Why US Manufacturers Are Drawn to Outsourcing
In the century since Henry Ford introduced the Model T and revolutionized the manufacturing industry in the United States, there have been ebbs and flows in the industry’s growth, but it always maintained a key role in the growth of the economy.
And then, towards the end of the 20th century, outsourcing became more common. By the early 2000s, many companies had jumped on the outsourcing bandwagon and started manufacturing in places like Mexico, Taiwan, Malaysia and China. What began as a trend in personal computer and electronics companies who were the first to reap the benefits of moving their manufacturing abroad, other sectors followed suit. Between 2000 and 2019, approximately 5 million manufacturing jobs were lost in the United States due to outsourcing abroad.
Despite the growing popularity of moving manufacturing abroad, the United
States’ manufacturing industry remains the world’s largest, producing 18.2% of goods.
Some say that it is in the best interest of the US economy to keep
manufacturing close to home because of the value it adds to the power of the
United States’ economy – for every dollar spent on manufacturing, $1.89 is added to other sectors that support
manufacturing such as retail and transportation.
So, if manufacturing is key to keeping America’s economy strong, why the pull to move it abroad?
Most business decisions are driven by cost and a desire to reduce expenses and increase profits. The same is true when a business decides where to produce their goods. There are a number of factors that drive outsourcing of manufacturing, but the bottom line is cost.
Labor Costs
Labor is the largest expense for manufacturing companies – employees need to be paid a living wage and usually health and other benefits as well. The cost of labor in the United States is higher than in other countries due to a higher standard of living and therefore greater expectations of workers to be paid more. The appeal of paying less money to workers in a foreign country is a big draw.
Overhead Costs
Running a factory includes paying for things like electricity, water, and building maintenance. Along with the costs of buying equipment and then servicing and maintaining that equipment, it all adds up to huge expense. Similar to labor, these types of costs are naturally higher in the United States than in places with emerging economies in the Far East, for example. Why not take advantage of the ability to produce the same goods at a lower cost?
Core Competencies
For those companies who analyze what their true core competency is – some realize that their expertise truly lies in selling a product, but not in manufacturing it. They will then want to spend fewer resources on manufacturing and put more effort into building up their main business activities that drive their revenue. It then makes sense to outsource manufacturing to a place where it costs less.
Tax Savings
There are certain elements of the US tax code that provide companies with an incentive to outsource manufacturing abroad. Companies are able to create a manufacturing-specific entity abroad through which they can funnel all of their manufacturing costs thereby lowering their US corporate tax rate.
“FOMO” (Fear of Missing Out)
Maybe it’s not a good reason, but it is important to point out that there is something of a herd mentality when it comes to moving manufacturing abroad. Companies see other companies doing it and succeeding at it and then want to do the same, even without necessarily considering whether it is truly the right business decision or not.
Greater Variety and Volume
In the US, it is unlikely to have a factory that can produce a variety of goods, ranging from cheap to premium. But in China, for example, that is quite common and provides companies with the flexibility to create a range of products in one location. Factories in other countries are also better equipped to manufacture at a much higher volume in one production run, which is also more efficient and…yes, there is that cost thing again, cheaper.
What’s the Bottom Line?
Ultimately, each company needs to make the decision for themselves based on their own priorities, expenses vs. revenues, and, controversial or not, their values.
It really comes down to Adam Smith’s idea of comparative advantage. What can be produced cheaper in the United States should be produced there. What can be produced cheaper in another country should be produced there (whether by an American company operating there or by a domestic company is a topic for another time). The end result should be top quality products at competitive prices for consumers.