Outsourcing manufacturing in foreign countries has been a common business practice in the US since the 1980s. US corporations located plants internationally or sourced products from overseas suppliers that offered the best price and quality.
People have become very comfortable with global supply chains. Everybody benefited: emerging economies got new jobs, US customers got lower product prices, and corporations managed their capital needs to become “asset light.”
The result is that major manufacturing industries migrated, leaving stores like Walmart with practically all imported products and pharmacies stocked with imported pharmaceuticals.
At the same time, companies investing in capital-intensive manufacturing did not get much respect in financial markets. For example, in the 1990s the public markets cheered when Jack Welch transformed General Electric, once a great manufacturing company, into a quasi-bank. GE became for some years one of the highest-valued companies by selling financial services.
It is also noteworthy that five of the most valuable US public companies do not manufacture anything: Amazon, Apple, Google, Microsoft and Facebook. (Apple outsources internationally all of its production.)
It takes a global crisis to change risk perception. Now global supply chains are deemed very risky and there is growing interest in increasing domestic manufacturing. We address here some hurdles facing such a process on a large scale.
Building competitive large-scale domestic production of migrated industries faces some major hurdles because many migrated manufacturing industries have become solidly entrenched overseas, making for low cost and quality production. Domestic plants will therefore face competitive issues.
Some history will be helpful. First to migrate, attracted by much lower labor costs, were the garment industries that relied largely on hand labor. Then followed the more mechanized parts of the industry as production equipment improved.
I recall a conversation with a former owner of a large hosiery company. His factory in South Carolina used to employ a thousand workers and his customers included Walmart and Target. To meet foreign competition, he invested heavily in automation with the best equipment in the world.
But the price pressure from his big customers continued, and he eventually reached his limits on cost-cutting. Losing money, he was forced to think of closing the business.
He chose an alternative: shipping his factory equipment to China and forming a joint venture there with a regional state-owned company. The JV partner (majority owner) provided capital for the move and training the workforce, and it benefited from a variety of financial incentives.
He makes little money from the business now but feels that this was a better choice for him than just walking away from the business.
Overseas manufacturing now includes even the most sophisticated industries, such as pharmaceuticals and electronics. Consider the consumer-electronics industry. A good early (1970s) example of migration is that of RCA, which was a leading producer of TV and other consumer electronics products.
The management of RCA was under attack by strong Japanese competitors that continued to reduce prices. As a result, the decision was made in the mid-1970s to phase out the Indianapolis factory and move to Mexico, which offered attractive facilities, a good low-cost workforce, and engineering talent locally trained. The move also removed the impact of the labor union on production practices. This was the start.
Today, all consumer electronics are produced outside the US at all levels of sophistication. Since the RCA move, the industry was transformed by flat-panel technology (invented at RCA Laboratories) that replaced vacuum-tube displays. Asian countries including Japan invested in this technology, which now generates hundreds of millions of dollars annually. South Korea is now the leading supplier of flat-panel displays in the world. Its production plants are highly sophisticated and incorporate proprietary production technology.
The degree of technological sophistication increased over time. For example, the growth of the consumer-electronics industry in South Korea led to the emergence of Samsung as a major chip manufacturer replacing products that were originally sourced from the US. And similarly, Taiwan and China produce an increasing volume of chips that replace imported products.
While Intel is still among the technology leaders, Taiwan Semiconductor Manufacturing Company (TSMC) and South Korea’s Samsung are in the same league. Regarding the semiconductor industry, the US has a large number of companies designing chips but the production is largely overseas because there are no domestic production facilities that provide (like TSMC) highest-quality production under contract.
The above discussion concerns electronics, but a similar discussion of other mass-production industries, such as pharmaceuticals, would lead to a similar conclusion, that very robust competitive barriers exist to companies entering large-scale production – unless they are plants moving to the US from overseas.
In public discussions of increasing domestic production in the US, the difficulty of direct competition is commonly overlooked because the technological complexity of modern manufacturing is not appreciated. This is not to say that such difficulties cannot be overcome with innovation, but this is neither a rapid nor an inexpensive process. We have historical examples of such efforts being very successful – for example in World War II, when US industries mobilized in record time. But it took a wartime national program.
We do have a current example of innovative mass-production success: Tesla and other companies started by a remarkable entrepreneur, Elon Musk, that include outstanding electric cars produced in (high cost) California as well as innovative reusable rockets.
But there are also examples of failed initiatives. The recent program to protect a new US solar-panel manufacturing industry in the face of foreign competition that decreased prices. Stiff tariffs were imposed, but to no avail. No domestic manufacturer could compete as imported prices were below domestic costs because they had no technological edge – head-to-head competition failed. That lesson is clear.
It is fair to conclude that large-scale US production would have to leverage innovative practices and large capital investments. The talent can be found. If important manufacturing industries make a comeback it will be because such industries will be innovative, be profitable, and justify the capital invested.
Dr Henry Kressel is a technologist, inventor and long-term Warburg Pincus private equity investor. Among his technological achievements is the pioneering of the modern semiconductor laser device that enables modern communications systems. He is the author, with N Winarsky, of If You Want to Change the World: A Guide to Creating, Building and Sustaining Breakthrough Ventures (Harvard Business Press, 2015).