Monday, January 03, 2005

China's Sucking Sound: Maybe not Giant?

Via danieldrezner.com comes an interesting link to a study from the always interesting McKinsey Quarterly on outsourcing. It turns out that outsourcing isn't always as profitable as one thinks. In many areas, we are reaching the limits of the savings that can be achieved by reducing labor costs.

We found compelling evidence that in a number of cases, offshore manufacturing isn't all it's cracked up to be. One reason is that for many manufacturers, the importance of direct labor is declining rapidly. Since it often accounts for just 7 to 15 percent of the cost of goods sold, hard-goods and high-tech manufacturers often say that wage rates are hardly the most critical determinants of their overall economic performance.

Consider the case of one fashion apparel company based in Los Angeles. Its 1,500 workers, paid at rates well above the minimum wage, make casual wear in an old, multistory downtown brick warehouse. The executives view labor costs, currently 3 percent of the retail price of these goods and heading lower, as a secondary concern to the company. If it were to move its operations offshore, logistics costs might well swallow up any savings from lower wages. Another example: A consumer electronics manufacturer we interviewed has stripped away roughly 60 percent of its labor costs from production and reduced lead times from weeks to days. Even if an offshore competitor drove down its own labor costs close to zero, this manufacturer would still have an insurmountable advantage in logistics—a fact that has emboldened the company to reverse-engineer low-end Chinese goods for manufacture in California.

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