Controlling rising manufacturing costs

Rising costs were a top challenge for manufacturers in 2023 — and this year looks to be no different. 

Inflation caused prices to spike for not only materials, but wages and energy. And while inflation has cooled some and prices have started to stabilize, the issue of how to mitigate high costs remains a key priority for companies at the start of the year. 

This balance has been difficult for manufacturers, as low demand remained a consistent drag on the industry and has caused more companies to cut both supply and labor costs and lower production. 

In budgeting for the year, manufacturers are weighing stubbornly high material and labor costs with the need to keep up production capacity and remain competitive.

So what are the 2024 manufacturing trends when it comes to costs? We spoke with experts on what companies should expect regarding labor, materials and operational costs like IT and insurance. 

Labor costs are likely to stay elevated, but turnover may ease

The cost of staffing factories is expected to keep climbing this year.

While manufacturing employment is expected to increase by 2% in 2024, wages and benefits costs are anticipated to rise by 5.2%, according to the Institute for Supply Management. That number is down from what manufacturers predicted for 2023 labor costs, which was 5.8%, according to ISM.

The downward tick is the result in part of easing inflation, said John Coykendall, vice chair of U.S. Industrial Products and Construction at Deloitte. In past years, a labor scarcity and high turnover rate drove costs up, reaching an average wage of $33.7 per hour in November, up 21% from January 2019, according to Coykendall. 

But a cooling voluntary turnover rate has prompted optimism among employers that wages won’t increase as steeply this year.

"Five percent may seem high, but relative to some of the labor increases that we saw earlier in COVID, it’s actually a real moderation," Coykendall said. 

Supply prices are slowly moderating from inflation highs

Commodity and energy prices have remained a concern for manufacturers amid high inflation. Looking into 2024, ISM forecasted that raw material prices would rise 3.2% during the first five months of the year. 

That rise is an improvement from past years, said Tim Fiore, ISM's chair of its Manufacturing Business Survey Committee. Prices rose 4.1% in 2023 and have spiked a whopping 25% since 2020. 

"We're going to continue to see price growth in the first half of 2024, and then it's going to stabilize and stay that way for the rest of the year," Fiore said. 

Fiore noted he expects to see some decreases in commodity prices as the year progresses, but without large price swings previously seen in materials like steel and aluminum. 

Lead times for getting supplies to factories are likely to continue improving amid normalizing supply chains. This fact should also help companies' bottom line, Coykenall noted. 

While lead times peaked at an average of 100 days during the pandemic, Coykendall said as of August 2023, they'd fallen back down to 87, showing a positive trend. 

"Time is money, and the longer it takes to receive parts, the longer it takes to do the production, you're inevitably going to see costs coming up," Coykendall said. 

Manufacturers should get ahead on cybersecurity costs

A key manufacturing operations area in which experts say companies need to up their budget in 2024 is cybersecurity infrastructure. 

Data breaches cost an average of $4.47 million for manufacturers and other industrial industries such as chemical and engineering firms in 2022, up 5.4% from the prior year, according to IBM. At the same time, nearly half of critical manufacturers face a significant risk of a data breach. 

And as the threat and costs of cyberattacks in supply chain-related industries continues to rise, manufacturers need to take precautions to protect their operations, said Aaron Tantleff, a partner in Foley and Lardner's technology transactions, cybersecurity and privacy practice. 

Tantleff encouraged manufacturers to increase their spending in 2024 to secure their tech infrastructure and employees' devices. The industry, he said, has lagged behind others when it comes to investing in cybersecurity. 

One of the top spending priorities for the year should be to upgrade security features on all needed devices, Tantleff said, ensuring they are equipped with industrial-grade cybersecurity features. Spending plans should also include "patching" any cybersecurity holes in a company's network on a more frequent basis. 

"The larger the number of devices that are added to the environment, the greater your attack surface vector is," Tantleff said. 

Climate change is driving up insurance costs

Last year's inflationary pressures were felt in not only wages and supplies, but insurance claims. 

As the cost of facilities and equipment has risen, it's also driven up the price of disruption downtime and interruption losses filed for insurance claims, said Brett Hoopingarner, director of underwriting at Sentry Insurance. 

As manufacturers prepare their insurance budgets, Hoopingarner encouraged companies to work with their provider to review their property limits. This can help ensure that a company's policy can cover the full scope of possible reconstruction costs, taking into account recent inflation. 

"We have seen, really since the end of 2019, reconstruction costs are up over 40% during that time," Hoopinger said. "If a manufacturer has not kept up, on an annual basis, reviewing those limits and making sure that the buildings are adequately insured, then unfortunately the time they usually find out is if they have a loss, and that's not the time you want to find out you're underinsured."

As the threat of climate change and extreme weather continues to grow, companies also need to account for greater possible storm destruction costs. This could include increasing the amount of interruption time covered by insurance, rather than simply a dollar amount. 

Tornadoes, flooding and other disasters are hitting greater swaths of the country, putting more facilities at risk. In 2022, the U.S. experienced 18 separate billion-dollar weather disasters; the annual average between 1980 and 1922 was 7.9 events, according to the National Oceanic and Atmospheric Administration. 

To mitigate those higher possible interruption costs, Hoopinger encourages companies to get facilities, particularly roofs, inspected and reinforced in advance.

"If a tornado is going to come through and rip up your building, there's nothing you can do to stop that. It's just a fact of the matter," Hoopingarner said. "But what you can do is have a good continuity plan in place if that happens.”

Dive Brief:

• Cloud managers in the manufacturing and automotive industries are adept at running systems but less confident in their ability to monitor, predict and control cost, according to an April 2024 report from Infosys. The IT consulting firm surveyed more than 2,500 cloud practitioners, including 412 in the automotive and manufacturing industries.
• More than half of manufacturing cloud managers reported difficulty monitoring cloud spend and nearly the same proportion said optimizing and predicting cost were challenging.
• Cloud today delivers more capabilities, which is clearly beneficial,” Jasmeet Singh, EVP and global head of manufacturing at Infosys, said. “However, the architecture, applications and funding model has grown more complex.”

Dive Insight:

Cloud adoption is a decision. Adapting to the technology is a process that can take years.

Manufacturing and automotive companies quickly adopted cloud, Infosys found. The sectors saw nearly 1 in 10 enterprises initiate migrations to AWS, Azure or Google Cloud in 2010. By the end of the decade, most manufacturers and automobile companies had a cloud footprint.

“The automotive and manufacturing industries are well past the cloud adoption stage,” Singh said, noting that 80% of the cloud services used by companies surveyed had been in service for nine or more years.

In a scenario that’s played out across industries, manufacturers harness cloud’s power to drive innovation, unlock revenue streams and modernize legacy systems. They’re more wary of migrating mature functions, such as testing and quality control, Infosys found.

“Cloud has become the industry standard,” Singh said. “Where companies keep systems on premise, it is purposeful for regulatory or intellectual property reasons and, in a small number of cases, for legacy systems that will be retired soon.”

Innovation comes at a price. Manufacturing companies spend an average of $30 million annually on cloud infrastructure and services, on par with retail but below average yearly spend in healthcare, energy and banking.

While 4 in 5 respondents expect cloud investments to rise this year, many are still sitting on unused prepaid credits, Infosys found. Respondents acknowledged they had only consumed 48% of their companies cloud commitments, an endemic enterprise oversight, according to ProsperOps data.

Singh attributed the disparity to overly optimistic expectations for what ultimately shifts to cloud.

Sponsored content

By SAP

Manufacturers are getting hit from all sides with increased business costs. In response, savvy manufacturers are leveraging robust, tech-enabled connections with their business partners for more visibility and efficiency in their operations. This enables them to see, share and collaborate outside their own “four walls” and work collectively to counter higher costs with greater effectiveness and supply assurance. 

Here are three core cost challenges manufacturers face and strategies to navigate them: 

Challenge: Siloed systems inhibit operational visibility.

Many manufacturers rely on legacy technology solutions that only operate in silos. Or they have moved to more modern technology but haven’t yet extended their systems and processes to their suppliers and trading partners. These systems often aren’t integrated and may struggle to share information internally, but they are certainly not able or geared to share information and processes externally with trading partners. This presents several challenges, including:

• Low operational visibility.
• Zero collaboration with partners like contract manufacturers, subcontractors, and third-party logistics providers (3PLs).
• A lack of end-to-end supply chain collaboration. 

These problems escalate outside of the manufacturer’s four walls, where good supply chain collaboration must involve integrated business planning and shared supply and demand forecasts among buyers and suppliers. Without this connectivity, some of the most important supply chain and production decisions may be left to single-sided assumptions, lacking in visibility and collaboration from trading partners. And as all companies have learned over the last few years, siloed thinking doesn’t play out well in the modern manufacturing environment. 

Blue Diamond Growers is one manufacturer that’s cultivating an intelligent, data-driven cooperative using SAP solutions. With SAP S/4HANA®, the SAP Transportation Management application, and SAP Business Network in place, the growing company has eliminated cumbersome and siloed manual processes to build a risk-resilient supply chain. 

These solutions give Blue Diamond a single source of truth for its planning and logistics processes. For example, using SAP solutions, the company:

• Reduced its supply-on-hand by 20%.
• Saved $1 million in annual transportation costs.
• Increased its customer order fill rates to 99%. 

Other key benefits from collaboration through their supply chain include faster and more dynamic planning; the elimination of bottlenecks and shortages; and improved response times in planning and customer support functions.  

Challenge: Manual processes inhibit efficiency and innovation.

Growing manufacturers know their siloed system and manual processes won’t cut it in today’s fast-paced business world. Yet many still use spreadsheets and email to run their supply chain operations and collaborate with trading partners. Where spreadsheets may have once been the workhorses for business data management, they’ve since been replaced by integrated systems and processes that enable partners to collaborate across companies for better efficiency and compliance. 

Despite the inefficiencies, many companies still rely on communication tools like email and electronic data interchange (EDI) for interacting and transacting with their business partners. Neither method supports effective collaboration and cohesion across the partner ecosystem, where inefficiency and poor visibility lead to rising costs that fall right to a manufacturer’s bottom line. 

When companies extend their processes to their supply chain partners, they can gain efficiency, visibility and improved compliance, to be more competitive, manage potential disruptions, and drive cost out of their businesses. Manufacturers with upstream and downstream supply chain visibility can more effectively address issues that can impact the entire supply chain, such as product recalls or product compliance to regulation.

The SAP Business Network Material Traceability solution, for example, provides trading partners along a supply chain the ability to trace materials and product content back to their origin, as well as to the distribution destination of finished goods. Quickly knowing what’s in a manufacturer’s product and where it came from goes a long way to fast and effective recalls when quality issues arise, and with meeting challenging, mission-critical regulations.  

Challenge: Disjointed supply chains add cost and stymie collaboration.

Smooth-running supply chains are a positive indicator of health for manufacturing organizations. But if raw materials, suppliers, production lines and distribution channels are misaligned, the consequences can be expensive and significant. Inventory problems, production delays and missed market opportunities — not to mention unhappy customers — are just some of the costly impacts that manufacturers feel when their supply chains are out of sync. 

A producer of household appliances, Mabe, understands the value of a tech-enabled supply chain. The company was using manual means to collaborate with direct materials suppliers on production planning, inventory and quality processes. As part of a digital supply chain transformation, Mabe streamlined these processes using SAP Business Network. Today, the company is collaborating with its trading partners more quickly and efficiently.

Mabe deployed the SAP Business Network Supply Chain Collaboration solution, enabling enhanced collaboration on planning, subcontracting, quality, consigned inventory, and related supply chain processes with trading partners, including direct materials suppliers and logistics and services providers. 

The company can now share information with its suppliers, providing a single source of truth that enables its supply chain to work more efficiently. Suppliers even use the solution to automatically generate invoices, which results in fewer errors and less work managing invoices. This frees up time for the company’s accounts payable department and translates into real cost savings for Mabe and its business partners. 

Get everyone working from the same playbook

Manufacturers rely on a complex ecosystem of partners to help them bring products from the point of raw material to the store shelves (or the consumer’s doorstep). Siloed information, process gaps and poor visibility interfere with an effective supply chain. However, a solution that connects the systems and processes across companies can build a stronger supply chain. 

When emails and phone calls to suppliers, contract manufacturers, and carriers are replaced by one integrated platform for collaboration, companies can let their people focus on growing the business. This is just one of many reasons manufacturers are extending their own processes to robust digital networks connecting their partners in a single ecosystem. 

SAP Business Network provides the visibility, efficiency, and platform for compliance that growing manufacturers need to avoid and withstand disruption — and boost their bottom line. 

Ready to extend your business processes for growth? Read more about how SAP Business Network can connect your supply chain.

Tyson Foods announced March 11, 2024 it will close a pork plant in Perry, Iowa, which will result in the loss of 1,276 manufacturing jobs.

“While this decision was not easy, it emphasizes our focus to optimize the efficiency of our operations to best serve our customers,” a Tyson spokesperson said in a statement to Food Dive. “Iowa remains a key state for Tyson Foods, with employment of more than 9,000 team members across our other Iowa facilities.”

The mayor of nearby Des Moines, Dirk Cavanaugh, said the plant is set to close on June 28, 2024, Reuters reported.

The spokesperson added that Tyson is working with Iowa officials to provide resources to the affected employees. It encouraged workers to apply at roles elsewhere in the company.

The Iowa closure comes after a volatile period for the company’s pork business, which has struggled with high grain costs but has shown signs of improving. In Tyson’s February 2024 earnings call, CEO Donnie King said a larger supply of hogs compared to 2023 is improving its margins in pork.

The broader meat category is contending with a challenging environment as consumer demand has softened because of high prices. Companies such as Tyson, Smithfield Foods and JBS Foods have offset losses by cutting costs within their operations. 

Since the beginning of 2023, Tyson alone has announced the closure of eight facilities — including six chicken plants and two case-ready meat processing plants — as it works to boost efficiency through its manufacturing capabilities. The Perry, Iowa, location would be its ninth.

Despite the closures, Tyson is investing in other areas of its business where it sees higher growth potential. In January 2024, the meat and poultry company opened a $355 million automated bacon processing plant in Bowling Green, Kentucky.

Tornadoes, floods, hurricanes and other calamities whipped up by climate change are upending a cornerstone for CFO risk management.

The cost of commercial property insurance in the U.S. has surged, increasing 15% last year in the biggest jump in more than three decades, the Insurance Information Institute said. During the first six months of 2023, the cost from commercial property claims ballooned 30%, according to the Swiss Re Institute.

Severe weather has created “certainly the most challenging property market we’ve seen probably since 9/11,” according to Brandon Thompson, senior vice president for risk management at Transwestern, a Houston-based commercial real estate company. “We’re in for a rough ride for the next couple of years.”

CFOs face a seller’s market for commercial property insurance as carriers push up premiums and pull back from high-risk areas, Thompson said in an interview. “You can’t just walk down the street any more and pick up an insurer.”

The turbulence from global warming puts pressure on CFOs and chief risk officers to precisely gauge company vulnerabilities and minimize insurance costs, according to experts in risk management. Solutions range from closer partnerships with insurers and hardening buildings against damage to use of new insurance structures and advanced data analytics.

“If you hold on to your old ways, you’re not going to be able to move forward,” said Zaheer Hooda, head of North America for Cytora, a London-based InsurTech firm.

The frequency of calamities induced by climate change shows no sign of falling.

Through early November this year, the U.S. suffered 25 weather-related disasters, each causing at least $1 billion in damage, according to the National Oceanic and Atmospheric Administration. From 1980 until 2022, the country annually faced just eight such catastrophes on average, adjusted for inflation.
 

A $1-billion-dollar catastrophe currently strikes the U.S. on average every three weeks compared with every four months during the 1980s, NOAA said in the U.S. National Climate Assessment released in November 2023, citing inflation-adjusted data.

The footprint from destruction is growing. So called convective storms of heavy rain, lightning, hail and violent wind spread further north this year into Great Lakes states, expanding the range of vulnerability for insurers and businesses alike.

During the first half of 2023, convective storms caused $34 billion in insured damage in the U.S. — a record for a six-month period and 68% of insured natural catastrophe losses worldwide, according to Swiss Re.
 

When calibrating their exposure to potential losses, insurers have long balanced the risk of policies written in damage-prone coastal states such as Florida and California with those in less vulnerable areas of the U.S. heartland.

“That’s no longer as effective with convective storm losses growing so much in the middle of the country,” Thompson said.

During the past 10 years rocketing costs to insurers from extreme weather have outpaced the rise in labor and construction materials costs from inflation — even after accounting for the high price pressures beginning in late 2021.

So-called claim severity, or the average cost of an insurance claim, has soared 150% during the past decade, or about six times faster than inflation, according to David Hemry, director of commercial strategy at LexisNexis Risk Solutions.

Facing losses from severe weather, several insurers are running for cover.

State Farm, one of several carriers pulling back from California, announced in May 2023 it will stop accepting new applications for commercial and personal property insurance in the Golden State. Nationwide announced in June unspecified risk reduction in its small- and middle-market commercial property insurance in unidentified states.

Hail in recent years has hammered several regions, especially along the Interstate 35 corridor in Texas and in Denver and other parts of Colorado, Hemry said in an interview. Carriers that for years could accurately predict claims in many areas can no do longer so.

“Insurers in Arkansas, Illinois, Kentucky and Indiana are in a particularly unstable situation,” Demex Group CEO Bill Clark said in an email response to questions.

Meanwhile, reinsurers — the providers of lifeblood financing to insurers — are pulling back. They have hiked premiums from 30% to 50% across the U.S. this year for insurers with catastrophic losses, according to an order signed by California Governor Gavin Newsom in September aimed at strengthening the state’s private insurance market.

“The impact of climate change and these billion-dollar losses has really put a strain on reinsurance, which ultimately dictates the terms of what you can buy in the retail insurance market,” Thompson said.

As insurance costs rise, CFOs and financial executives who gauge risk and handle insurance will likely gain greater C-suite clout, he said. “Risk management is going to need a bigger seat at the table than they probably have had in the past few years.”

Called to a larger role, a CFO can limit the costs from climate change, risk management experts said, by taking five steps:

1. Run a clean-sheet review of risk tolerance

A CFO who thoroughly gauges a company's ability to cope with damage from extreme weather will sooner adapt to rising commercial property insurance premiums and the prospect that inflation will exceed the Federal Reserve’s 2% target for a few more years, experts in risk management said.

A CFO should no longer treat insurance as just another expense item, rolled over from one year to the next, they said.

Financial executives will likely need to more frequently change insurance packages and more precisely gauge company needs, using data that models weather as well as labor, construction and other costs. CFOs will probably find they need to budget more for insurance for at least the foreseeable future.

As always, shopping around for higher-value insurance will probably help hold down costs, Hooda said in an interview.

Yet CFOs need to keep in mind a basic principle, Hooda said: “Number One, accept the reality that premiums are increasing and adjust your bottom line implications for it.”

2. Tighten partnerships with insurers

A CFO should increase the frequency and depth of contacts with carriers as the market for commercial property insurance adjusts to the barrage in extreme weather, the experts said.

Financial executives should reach out to insurers as many as 180 days before an application is due rather than the usual 90 days, they said. They should also detail, with supporting data, the ways that they are reducing risk and limiting losses.

“Make sure you’re putting together a top-notch submission with a loss-control narrative,” Thompson said.

3. Redouble efforts to avert loss

CFOs should not neglect the surefire tactic of reducing insurance costs by installing improvements such as storm shutters, flood barriers and fire-suppression systems, the risk management experts said.

Each dollar invested in limiting property damage through steps including retrofitting or adopting updated building codes can avert as much as $13 in damage, according to the National Institute of Building Sciences.

“It’s not just the property risk,” Hemry said. “It’s also the liability risks of people getting hurt on the property, breaking into the property — those sorts of things.”

Many owners of commercial properties neglected maintenance after the pandemic pushed down occupancy, the risk management experts said. Instead, with the Fed having hiked the benchmark interest rate to a 22-year high, CFOs are focused on the high cost of refinancing debt.

“We’re in a bit of a vicious cycle that as occupancy drops and loans are coming due, there can be retreat from investing back in the properties,” Thompson said. “That’s only going to lead to increased severity of claims.”

4. Consider insurance innovations

Alternatives to traditional commercial property insurance can fill in for policies scaled back or withdrawn because of the frequency in severe weather, the risk management experts said.

CFOs responsible for properties in disaster-prone areas may want to consider so-called parametric insurance, which pays out a set dollar amount based on the traits of a destructive event rather than repair costs.

CFOs most often buy parametric insurance as a supplement or substitute for traditional policies.

“It gives a bit of stability from a CFO perspective,” Hooda said, while noting that the ratio of loss to payout is usually less favorable than with traditional policies.

5. Dive into data analytics

“Big data has been around for as long as insurance companies have been around,” Gary Sullivan, senior director for emerging risks at the American Property Casualty Insurance Association, said in an interview. Yet today, insurers can use advanced analytics to more precisely measure wind, wildfire and other risks, identifying vulnerabilities and finding new opportunities.

“Historically, the insurance industry has been fairly glacial to move,” Hemry said. “It’s conservative in nature.”

Insurance start-ups are stirring up older firms by using new forms of data gathering and analysis. For example, computer analysis of photos of rooftops taken from an aircraft precisely gauges risk across vast areas, reducing claims and premiums.

InsurTechs “integrate with carriers to help them do things that, quite frankly, they haven’t been able to do for the past 100 years because it’s not their nature,” Hemry said.

CFOs should ask carriers how they are using artificial intelligence, data analytics and other advanced technology to measure risk, the risk management experts said.

Also, when drawing up an application for insurance, CFOs should consider using customized risk management systems “to tell a narrative that prevents getting baked into the general market trend,” Thompson said.

Eventually, higher premiums triggered by destructive weather will likely attract fresh capital for insurance. The market for commercial property insurance will stabilize and CFOs may find the costs of risk management easier to bear.

“Folks are going to see this as an entrepreneurial opportunity, and they’ll jump in,” Hooda predicted. “You’ll see an improvement over time.”

Thermo Fisher Scientific announced plans to lay off 74 workers at a plasmid DNA manufacturing facility in Carlsbad, California, according to a March 28 state Worker Adjustment and Retraining Notification. 

Layoffs were scheduled to take effect May 31. The biotech and medical device company is still exploring options for the site's future and no decision has been made regarding the fate of its operations, according to a Thermo Fisher spokesperson.

"There are times when we must adjust staffing levels to remain in line with current volume demands," the company said in a statement. "In alignment with this ongoing effort, we have made the decision to adjust staffing levels in our plasmids manufacturing laboratory at our location in Carlsbad, California."

The closure is less than three years after the biotech giant opened the site in a bid to tap into rising demand for cell and gene therapies and vaccines. The 67,000-square-foot facility was expected to create 150 jobs when the project was first announced in December 2020. 

The medical device and equipment manufacturer has been downsizing its California operations for several months, particularly in the San Diego area. Thermo Fisher closed sites in Carroll Park Drive, Kearny Villa Road and Cornerstone in spring 2023 and cut 218 jobs amid waning demand for COVID-19 testing products. 

The financial headwinds continued throughout 2023. The company announced $450 million in cost cuts last year, including layoffs, citing a challenging macroeconomic environment in Q2. 

Revenue was also down overall in 2023, sinking 5% year over year to about $42.9 billion, according to a Thermo Fisher earnings release. 

The company is expecting to hold relatively steady revenue in fiscal year 2024, with a guidance range of $42.1 billion to $43.3 billion, Chairman, President and CEO Marc Casper said during a January earnings call. 

The medtech and drug manufacturing industries have been rife with layoffs and downsizing amid funding challenges and the end of the pandemic-driven vaccine and testing boom. 

Several medical device companies have already announced closures and layoffs so far in 2023. Baxter International announced plans in February 2024 to close its manufacturing operations in Acton, Massachusetts, while Carclo announced plans the same month to close its Tuscon, Arizona, plastics injection molding manufacturing facility.

A new wave of supply chain shifts is spreading after the pandemic, and behind it lies a complex set of global business decisions made to optimize operations.

Companies had been considering production shifts for years, even before 2020. Now, as firms crawl back from an unending list of disruptions, experts say those decisions have accelerated as cost pressures, policy incentives and new ways of thinking recently converged to influence supply chain resilience strategies.

For some, those goals include de-risking their operations from geopolitics after several high-profile wars and coups have shaken up logistics. For others, moving sourcing, logistics or production networks is a means to chase lower costs, emissions and lead times all at once.

Most, however, see their decisions driven by a combination of factors. Here are six of the most prominent reasons experts cited in interviews.

1. A new way of looking at costs

Supply chain shifts have long been opportunities for companies looking to cut costs, and cost assessments remain the leading factor behind network shifts.

Costs have been rising across the board for the past few years. In the past decade, supply chain managers have dealt with global trade wars that have inflated the price of commodities, international freight rates that skyrocketed during the pandemic, and consistently rising wages in major manufacturing hubs like China and Mexico.

Altogether, the growing costs tipped the scale for many companies’ considerations of the optimal country to source from, according to several experts. Now, business executives are rethinking the KPIs they use to assess supply chain choices, and considering whether terms like “total cost of ownership,” “landed costs” and “revenue impact” are better suited for modern trade dynamics. So far, while no single term has risen to ubiquity, each variation highlights how executives are seriously factoring in the costs of tariffs, transportation, product lead times, brand risk, emissions, among other factors, into network design decisions.

“It was sort of a gradual process [of] companies becoming aware and starting to quantify all the costs and risks that offshoring encompassed,” said Harry Moser, founder and president of the Reshoring Initiative. “It wasn’t just one of those things, it​​​​​​ was the aggregate of all that stuff that caused them to decide to bring the work back.”

2. Tariffs and subsidies

Tariffs and subsidies are two sides of the same coin, and the past two U.S. presidents have used both to alter the shape of supply chains.

The financial penalties and incentives amount to a bipartisan carrot-and-stick. President Donald Trump’s administration used tariffs as policy tool to force global trade conversations, and penalize importers from sourcing products from cheaper markets abroad. Most notably, section 301 tariffs targeting China added a 25% duty on hundreds of products. However, rather than revoke the tariffs on a partisan basis, President Joe Biden kept the tariffs in place alleging discriminatory trade practices — and offered companies billions of dollars in federal incentives to tip the balance of production back to the United States.

Such rare consistency in industrial policy from the U.S. led many companies out of a “wait-and-see” approach in the past few years, according to an economic research paper presented in August 2023 at the annual Jackson Hole Economic Symposium.

“Biden didn't get rid of the tariffs and Biden gave subsidies,” said Laura Alfaro, the Warren Alpert Professor of Business Administration at Harvard Business School, and one of the two authors behind the research paper. She emphasized those two actions gave companies certainty and effectively told them: “It doesn't matter who's gonna win the next election, they will get tariffs and subsidies.”

That certainty was important to spur a wave of investments since 2017. Companies reacted to the section 301 tariffs, the pandemic, and several other factors to move production out of China. According to the research paper, investments went to:

• Nearby low-wage countries in Asia like Vietnam;
• Locations closer to the U.S. like Mexico and Canada;
• Or to other destinations that had a market capable of absorbing new capacity for key industries, like Ireland, Switzerland and the United States.

“Many firms were leaving China because China has developed and development is to pay higher wages,” Alfaro said. “But there is no doubt that there was a push in the last five years due to policy.”

3. Geopolitical risk

Concerns around tariffs and the rise of subsidies also highlight another emerging risk factor in modern supply chain decisions: geopolitics.

“The thing that's really in people's minds at the moment now is geopolitical risk. And that of course — it relates to tariffs, but it's also country risk,” said David Shillingford, co-founder at Everstream Analytics.

The U.S.-China trade war was but one of a rising number of geopolitical flashpoints that have threatened the global flow of supplies. In the past three years alone, executives have had to navigate extreme disruptions to production from protracted lockdowns or regional conflicts like the Russia-Ukraine war.

Throughout the pandemic, companies “saw what it was like [for orders] to be a week late or a month late,” Moser said. Now, he added, companies are realizing “it could be you're never going to get the things you ordered.”

Such geopolitical risks are why consultants like Moser and The Boston Consulting Group began offering their clients new resources, attempting to grade countries by their “risk level.” Moser’s version, for example, grades countries by their likelihood of having a prolonged interruption, where a U.S. buyer could not get in touch with their foreign supplier.

Moser said he advises executives to think about the number of sales that could be lost from a prolonged interruption to a country. Then, ask if “you can justify paying moderately more, 10 to 15% more, as insurance to make sure that you have the components to be able to make your product sell.”

However, other experts have warned geopolitics are far from the leading factor on executives’ minds, as companies make investment decisions not based on a two- or four-year time frame, but rather a ten- to fifteen-year assessment.

And even if an executive wanted to protect against geopolitical risk by, for example, fully de-coupling from China, several experts warned doing so is tough without full visibility into tier 2 and tier 3 suppliers. After all, companies in China are driving both imports and greenfield investments in countries like Mexico and Vietnam as they chase shifting U.S. demand.

“If you're making a decision to reshore, you're basically putting steel in the ground, you're putting that in the ground for at least the minimum of 15 years before you have your return on investment. On a timeline of 15 years, political stuff doesn't matter,” said Patrick Van den Bossche, a partner at Kearney.

Still, even if not the leading factor for executives, the topic continues to be a crucial one among policymakers — a fact that has had powerful repercussions for supply chain designs.

4. Existing supply networks

With so many countries competing to be production hubs, how do executives pick the best location for their supply chains?

A country’s ability to absorb new production capacity is top of mind for executives making production shifts, and that’s a big reason why countries like Mexico and Vietnam, with a strong existing share of exports to the United States, are winning even more business.

Take Mexico for example. The country has long been an industrial hub for goods like auto parts, which means companies are more likely to find legal support to operate as well as workers with industry-specific skills. 

Such a history also makes the country a more competitive choice than the United States in sectors like electronics, experts said. In fact, a Kearney analysis found that the United States cannot alone support an entirely reshored electronics industry supply chain.

“To supply just the U.S. market by 2030, you would need more than $500 billion in investments and 10 times the increase in workforce,” said Van den Bossche, who led the Kearney study on electronics supply chain resiliency for the Consumer Technology Association. He added such a feat would be difficult not just from a monetary standpoint, but also because the U.S. manufacturing industry continues to struggle to fill jobs.

Instead, a “team approach” is needed to meet mid-term resiliency goals, where U.S. investments are spread out across the various countries best suited to quickly absorb new capacity, according to the study. 

“All the stuff you've seen with alt-Asia and China-plus-one, China-plus-two, is a lot more of ‘move a little bit over to other countries and see if we can maybe start building an ecosystem similar to the one that China has been building for the last four decades,’” said Van den Bossche.

Similarly, multiple research papers have found countries in Europe, Asia and North America that are benefiting from supply chain reallocations have one thing in common: They are primarily winning market share in sectors they already have a strong presence in.

5. Lead times and agility

In addition to tariffs and subsidies, executives are also considering the need for speed and supply chain agility, as many saw just how quickly demand patterns shifted throughout the pandemic, according to several experts.

While companies have been investing in technology and other practices to better forecast category demand, during the pandemic many found accurate forecasts meant little if inventory was not at the right place at the right time. And though congestion at ports and warehouses — which passed as demand receded — were often to blame for long lead times, logistics managers operating in the high-pressure environment increasingly made decisions to cut lead times where possible.

In some cases, companies chose to rework their logistics flows to import and store goods closer to the consumer markets they were serving. Then, a push to nearshore production followed, with many companies touting the advantages of having products stored or produced close to the next step in the supply chain as a boon to agility.

For example, Hydroflask-maker Helen of Troy has sought to nearshore some of its bottle production in the past year, relocating it from China to the Western Hemisphere. 

“This will help us diversify geopolitical risk, enhance our responsiveness and reduce inventory,” COO Noel Geoffroy said in a July 2023 earnings call. “These moves also create value as they can provide quicker transit times, greater speed to market, scale advantages and process standardization.”

6. ESG goals

While not the leading factor, environmental, social and governance goals or concerns are being increasingly considered when changing supply networks, according to several experts.

“Sustainability is more top of mind now than it was when these systems were originally designed. So the redesign is more sustainable or greener in effect,” said David Correll, a research scientist and lecturer at the Massachusetts Institute of Technology’s Center for Transportation and Logistics.

Part of the reason is that nearshoring, friend-shoring and reshoring efforts could also have the side effect of helping cut down on several layers of emissions and brand risk.

A facility move from China to the U.S., for example, could simultaneously result in fewer transportation services utilized and fewer emissions per kilowatt hour of electricity consumed at production plants, due to the United States’ energy mix, according to Moser. And, Shillingford pointed to companies’ need to avoid sourcing from the Xinjiang region of China to ensure compliance with the Uyghur Forced Labor Prevention Act.

“If you want to see companies that are taking action, look at the the Uyghur Forced Labor Prevention Act,” Shillingford said, noting companies affected by it run a very real risk of having inputs held up or sent back, which translates into direct and immediate costs. “And it’s happening.”

Some experts warned moving supply chains is not a panacea for sustainability. In fact, moving a facility from one country to another could result in more emissions if tier 2 and tier 3 suppliers don’t follow suit. However, others acknowledged executives were increasingly prioritizing sustainability, citing recent surveys as evidence for the inclusion of ESG goals into supply chain design decisions.

“It used to be, you know, you invest X and you see return Y,” Van den Bossche said, adding now executives acknowledge you returns may be lower and costs may not be cheaper, but “you can service your customers better. You are closer by so you can have more innovation. And you have a better ESG score.”

When President Joe Biden gathered executives from Google, Amkor, Intel, Marvell, GlobalFoundries and Boeing to meet with Vietnamese Prime Minister Pham Minh Chính in September 2023, it marked one of the most significant gatherings in recent years between the U.S. and Vietnam when it comes to trade relations.

China has long been a popular choice for contract production in Asia due to its extensive labor pool, raw material availability and established logistics ecosystem. But as trade relations between it and the U.S. continue to sour, companies and the Biden administration are looking elsewhere for friendlier business partners. Enter Vietnam. 

Vietnam has put a premium on attracting semiconductor and advanced electronics manufacturing, bringing in some of the world's biggest companies. 

In October 2023, chip packaging maker Amkor announced its first, $1.6 billion factory in Vietnam, slated to be the company's largest facility to date. And in September 2022, Google announced plans to produce its Pixel smartphones in Vietnam in September 2022, while semiconductor developer Marvell announced in May it would establish a design center in Ho Chi Minh City.

In tandem with the U.S.-Vietnam business roundtable, in September 2023 the two countries signed a new strategic partnership — the highest tier of economic partnership Vietnam forges with other countries, according to the White House — dedicated to building a resilient semiconductor supply chain to support U.S. industry. 

Foreign direct investment in Vietnam rose 54% year-on-year in October 2023, reaching $15.3 billion, according to data from the country's Ministry of Planning and Investment. Investment in processing and manufacturing accounted for nearly 75% of the money. 

"The U.S. is at a government level recognizing the growing importance of Vietnam as a manufacturing hub for U.S. multinationals," said Asia-Pacific Chief Economist at S&P Global Market Intelligence Rajiv Biswas. "They want to tap into that capacity of Vietnam to be part of U.S. supply chains and electronics manufacturing."

As U.S. manufacturers’ eyes turn towards the country, Vietnam is pushing to ensure its industry and economy are set up for long-term growth.

Vietnam's rise to manufacturing prominence

The first major foreign semiconductor-related manufacturer to establish operations in Vietnam was Intel in 2010, when it opened a $1 billion chip assembly and test facility in Ho Chi Minh City. The opening of the factory illustrated the country's advantages as a manufacturing base for others in the advanced electronics industry, Biswas said.

"Ever since then, what we've seen is that Vietnam has really gone from strength to strength in developing its electronics sector," he noted.

In the more than 13 years since Intel's arrival, Vietnam has successfully pursued investment from global electronics leaders, like South Korea-based companies LG and Samsung, U.S. firms such as Amkor, and others. One of the keys to this success has been lucrative tax incentives for foreign investors. 

The country offers three main types of foreign investment incentives, related to corporate income tax, import duties and land rent. Vietnam has also established economic zones that "provide increased access to infrastructure, pools of talent, and networks of suppliers," according to Vietnam Briefing. 

The cost of labor in Vietnam also remains cheaper than in China: Vietnam's labor costs are roughly $2.99 per hour compared to $6.50 per hour in China as of 2022.

Finally, the country has leaned into free trade agreements, making it a more attractive trade partner for U.S. businesses with global supply chains. The country signed a free trade deal with the EU in 2019, an agreement with the UK in 2020 and joined the Comprehensive and Progressive Agreement for Trans-Pacific Partnership when it was created in 2018. 

It's also a member of the Association of Southeast Asian Nations alongside Brunei Darussalam, Myanmar, Cambodia, Indonesia, Laos, Malaysia, Philippines, Singapore and Thailand. The group is collectively the U.S.'s fourth largest trading partner.

"There's been a lot of bilateral free trade agreements between ASEAN and other countries, which has helped to lower the tariff barriers for trade for Vietnam for imports and exports," Biswas said. "Which is also very important for developing their export sector, as well as getting competitive import costs."

The increase in U.S. reliance on Vietnam for goods in the last decade is clear. U.S. goods imports from Vietnam reached $127.5 billion in 2022, up 25.1% from 2021 and up a whopping 529% from 2012, according to the office of the U.S. Trade Representative. 

Vietnam focuses on 'supporting industries'

Vietnam has aggressive goals for its manufacturing growth. The country set a target for 30% of its GDP to come from manufacturing by 2030, growing the industry's contribution by 8.5% a year, according to McKinsey. 

Vietnamese officials are keenly aware of trying to ensure the state is creating a durable domestic sector that can support the country into the future, said Arrian Ebrahimi, author of the Chip Capitols newsletter and a former policy assistant at the Semiconductor Industry Association.

"Vietnam seems to be trying to take a similar path of development as Taiwan did a while back, where they start with lower value-add parts of the chip industry, and by attracting both investment and talent through those lower value added segments, slowly climb up the food chain," Ebrahimi said.

The strategy aims to lay Vietnam's foundation to host other industries down the road.

"They're trying to take a long-term approach to their industry," Ebrahimi said. "They don't want to just give out state dollars to any manufacturer that will come in and make jobs in Vietnam [and add] to the GDP short-term."

Vietnam has been focused on growing its “supporting industries:” Companies that produce raw materials, components and spare parts used to assemble finished goods. 

Doing so is meant to help elevate the country's manufacturing capacity in key sectors such as semiconductors, electronics and automotive, according to Vietnam Briefing. In 2021, industrial parks in the country attracted $1.1 billion in supporting industry investments.

Vietnam has aggressive goals for its manufacturing growth. The country set a target for 30% of its GDP to come from manufacturing by 2030, growing the industry's contribution by 8.5% a year, according to McKinsey. 

"Vietnam seems to be trying to take a similar path of development as Taiwan did a while back, where they start with lower value-add parts of the chip industry and by attracting both investment and talent through those lower value added segments, slowly climb up the food chain," Ebrahimi said.

"Even if the company coming in is primarily a semiconductor upstream equipment or materials provider, they still want to know what other technologies down the road it would also support."

What does the future hold for Vietnam?

Vietnam is one of multiple countries that has benefited from a surge in shifting global supply chains, alongside the likes of Mexico and India. So where could the country see its manufacturing industry in the next several years?

"We do expect a very big increase in the size of the [Vietnamese] economy in the next 10 years," Biswas said. "And what that means is the size of the domestic consumer market will grow quite substantially."

As the domestic market grows, Biswas noted that more multinationals are likely to set up shop in the country to tap into not only its manufacturing sector but also to capture its consumer appetite. Vietnam's GDP was $410 billion in 2022, and S&P Global Market Intelligence estimates it to grow to $750 billion by 2030. 

And with its growing trade friendliness with the U.S., as well as a relatively stable economy, political landscape and labor wage market, the economist noted its relationship with foreign investors is likely to grow. 

"I think more and more we're going to see U.S. electronics firms at least establishing part of their supply chains in Vietnam as part of a diversified global supply chain system," Biswas said. "There's probably at least another 10 to 20 years of ability for Vietnam to compete in low cost manufacturing."