The Total Cost of Ownership for Offshored Products
The Origins of Offshoring
The American landscape is littered with tens of thousands of abandoned factories. The reasons why we got here have already been explained, not only by HermitCrab, but in hundreds (if not thousands) of policy papers, manufacturing-related articles, and think tank blogs. The original decisions for sending manufacturing overseas is often couched in word salads that combine multiple rationales to justify the elimination of jobs in the US, including the following tropes:
We are spreading democracy through capitalism.
We can have more influence on trading partners if we give them access to our markets.
We want to focus on our core competencies of branding and product marketing – who cares where the manufacturing occurs?
We need to get the CAPEX (Capital Expenditures) off of our books, so we present a leaner set of accounting to Wall Street.
When China was allowed into the World Trade Organization in 2000, not only were their workers paid 5% (or less) per hour than US-based workers, but the cost of worker benefits and labor conditions regulations were practically nonexistent. The CEOs, Boards of Directors, and other company leadership took a disinterest in these specifics, because offshoring allowed them to eliminate multiple headaches, such as worker pay, capital assets, manufacturing administration, and just the overall headache of dealing with supply chains.
Ironically, the stock price of a company would often rise when large offshoring plans were announced. Even Wall Street rewarded what has turned out to be bad for America, in hindsight. At the end of the day, when you peel back the onion layers of rationales for offshoring, it always would come down to getting the lowest landed cost of a widget into the company’s distribution centers.
That brings us to the concept of FOB. The FOB (Free on Board) price is the price of goods at the frontier of the exporting country or price of a service provided to a non-resident. It includes the values of the goods or services at the basic price, the transport and distribution services up to the frontier, the taxes minus the subsidies.
The bottom line was price. It was always about price. FOB Price. But that was also always the “tip of the iceberg.”
The TCO Iceberg
Economists like to apply the “80-20 Rule” to icebergs, meaning that the part of the iceberg you see above the waterline is 20% of the total iceberg, and 80% is below the surface. Not exactly true. Physics says that the frozen ice mass known as an iceberg actually only presents 10% of the total mass above the waterline, and 90% is below the surface. This more accurate portrayal of the iceberg is also true for the TCO Iceberg. For decades, the Lowest Landed Cost was the driver for offshoring, without enough regard to the dozen or more costs that are incurred through offshoring that would be avoided by making goods in the US. 90% of the hidden costs are below the waterline.
Figure 1: The TCO Iceberg (So many costs are not accounted for)
The picture above represents this reality well. The single greatest justification for offshoring (FOB Pricing) is swamped by the multiple hidden costs to administer and manage the offshoring that exists outside of the Procurement Function. Very few current commentaries even mention ESG, and that is the one of the biggest factors that justifies reshoring in today’s environmentally conscious world.
Here’s some of the costs that sit below the surface:
Environmental, Social and Governance Costs: This is the new cost that is just beginning to surface. Offshore goods consume 20 times the CO2 as American made goods due to the multiple handling nodes and distance traveled. Local manufacturing aligns better with environmental standards, reducing fines and improving brand reputation sustainably.
Excess Inventory: Local production allows for just-in-time inventory, reducing excess stock costs significantly. Imagine reducing inventory turns by 20% and the cash that will be freed up from that.
Ocean Freight: Higher shipping costs justify reshoring to reduce expenses and increase profit margins by avoiding long-distance ocean transport. ESG costs are also enormous.
Multiple Handling nodes: Domestic production cuts costs accrued from complex supply chains requiring multiple logistics and handling points globally, including two stops at ports and the time and costs to load/unload container ships.
Tariffs: Avoiding high tariffs on imported goods by producing locally leads to significant financial savings and competitive pricing. Tariffs are not going to change anytime soon – both political parties are in favor of tariffs. So is HermitCrab.
Quality Management (Costs of Defects): Manufacturing in America minimizes quality defects, reducing cost overruns, rework, and customer dissatisfaction. Most defects from offshore production won’t be discovered until the container is unpacked at the warehouse.
Damage in Shipment: Shorter domestic shipping reduces product damage risks, ensuring better quality control and customer satisfaction.
Transit Carrying Costs: Shorter supply chains lower carrying costs, freeing up capital for other business operations efficiently.
Cost Obsolescence due to Demand Shifts: Reshoring enables quick adaptation to market changes, minimizing obsolescence and waste costs. Tastes change frequently, so having manufacturing close minimizes costs to adapt to those changes.
Unrecoverable Product Liability: Producing domestically reduces risks of non-compliance and enhances product liability recoverability. Try collecting liability settlements from your offshore supplier if an offshore-produced product causes harm.
Rising Labor Costs: With overseas labor costs increasing, reshoring stabilizes expenses and supports predictable wage structures. Why move production from China to another poor country (such as Vietnam and Cambodia) just to chase cheap labor?
Intellectual Property Loss of Control: Local manufacturing lowers intellectual property theft risks, safeguarding company innovations securely.
Rising Insurance from Geopolitical Risks: Domestic production avoids overseas geopolitical tensions, reducing the need for high-risk insurance premiums.
Terminal (Namely, Ports) Handling and Duties: Eliminate port handling charges by producing locally, cutting down on import-related costs dramatically.
Trips to Suppliers: Reshoring reduces the need for frequent international supplier visits, saving on travel costs and time.
Emergency Air Freight: Manufacturing closer to the market cuts emergency air freight expenses by ensuring faster and easier access to products.
Reshoring Initiative’s TCO Calculator
There's no reason to reinvent the wheel here. Harry Moser and his team at the Reshoring Initiative have already created an excellent Total Cost of Ownership Calculator. This methodology is so widely used, that it is often cited by the Department of Commerce. By Harry’s estimate, about 20-30% of imported products would actually be cheaper if you considered all the costs involved, not just the Free on Board (FOB) price.
To help explain the concept of TCO, Harry uses the personal example of purchasing a new vehicle. Most people will base their decision on the sticker price. But if you factor in long-term factors like fuel efficiency and anticipated repair costs, the “cheaper” vehicle may surprisingly cost you more in the end.
The same principle applies to the Total Cost of Ownership of manufacturing. The FOB price is only one factor in the overall cost of a product. Many other hidden costs to consider include freight, duty, inventory, tariffs, purchasing operations, and plenty more, as shown in the iceberg image above.
Click Here to Access the Reshoring Initiative’s TCO Calculator
Remember the TCO model gives you a broad-brush view of the potential to reshore a particular product, but the detailed work needs to be done between the company considering reshoring and a knowledgeable consulting partner to drive the specifics of the plan. Please consider HermitCrab, and our network of partnerships in the Southeast that are oriented around making the reshoring decision easy and successful.
Conclusion: For decades, many retailers, buying groups, large manufacturers, and global conglomerates took the easy way out, offshoring their manufacturing to poor, underdeveloped Asian nations. There is no longer anything poor, or underdeveloped, as the current group of Asian manufacturing powerhouses, led by China. China is a case study for the successful execution of a concerted government-oriented effort to dominate the manufacturing sector. We should not dislike China for their success. They have outworked us and outsmarted us for the last 30 years. We now need to decide who is going to work harder and smarter for the next 30 years. HermitCrab is rooting for America.
Thank you for Reading! Come back tomorrow for Day 14: Factory Revitalization: The benefits of converting an empty shell versus new site development. This is a fundamental element of the HermitCrab concept – let’s bring something old back to life versus carving up the landscape to create a plant from scratch.
Thanks for reading,
The HermitCrab Team
