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Pricey oil is dulling the mainland's edge in manufacturing. But American industry may not be ready to seize the opportunity
Christina Lampe-Onnerud has a long-lasting, fast-charging battery for notebook computers that she believes will revolutionize the industry. Her company, Boston-Power, would like to make the batteries in the U.S., which she says is feasible despite high American wages.
But Lampe-Onnerud has had trouble finding anyone in the U.S. even to make a prototype, let alone manufacture the battery in bulk. China, by contrast, is home to more than 200 battery manufacturers. On visits to the mainland, Lampe-Onnerud toured dozens of factories with ample staff and laboratories, and none wanted the millions of dollars up front that one contract manufacturer in the U.S. had demanded. She recalls a negotiating session last year that started at 9 a.m. and ended with a midnight dinner. Despite parting with 30 unresolved questions, "at 9:00 the next morning, the entire management team was there with pressed white shirts and a PowerPoint presentation addressing every issue," she says. "That's how badly they wanted the business." In six months, Boston-Power was ramping up production in a 400-worker factory in Shenzhen.
This would seem to be a good time for an American manufacturing renaissance. The economics of global trade are starting to tilt back in favor of the U.S. to a degree unseen in a generation. Since 2002 the dollar has plunged by 30% against major world currencies and is falling against the yuan. Wages in China are rising 10% to 15% a year. And spiking oil prices are driving up shipping rates. The cost of sending a 40-foot container from Shanghai to San Diego has soared by 150%, to $5,500, since 2000. If oil hits $200 a barrel, that could reach $10,000, projects Toronto financial-services firm CIBC World Markets.
But as the experience of Boston-Power and countless companies like it shows, the map of global commerce can't be redrawn overnight. American factories and supplier networks in many industries have withered in the era of globalization, so it will take lots of time and capital before the U.S. can become a big player again. In electronics, for instance, there has been a mass migration of component makers to China in the past decade. Ditto for suppliers to Midwest heavy-equipment makers and North Carolina's furniture industry.
The bulk of goods made in China—clothing, toys, small appliances, and the like—probably won't be coming back, because they require abundant cheap labor. If anything, their manufacture will go to other low-wage nations in Asia or Latin America. And in industries from machinery to motorbikes, China's productivity gains nearly offset rising wages and fuel prices.
In areas where the U.S. is at the forefront of innovation—renewable energy, nano materials, solid-state lighting—the U.S. must compete with Asian and European nations willing to lavish entrepreneurs with start-up capital, cash grants, and cheap loans. Similar help may be needed to persuade U.S. companies to build capacity.
EATING INTO "THE CHINA PRICE"
The global industrial landscape certainly appears to be in the early stages of a realignment. The euro's breathtaking rise against the dollar has spurred European makers of cars, steel, aircraft, and more to shift production to the U.S. Now the soaring cost of fuel is making it pricier to send goods across the Pacific. Consider Japan's steel industry, which depends on imported iron ore and coal to create high-end metal for Japanese automakers in the U.S. In 2003 it cost $15 to ship a ton of iron ore costing $30 from Brazil to Japan. By last fall, while the ore had jumped to $80 per ton, shipping costs had risen to $90. Shipping of raw materials now accounts for 13% of the price of rolled steel used in car bodies, estimates CLSA Asia-Pacific Markets. The finished steel must then be sent to factories in the U.S., pumping up the price even further.
Rising costs are starting to eat into what American managers fearfully call the China Price, the once-formidable 40% to 50% cost advantage enjoyed by Chinese manufacturers—and demanded by customers. "Fuel prices just shot up so fast that everyone was caught flat-footed," says Allen J. Delattre, who heads Accenture's (ACN) global supply chain practice. "Now logistics costs are an overarching priority." Richard Sinkin, a San Diego consultant who scouts manufacturing sites in the U.S., Mexico, and China for multinationals, also senses a major strategic shift. "A lot of clients who were thinking about going to China are now saying, Not at these prices,'" says Sinkin. "The high cost of fuel is going to radically transform the way people look at the geography of their manufacturing."
Examples of production shifts abound. Chinese steel exports to America are down 20% in the past year, notes CIBC, while U.S. steel output has jumped 10% despite the slowdown in construction. Big electronics manufacturers are expanding assembly of high-end telecommunications, computer, and medical equipment in Mexico and some parts of the U.S. for greater proximity to corporate buyers. Tesla Motors, which has just begun production of its $109,000, electric-powered sports car, transferred assembly of battery packs from Thailand to a plant next to its San Carlos (Calif.) headquarters. Thailand's low factory wages were more than offset by the costs of shipping thousand-pound battery packs across the Pacific. "We were seeing tens of millions of dollars of value sitting on the water for months," says Darryl Siry, Tesla's vice-president for marketing. "It was one of those things that became obvious all of a sudden, and you said, Why are we doing this?'"
Look behind these examples, though, and obstacles to a broad manufacturing migration become clear. Iron castings maker Donsco, on the banks of the Susquehanna River in eastern Pennsylvania, illustrates the dilemma. In recent years, Donsco has laid off hundreds of workers as customers shifted production of gear boxes, oil rig parts, and much more to Chinese competitors. Now, Donsco says it's flooded with order inquiries from U.S.-based clients. "All of a sudden our customers are saying, Whoops, it's cheaper to buy in our backyard,'" says Donsco Chairman Art Mann Sr. While Donsco managed to keep its doors open, many of its U.S. rivals shut down, so there's now a shortage of capacity.
STAYING PUT, FOR NOW
Despite growing demand, Mann says Donsco will be "real cautious" about spending the $30 million and two years needed to build a new foundry. The impact of this reluctance is being felt in Belen, N.M., where CEMCO, a maker of rock-crushing and farming equipment, is looking to cut costs and logistical headaches. The company today imports many metal parts from Asia but would prefer to buy domestically because of rising shipping rates and the weak dollar. "American foundries now can compete head-to-head on cost, but there aren't many foundries, welders, machinists, and quality-control engineers," says James B. Turk, CEMCO's chief financial officer. "What we had 10 years ago is gone." Where did all the capacity go? Mainly to China, where modern foundries are proliferating.
The furniture industry has undergone a similar transformation. Hundreds of factories have shut their doors across the U.S. South, while giant plants churning out beds, armoires, and coffee tables have sprung up in industrial estates that sprawl for miles and miles outside Chinese cities such as Dongguan, just north of Hong Kong. It's true that wages are up, the Chinese plants import much of their wood from North America, and bulky bed frames and mattresses consume a lot of space in shipping containers. Yet Stylution Group's 1,600-worker complex in Dongguan isn't going anywhere. Stylution churns out 1 million mattresses and 300,000 bedroom sets every year, exporting about half of them. "It's not easy to pick up and move," says Stylution's marketing manager, Frank Masiello. Besides, he says, most of the supply base has gone to China, down to the paint and tiniest screws, and the mainland market is growing fast. "High Point [N.C.] used to be the center," Masiello says. "But over the last eight years, pretty much everything moved here."
The same goes for lighting fixtures, household appliances, and more. An overwhelming majority of many of these products are made in China. And while some companies are shifting production to Vietnam or Indonesia, those countries don't have enough skilled workers to match Chinese quality and efficiency. If global shipping costs continue to rise, some businesses could eventually move their factories back to the U.S., but that process will take years. "In the short term, China is irreplaceable," says Xu Dongsheng, deputy secretary general of the China Household Electrical Appliances Assn.
How has China been able to keep its edge in the face of soaring costs? One factor that's widely overlooked is rising productivity. For the past decade, U.S. manufacturing productivity growth has averaged 4.8%. That's impressive for an industrialized nation, and bodes well for U.S. industry when the economy recovers. But productivity at medium and large Chinese manufacturers—the backbone of country's export boom—has averaged nearly 19% over the same period, says Bart van Ark, chief economist at the Conference Board, a business research group.
While American manufacturers have been tightening their belts, producers in China have been plowing money into bigger and more advanced facilities that are ahead of their U.S. counterparts. Douglas Bartlett, chairman of Bartlett Manufacturing, a Cary (Ill.) maker of high-end circuit boards used in defense and medical systems, doesn't see a big reversal in store. A decade ago the U.S. accounted for one-third of global circuit-board output. Today that's down to 10%, with China making 80%. Chinese boards are still 40% to 50% cheaper than the ones Bartlett makes in the U.S., in part because producers there have superior technology. "When factories went to China, so did the R&D," says Bartlett, who also heads the U.S. Business & Industry Council, a lobbying group for manufacturers. "I can't envision a scenario in which the price gap will drop significantly anytime soon."
Some analysts contend the China Price edge against the U.S. will remain for at least a decade. While the U.S. has become a "midprice" alternative to Western Europe thanks to the plunge in the dollar, says Boston Consulting Group senior partner Harold L. Sirkin, its cost structure in relation to China has changed only marginally. Sirkin points to industrial compressors, which are used to power equipment such as office air-conditioning systems. Three years ago it cost 38% less to make a 1.5-ton compressor in a factory in China than in an American plant. The big driver was Chinese wages and benefits, which were 65% below those in the U.S. Even accounting for rising labor costs in China, the strengthening yuan, and higher shipping rates, Sirkin estimates Chinese-made compressors are still about 30% cheaper. While that puts Mexico within striking distance as a rival site, "this is not enough of a change to bring this production home to America," Sirkin says, "and there is likely no factory and equipment left to come back to."
Expecting the U.S. to recapture industries that have already gone to China may not be realistic. But the new cost equation likely will influence many decisions about where to locate production in the future. America remains the world's biggest manufacturer, after all, because it's still the largest market for everything from drugs and packaged foods to high-end medical equipment. The U.S. may have as good a chance as anyone of being a strong player in nascent industries, whether next-generation wind turbines, medical devices with nano-scale sensors, or electric cars. The challenge will be to persuade reluctant venture capitalists and corporations to invest again in modern U.S. production facilities.
What would be required, for instance, for the U.S. to re-emerge as a player in batteries? It is an industry, after all, on the cusp of radical technological change that could spur development of future eco-friendly vehicles, cell phones, and home appliances. Boston-Power's Lampe-Onnerud has suggestions, but America may not be ready for them. Washington could lend up to $50 million in seed capital to promising startups, for example, and state governments could build industrial parks with low-cost facilities and services that rival those found in China. "If we got state and federal support," she says, "we would team up with others in a heartbeat and grow an industry."
Cargo ships may soon have an incentive to burn lower-sulfur fuel when sailing off the California coast. Port operators will reimburse shippers the price difference between so-called bunker fuel, a viscous distillate used by big vessels, and a more expensive but cleaner-burning alternative, the Los Angeles Times wrote on Mar. 19. The measure, expected to go into effect by July 1, would cut sulfur-oxide air pollution in the L.A. basin by 11%.