Changing economics is moving contract assembly to North America.

In which direction do the economies of electronics production push the manufacturing location? What is the history of the situation and assumptions? And when is it time to reevaluate those assumptions?

In the 1950s and ’60s, US and other Western-based companies moved manufacturing to Japan, where labor was cheap and factories were being rebuilt using enormous investments from the US and its allies. Japan’s quality was initially poor but rapidly improved, and the nation became an economic powerhouse. Along with this increased sophistication came increased cost, and Western companies relocated to Korea where, again, investment poured in after a cease-fire in hostilities.

The Koreans were mindful of the Japanese experience and from the start emphasized quality. This made Korea a better source for electronics assemblies, but their smaller population (25 million Koreans vs. 95 million Japanese in 1960) prompted rapid increases in labor costs. Next stop Taiwan.

The very Western-leaning government in Taipei, combined with a large, educated workforce, made Taiwan an easy fit for American companies. This writer’s personal experience was that working there was much like Bayonne or Bayport: The locals might have displayed a “funny” accent, but followed the same Yankee Doodle drummer. Sophistication and profits escalated, followed by costs. By the turn of the 21st Century, even Taiwanese companies read the kanji on the wall and began to open subsidiaries in mainland China, where land and labor were cheap.

These lower costs coupled with loosening governmental control in mainland China made for fertile ground where companies could expect to grow quickly and dramatically cut costs. There was a scarcity of university-educated engineers and experienced managers, so most startups were not Chinese-based but rather staffed and managed by Japanese, Koreans, and finally the entrepreneurial Taiwanese.

Part of the competitive nature of the Chinese model was based on low labor costs, where human labor was usually more cost-effective than automation. This meant startup capital was low but also made quality difficult to control. When output varied because of the human interface, the parts not-to-specification were simply culled out during inspection and discarded, or sometimes just ignored as being “close enough.”

As the world demanded higher quality, producers in China invested in more automation and higher caliber staff, with increased training and product flow responsibility. Inevitably costs began their upward climb. The price of fuel increased globally and, with it, the cost to ship to customers halfway around the globe, so the competitiveness of China began to wane.

North American sources for contract assembly, having watched their markets shrinking, see a ray of hope. They could compete on the world stage and indeed win the economic struggle, not only against the historical competitors, but also against any of the new, smaller (Vietnam, Thailand) and potentially larger (Brazil, India) low-cost regions.

But we should put off blue sky guestimating and instead review the actual history and trends in China and what has happened to the cost savings that were envisioned just a few years ago.

Supporting data. Five to seven years ago the push to offshore contract assembly was at its peak, and with good reason. US demand was up, and volumes were increasing. US labor and raw material costs had risen dramatically. Cheap knockoffs from Chinese companies were flooding the market. To compete, the US companies chose to join them, not fight them, and began moving first simple subassemblies and then more complete products to LCRs (low-cost regions) like China and Vietnam.

The American consumer cannot blame US companies for migrating east. We wanted more, and we wanted it cheaper. We accepted lower quality because ours was a throwaway society – use it for a while and when it breaks, just buy a cheap replacement. We went from buying just the most basic components offshore to buying completed goods, all made in the world’s LCR.

Today the tide is turning. Changes in currency values have made this a different world. US dollars just do not buy as much offshore as they once did (Figure 1).

Moreover, the environmental mantra of “reduce, reuse, recycle” has taken hold. Americans are willing to pay a bit more for things of a higher quality that might last longer. Would we pay double? Probably not. So where is that tipping point, and how close to it are we? When should producers in this hemisphere investigate onshore contract assembly? Let’s look first at recent changes in cost in the Pacific Rim:

Chinese labor costs have doubled and are expected to rise another 50% in four to five years.
Chinese currency is 30% more expensive; it has surged from RMB 8.11 per $1 to RMB 6.21.
Shipping costs have also increased, some rates by 43%, others by more (Figure 2).



If you left Western shores for contract assembly in the Far East, and you then saved one-half of your production cost, how much of that savings remains today? 15%? 10%? Less (Figure 3)? Even just 10% might be a reason to let the business remain there because, after all, why incur an avoidable cost increase? But are there other issues to consider? The answers might be in the less obvious areas.

Doing business around the world has obvious hurdles, like language. There are also less obvious obstacles like business mindset and ethics. We in the West have standards that differ even on a single continent. We should not be surprised to discover that there is a greater difference between cultures with less history in common. That is not to say that one is better than the other, only that they are different and must be taken into account in negotiations and daily business transactions.

What other practical issues impact an OEM’s business when considering off- vs. onshoring?

• Should you invest in an overseas manufacturing scenario today if there are major aspects over which you have limited control, and there are forecasts of increasing economic pressure (Figure 4)?
• The 12-hr. time difference: How easy is it to have a phone or video conference if one group is just arising, while the other is getting ready for dinner? Is everyone really at the top of their game?
• The 24-hr. trip to have an onsite roundtable discussion: How many staff could you spare at the same time to make the meeting truly productive? And what happens back home while they are gone?
• What are the background, ability and availability of the LCR staff? Do they have the skillset you are used to encountering? Do they smile and nod because they agree or because they do not understand?

Are your quality standards something that they are just willing to accept, or do they wholeheartedly embrace the concept? Are they committed to protect product quality and hence the good name of their clients, or would they walk away from a situation and move on to another client from a different industry or different country? After all, their name is shielded from notoriety by secrecy agreements.

And speaking of secrecy, is intellectual property protected, and how? Agreements for nondisclosure are easy to sign but difficult to enforce when the parties are separated by 8,000 miles, different legal systems and centuries of tradition.

Quantifying these non-monetary aspects is difficult, but we know they exist. When do they, added to the direct cost, warrant moving contract assembly to North America?

The question could be answered with the use of a supercomputer and the services of many an expensive consultant. Or you could bid your next job here and there, compare the economic results, factor in the ease of dealing locally, and make your first onshore placement.

Robert Simon is a veteran of technology development and marketing, having worked R&D and marketing for electronics, polymer, and metal companies, including Bayer AG of Leverkusen Germany and Battelle Memorial Institute of Columbus, Ohio, before founding USTEK Inc.; r.simon@ustek.com.

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