Nearshoring and Reshoring Keep Operations Closer to Home

Nearshoring is a variation on offshoring in which certain business operations, such as software development, or back-office support services, are outsourced to locations that are relatively close to the home country of the client company. Nearshoring aims to achieve results similar to those of offshoring in general (such as labor cost savings), while at the same time taking advantage of the relative proximity of the services provider to maintain outsourced operations in areas that share, for example, cultural heritage, common languages or a common time zone.

Nearshored operations can be easier to monitor, since the costs and time involved in travelling to such sites are kept at a minimum, and similar time zones make it easier to communicate. Examples include a firm in the U.K. outsourcing to Eastern Europe, or a U.S. or Canadian corporation outsourcing to Mexico or Latin America.

In recent years, offshoring has occurred predominantly by Western companies seeking cheaper labor in countries such as India and China. Nearshoring is shifting work away from those countries to others such as Argentina, Costa Rica, the Philippines, Poland and the Czech Republic. Although wages tend to be higher in these countries than in India, they are still significantly lower that wages paid in the U.S., the UK or Japan. Growing numbers of manufacturers in North America, Japan and Europe are considering reshoring critical parts of their supply chains as a result of disruptions caused by the Coronavirus. The government of Japan is even offering cash assistance to companies to encourage reshoring. During 2020, Japan budgeted $2 billion of its total economic stimulus package to help firms move home to Japan.

IBM has opened a number of research centers in Sao Paulo, Brazil, while Copal Amba (an outsourcing firm that serves financial and corporate clients and was the result of the combination of the former Copal Partners and Amba Research) launched an office in Buenos Aires, Argentina in recent years. Meanwhile, IBM, Microsoft and EY (Ernst & Young) opened business centers in Wroclaw, Poland’s fourth largest city. The reasons for selecting these office locations vary. In some cases, the strategy is to be closer to customers in rapidly emerging nations.

Meanwhile, some industries are experiencing reshoring, or the practice of moving formerly offshored tasks back to a company’s home country. In 2022 alone, the Reshoring Initiative reported 364,000 reshored jobs to the U.S., up 53% from 2021 (reshored jobs rose 54% from 2020 to 2021).

As wages rise in countries such as China and India, a number of manufacturers are rethinking offshoring, taking into account higher productivity rates among American workers (3.2 to 3.4 times higher than Chinese workers according to Boston Consulting Group) and higher instances of using cost-effective robotics in manufacturing (although Chinese firms are investing very heavily in robotics). A survey of 106 manufacturing companies with $1 billion or more in annual sales conducted by Boston Consulting Group found that 37% were planning or considering reshoring. Almost 50% of companies with more than $10 billion in revenue are actively planning or considering it. The consulting firm further forecasted that reshoring could generate between 2 million and 3 million manufacturing jobs in the U.S. (Of those jobs, 1 million are expected to come from factory work while the remaining jobs would come from support services including construction, transportation and retail.) Many local governments and manufacturing associations are vigorously encouraging an expansion of community-based vocational training and skills-building apprenticeships as a way to solve this workforce need.

In the wake of the Coronavirus pandemic, many western companies are considering moving some or all of their supply chains out of China. A 2020 study by UBS found that 76% of surveyed firms in the U.S. were considering moving manufacturing out of China. UBS estimates between $500 million and $750 million in annual Chinese exports moving to other nations for production. Analysts at Bank of America estimate that fully moving export operations out of China would require $1 trillion in capital expenditures over five years, which would reduce returns on capital employed by approximately 0.7 percentage points (before accounting for any higher overhead costs such as increased wages). Meanwhile, China is seeing rising wages due to a scarcity of workers in the manufacturing sector. China’s working age segment of the population is in decline. Investment firm KKR reported that U.S. manufacturing wages were less than four times as much as those in China as of early 2022, compared to 26 times as much as Chinese wages in 2001.

Another factor fueling reshoring is energy costs, which analysts predict will continue to be lower in the U.S. than in other countries, especially China. Powering factories costs less at home in America than in a number of countries abroad. Natural gas and electricity costs dramatically less in the U.S. than in most of the rest of the world.

Savings in energy costs are being augmented by increased manufacturing efficiency. This is due to the growing adoption of robotics, which has seen average equipment prices fall significantly. Since cost-effective automation replaces human workers, this is a boost to reshoring. 3-D printing (additive manufacturing) is another technology that is significantly lowering prototyping and product design costs.

Yet another shift that is allowing work to be reshored to the U.S. is new agreements between management and labor unions to cut wages for younger, less experienced workers. At Ford Motor Company, for example, second-tier UAW workers may be hired for considerably lower pay than what older workers are earning, making it possible for Ford to move production of medium-duty trucks from Mexico to Ohio and to add capacity to a Michigan plant.

United Technologies Corp. relocated an Otis elevator plant from Nogales, Mexico to Florence, South Carolina. The company hoped the move will lower freight and logistics costs by 17%, since 70% of its customers in the U.S. and Canada are located east of the Mississippi River. The company also moved all its white-collar elevator design and production workers to the Florence plant, hoping to cut costs by another 20% through collaboration and other efficiencies. Other examples include Caterpillar’s Inc.’s shift of production of small tractors and excavators from a Sagami, Japan plant to Athens, Georgia and closing of a construction equipment manufacturing plant in Nuevo Leon, Mexico in order to move production to Victoria, Texas.

Reshoring is getting a boost from Wal-Mart, which in late 2013 promised to increase annual purchases of U.S.-made merchandise by $50 billion by 2022. While that is only a small fraction of what the retail giant spends annually on merchandise, it is very significant to U.S. companies aiming to supply the stores. For example, plastic smartphone and tablet computer case maker AFC Trident, Inc., which formerly contracted manufacturing out to Shenzhen, China, opened a small factory in Rancho Cucamonga, California to appeal to Wal-Mart and other U.S. retailers.

Reshoring is largely an American phenomenon. While Western European companies have offshored to a certain extent (often to Eastern Europe), European labor markets are less flexible and more costly than those in the U.S. Reshoring is unlikely to make any sense from a cost efficiency standpoint.

This is not to say that Western companies are abandoning their offshored operations. Most firms that are reshoring are moving a portion of their operations home while maintaining or even expanding their offshored activity.

Investment in manufacturing in the U.S. is on the rebound. U.S. Census Bureau data showed spending up to $108 billion in 2022 (a record), with the lions’ share spent in the electric vehicle (EV) battery and semiconductor industries, backed by very generous government incentives. After years of stagnant U.S. production capacity growth, 2022 saw significant gains after COVID shortages forced suppliers to retool supply chain systems.

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