Thursday, November 15, 2007

Drewry: Labor costs deflate China's bubble, near-sourcing on the rise

Hey, I just reviewed this white paper and its pretty interesting...Drewry has always been a subtle shill for the ocean transport industry (and there is nothing wrong with that...the industry needs the support)and they remain bullish on China. I am more skeptical...going back to my "why not outsource in our back yard" posts earlier this year...Check out the link below and read the white paper.

So, the case can be made for "near sourcing" and China's cost structure may become much more expensive than anticipated (plus you have to add risk factors in having such far-flung supply chains). I still believe we are closer to outsourcing in states like West Virginia and Ohio than many people think.

But in the future that shirt stands a better chance of being produced in Mexico as rising labor costs in the Asian superpower are making companies consider shifting the sourcing of men's shirts and other products with short life cycles to countries closer to market, according to Drewry Supply Chain Advisors, a new division of Drewry Shipping Consultants.

A white paper from the London-based firm, Will China's Apparel Supply Chains Become Uncompetitive?, suggests that China has virtually no cost advantage relative to Mexico or Vietnam for the export of men's shirts when factoring in "logistics opportunity costs," such as loss of income from higher inventory, stock outs/lost sales and obsolete stock.

The decision to outsource to low-cost but remote countries has increased supply chain costs and reduced their performance due to longer lead times and greater risk for delays, said Drewry associate David Charlesworth at the white paper's launch in London on Thursday.

"Underestimation of opportunity costs skew the retailers' understanding of the price/reliability of logistics providers. It also leads to incorrect sourcing decisions -- although assessing all these variables is complicated and critically dependent on the specific market and products concerned," said Charlesworth, a former P&O Nedlloyd manager.

Spanish retailer Zara is a famous proponent of "near-sourcing." It makes a high proportion of its clothing in relatively high-wage locations in its home country and across Europe so that it can get a new range onto shelves in less than two weeks from design.

Drewry Research Director Philip Damas said supply chains need to be more responsive as product life cycles get shorter. The life cycle for men's shirts, he said, is on average about three-to-four months long, and importers and shipping lines are seriously underestimating the opportunity costs by not paying more attention to transit times or schedule reliability. The consultant's latest liner shipping schedule reliability study found that about half of all vessels tracked arrived in port later than advertised.

Damas said companies are contemplating sourcing to less remote countries than China because of the weakening of its traditional pillars of low labor costs, favorable exchange rates and low maritime costs. He also highlighted concerns over product quality, the environmental impact of longer transport distances and infrastructure bottlenecks as factors that could see a production shift away from China.

While maritime shipping carries the vast majority of the world's manufactured goods, Drewry's Sourcing/Mode Model assesses alternative transport modes.

A day saved in shipping a China-made shirt into the United States results in an estimated reduction in opportunity costs of about 1.8 cents, or about 0.2 percent of the product value. This is not sufficient, Drewry said, to swing the balance towards air transport, which it estimates carries about 10 percent of U.S. imports of Chinese shirts. Air freight becomes a viable option when the opportunity cost exceeds 5 cents per day.

High-value men's shirts imported into the Unites States from Italy for example have such high opportunity costs they warrant choosing the faster but much more expensive air transport option.

Mexico's combination of relative low wages, geographical position and absence of import duties is resulting in some companies switching production back there, and as such trucking into the United States is becoming more competitive, Drewry said.

Because logistics costs are a tiny fraction of the "delivered to DC" total cost -- Drewry estimates the ocean logistics chain cost for a shirt made in China for the U.S. market at just 1.5 percent of the DC cost, or 12 cents per shirt -- companies will continue lowest-cost sourcing unless they sense a very significant marketing disadvantage.

The consultants added that for big consumer markets like the United States and United Kingdom, foreign production of goods "is a fact of life for generations to come" due to the wide gap in labor costs.

Drewry said that based on information received from manufacturers the labor costs of a mid-priced shirt from China is about 10 percent to 30 percent of the ex-factory price. A 30 percent increase in relative labor costs in China, possibly triggered by a revaluation of the Yuan, would make China less competitive in terms of total product cost for men's shirts than Vietnam and Mexico for U.S. imports, when opportunity costs are taken into account.

"Our analysis shows that supply chains based on vendors located in intermediate offshore countries allow an effective combination of faster delivery times and relatively low labor costs," Damas said.

"We expect this near-sourcing logistics strategy to become more common, although it will not work for all products."

Drewry's white paper on China's apparel supply chains is available for free download by visiting