when the safety value will pop in China’s boiler of social unrest? After all, it took just one Tunisian street vendor, Mohamed Bouazizi, whose self-immolation after police confiscated his unlicensed produce stand in December 2010, to spark the Jasmine Revolution that led first to the overthrow of Tunisian President Zine Al Abidine Ben Ali, and then to uprisings against repressive governments across North Africa, destabilizing the entire region. Already, anonymous calls for a similar upheaval in China’s major cities have appeared on (and were quickly suppressed.) When will fury over the latest episode of contaminated baby food, adulterated milk, pollution, or the most recent industrial catastrophe spark a similar upheaval?

Astute metalcasters will not wait. They have reasons of their own to adjust to the changing economics of global supply. They know that “good enough” is not good enough, that fighting inertia is a constant battle, and that the pursuit of efficiency and competitiveness never ends if they are to survive…and perhaps prosper.

I mean, really prosper.  When are you going to start?

Dr. Imberman is president of Imberman and DeForest, Inc. management consultants speializing in improving managerial effectiveness, supervisory efficiency, and employee productivity through management and supervisory training, workforce audits, Gainsharing Plans, and other pay-for-performance programs. Contact him at [email protected]. or tel. 847-733-0071.