What is the Tipping Point for Bringing Back Production to Domestic Market?

(Supply Chain Digest)

With the dramatic rise in fuel prices and thus transportation costs, there is growing evidence that some companies are relooking at the numbers and, in some cases, deciding to bring back production from Asia to domestic sources or “nearshore” low-cost countries, such as Mexico for the U.S. or Eastern European countries for Europe.

“For every company and product, there is of course a “tipping point” where rising logistics costs negate the unit cost advantages of China or other Asian countries,” says Dr. David Simchi-Levi of MIT, who has been doing research in this area.

Earlier this year, Simchi-Levi did an analysis for Supply Chain Digest that showed how rising transportation costs would impact optimal network design as the price of oil reached progressively higher levels. In one case, using real customer data, the analysis showed that as the price of oil went over $150 per barrel, triggering a corresponding increase in transportation costs, one consumer goods company should move a substantial amount of production volume from Mexico to a factory in Omaha to have the lowest total supply chain cost. Even though the U.S. unit manufacturing costs were higher, they were offset by lower shipping costs to customers.

“Now, what we are starting to see is that, what we predicted might happen then, actually beginning to occur,” Simchi-Levi said. He added that he has seen a number of companies that either put Asian offshoring plans on hold or, in some cases, brought production back to domestic or nearshore sources.

Simchi-Levi said he has been looking at a variety of macro-economic data for the past 4-5 years. He said that during that time, transportation costs have risen by about 40% – and not surprisingly, inventory carrying costs have also risen about 50%.

Why? In the constant trade-off between transportation and inventory costs, rising fuel costs ultimately mean it is cheaper on the margin to hold more inventory if doing so can reduce other logistics costs. Read the complete article (PDF).