By Johan Beukema and Maurice Kuipers
From the May / June 2023 Issue
Geopolitical tensions, war in Ukraine, high inflation, labor market pressures, natural disasters, and other unexpected disruptions are driving companies to plan for a future in which uncertainty has become the new normal. The Volatile, Uncertain, Complex, and Ambiguous (VUCA) world that we live in must be taken into account in companies’ overall business strategy development and therefore also in the resulting manufacturing footprint and location strategies.
In this article we give our insight, based on our own global practice in working with companies in optimizing their manufacturing footprints and selecting new locations, in how this results in different decisions than before.
External Factors Driving Change
External factors that drive change in manufacturing footprints are numerous. Four prominent reasons for companies to adapt their footprint are changing regional risk profiles, increasing regional cost profiles, access to resources, and more stringent corporate social responsibility requirements.
Regional risk profiles. Geopolitical tensions with disruptive consequences for manufacturing footprints are currently clearly displayed by the Russia-Ukraine war. Supply chains to and from Russia are impacted because of heavy international sanctions. Ukraine is a war zone allowing almost no trade flows. A second geopolitical conflict, maybe with even more economic impact in the long term, is the U.S. – China trade war. In first instance the main goal for the U.S. was to reduce the bilateral trade deficit. This was followed soon by restricting high tech exports to China to keep the upper hand as the leading tech nation. U.S. allies and trade partners got involved as well. A recent example is the restriction for Dutch chip making equipment company ASML in exporting its most advanced machines to China. Meanwhile, changing environmental risks come as a result of global warming. Some regions experience more regular floodings and extreme weather conditions.
Regional cost profiles. In mature Western economies, but even more so in upcoming regions, costs have increased sharply. Take for example the Central and Eastern European countries Poland and the Czech Republic with year-on-year labor cost increases at around 10%. Or Mexico with an annual labor cost increase of up to 20% in manufacturing jobs. In China the average labor cost increases at a slower rate (around 5%), but strong economic regions like Shanghai are now for certain types of job profiles already on par, or even more expensive than many Western European and U.S. regions.
Access to resources. All over the world our partners and clients report that labor markets are tight, raw materials scarce, and access to energy not always guaranteed. China for example is struggling with an aging population, but also worker preferences are changing: the new middle class wants to work in an office, not in a factory.
As a result of the COVID-19 lockdowns supply chains were disrupted, and many raw materials and semi-finished products became scarce and (very) expensive. The markets are recovering from that, but now the main concern is about who controls the raw material sources. In the battery industry for example Europe is dependent on mainly China, India, and African countries. Especially hard felt in Europe are rising energy costs because of limited supply now that Russia is no longer is a major supplier of natural gas. New sources need to be found until the energy transition has progressed significantly. An example is the liquefied natural gas (LNG) imported from the U.S. and the Middle East.
Corporate social responsibility. The fourth fast changing external change factor we bring forward is corporate social responsibility. Bound by the Paris Agreement, countries aim to reduce carbon emissions significantly. The EU for example has already pledged to reduce CO2 emissions by 55% until 2030 (compared to 1990). In another field, the EU is a front runner. On January 5, 2023, the Corporate Sustainability Reporting Directive (CSRD) became effective. This new directive strengthens the rules concerning the social and environmental information that companies have to report. The first companies will have to apply the new rules in the 2024 financial year, for reports published in 2025.
Drivers & Strategies: The Changing Environment
We see companies developing and implementing different footprint strategies in order to prepare themselves for dealing with continued uncertainty in the future. Below we look into three potential strategies in more detail:
- Strategy 1: Decentralization of the manufacturing footprint
- Strategy 2: Friend-shoring
- Strategy 3: Decarbonization of the footprint
The decentralization strategy focuses on regionalization, dual sourcing, and/or reshoring. The main goal is the same: reduce risk by putting your eggs in multiple baskets. Having more plants with similar competencies provides companies backup capacity. Reshoring means less exposure to geopolitical tensions, and dual sourcing increases raw material independence.
Friend-shoring is mainly applied by companies that have operations in China (and nowadays Russia). In the period after the Cold War came to an end (and before the current trade war started), location strategies were aimed at finding the best fitting business environment. There were (almost) no regions where geopolitical circumstances were so hostile that landing a new operation was not an option. Nowadays, Western companies face more hostile circumstances in several geographies. Given all developments that are ongoing at a global geopolitical level, decoupling of value chains from China is gearing up. This will encourage companies to consider alternative locations for new investments, after US tech companies like Apple, Amazon and Google already moved significant operations from China to e.g. Vietnam and India. (Editor’s Note: See The Last Word from this issue for more on this topic.)
A strategy to cope with the CO2 emission reduction requirements is to decarbonize the manufacturing footprint. We have not yet seen companies that indicate CO2 reduction as the principal driver for changing a manufacturing footprint. But in more and more projects for clients, assessing the carbon footprint is an integral part of the wider analysis that leads to an alternative manufacturing footprint. In the years ahead, this may become the norm.
Manufacturing Footprint Strategies
The table below looks at how different manufacturing footprint strategies are used to address external factors. In our daily practice, companies indicate the regional risk profile, regional cost profile, and access to resources are strong drivers for adjusting location strategy. Although corporate social responsibility (CSR) is not (yet) seen as a strong enough driver in its own, it does play a role in final decision-making. The table below highlights these four fast changing external factors and indicates which strategy may be used to address them.
Impact On Location Decisions
In adapting to a fast-changing world, companies choose different manufacturing footprint strategies. Whatever solution is chosen, selecting the right location is key: In which regional labor markets do you find the talent you need? Where do you find sufficient supply of energy, and should it be renewable energy? Which countries offer a stable and welcoming environment?