Newest Manufacturing Buzzword: The Neighborhood Effect

The McKinsey Quarterly recently published an interesting report about whether or not manufacturing companies need to rethink their offshoring strategies and the New York Times ran a prominent article last month on rising shipping costs that had a similar theme. The content of these two pieces could be good news for small manufacturers here in the U.S. If large companies seriously re-think the economics of their global supply chains, small U.S. suppliers could be the winners.

The obvious reason for re-evaluating the wisdom of offshoring is, of course, the high cost of oil. As I write, oil is selling for about $108 per barrel, down $40 from its high in July, but up more than $80 since 2000. That's a big number. But until recently, the rise has been slow and gradual, which means it has escaped notice. Now, with the sudden spike we've experienced, supply chain managers are getting out their calculators. According to McKinsey, shipping costs are now equivalent to an 11 percent tariff, as opposed to a 3 percent tariff in 2000. And these costs not only affect finished goods. They also affect raw materials, e.g. the cost of shipping iron from Brazil to China.

Oil isn't the only factor that's affecting sourcing decisions. Again, according to McKinsey, the wages of an average production worker in China have gone up from $1,740 in 2003 to  $4,140 today, a rise of 19 percent. This means that the cost of goods from one primary offshore supplier must rise proportionally.

A weaker dollar also makes offshore sourcing more expensive than it has been. And there are hidden costs associated with using offshore suppliers that will receive new scrutiny, including warehousing inventory as a hedge against transportation glitches, financing, safety and quality issues.

Finally, the growing environmental consciousness around companies' carbon footprint will begin to play a role in the choice of suppliers. In the New York Times article, Naomi Klein, author of "the Shock Doctrine: The Rise of Disaster Capitalism" characterizes the Wal-Mart model as "incredibly fuel-intensive at every stage." This sort of publicity is perceived as being very damaging by senior corporate executives.

Add it all up and you've got the "neighborhood effect." It has important implications for your sales efforts. Here are some tips:

?   Don't assume you can't compete on price. Now's a good time to re-evaluate who you're calling on, and lay the groundwork for picking up business from companies who are changing their corporate policies on offshoring and will consider domestic suppliers whose prices are at least in the ballpark.

?   Emphasize the lean benefits of suppliers who are "neighbors." You can virtually guarantee just-in-time delivery. For companies that are thousands of miles away, this is impossible.

?   Talk about risk. It may not seem like it when you're in the middle of a negotiation, but risk avoidance can be as important as price for many large companies.

?   Play the environmental card. Make sure prospects are thinking about the environmental impact of far-flung supply chains. Many large companies are now operating under edicts from top management to become more green.

The global economy isn't going to disappear anytime soon, but it's changing, and the advantage has definitely shifted a little back towards U.S. manufacturers.