Regionalizing supply chains

WHEN THE HOME PORT CALLS

 

 

 

 

The globalization of supply chains has helped European companies to become more efficient in recent years. But as current crises worsen, the risks are becoming clearer. For this reason, nearshoring is now on the agenda of management meetings at many companies. What are the advantages of nearshoring – and is regionalization worthwhile even with volatile logistics costs?

 

IBM’s employees were so fond of the company that they gave it a pet name: Big Blue. It sounded powerful, sublime and ironically, it also sounded like a blue whale disappearing into the distance. That was the situation at IBM in the early 2000s.

America’s former favorite has since shifted jobs en masse to low-wage countries like India, Brazil and China, stating that IBM was a global company and that labor costs were simply too high in the USA.

 

Offshoring formerly the go-to strategy

At that time, IBM was an extremely controversial example of offshoring, but many other companies soon followed suit. Industry giants like Siemens also relocated jobs and production sites abroad, as did manufacturers in the clothing and toy manufacturing sectors. They all saw Asia or South and Central America as a great opportunity, because ultimately the labor costs were a price advantage, despite additional logistics costs. This led to many companies reducing the amount they produced in Europe or the USA – or relocating their business altogether.

In the years that followed, global supply chains were established in various industries in a number of different countries, and products were sent all around the world before reaching the  end consumer. The system worked well and made good economic sense – for the time being, that is. Because the concept of free trade has been weakening for some years now – economic  tensions between China and the USA, protectionism and new tariffs have created uncertainty on the markets. Since the coronavirus pandemic, the rules of the global game have changed.

In the years that followed, global supply chains were established in various industries.

 

The collapse of supply chains – and the consequences

Logistics costs have risen sharply in recent years. Due to the pandemic, production and vital hubs all over the world – such as ports and airports – ground to a halt, bringing global logistics networks to a standstill. This resulted in enormous cost increases and bottlenecks. There was suddenly one issue being hotly debated in many executive boardrooms: How do we source our products and raw materials for production? As the situation eased, some companies tried to prepare for the future and reduce their reliance on factors outside of their control by keeping as much stock as possible.

 

It was clear though, that alternatives to the global just-in-time approach would need to be found in the medium term, so as to ensure a resilient supply chain. A regional, diversified multi-sourcing strategy allows supply chains to become much more resilient. Discussions then moved on to bringing production back closer to sales markets again, according to executives from 1,500 companies in 15 industrialized countries who were surveyed by BCG in February 2022. Even though nearshoring and reshoring have been in the spotlight for some years now, it was thanks to the pandemic that they suddenly shot to the top of the priority list at many businesses around the world.

So, how do things stand now?

 

 

The many benefits of nearshoring

A good three years after the pandemic, interest has subsided slightly. Logistics costs have temporarily fallen again and the risk of supply chain failures has decreased. Yet the number of early adopters is on the increase: Companies looking to the future, such as fashion giant C&A, have reverted to producing in Germany again after over 20 years; ski specialist Salomon is bringing production of its footwear back to its high-tech factory in France; and IT service providers are suddenly no longer moving to India but to the Algarve in Portugal. The country scores with high quality coupled with low labor costs compared to Northern Europe and has now received so many requests to establish company bases that sometimes they would get the response: “Sorry, we haven’t got any more capacity.”

This is hardly surprising, as there are many advantages of regional supply chains. Nearshoring reduces supply chain risks and increases transparency. If we look at existing and future regulations, which often involve the control of the business’ own suppliers and upstream suppliers being located only a short distance away offers enormous benefits.

Furthermore, there is an increasing focus on sustainability: Are the materials sustainable? Is production sustainable? How can CO2 emissions be reduced?

Thanks to highly automated, state-of-the-art production and shorter supply chains, nearshoring can play a crucial role in the green revolution.

In addition, partially relocating production and developing parallel production capacities close to sales markets can increase flexibility. Especially in the end-customer market, the last few years have shown that volatility is rising sharply. Companies find it difficult to respond to this when delivery by sea takes several weeks.

Relocating often makes economic sense, too. When senior managers calculate the total cost and price in premiums for risk and sustainability, suppliers in Asia are no longer always the cheapest option. To obtain a systematic overview, it’s important to consider the Total Cost of Ownership (TCO). This also includes working capital effects due to excessive inventories as well as the benefits of a shorter time-to-market.

 

 

Advantage for early adopters: benefitting from incentives

Nearshoring requires an initial investment that a company must be willing to make. Although in the medium term, this is worth it from the perspective of risk management, sustainability, and transparency, as it is critical to put plans in place before the next crisis arrives and supply chains grind to a standstill once more.

Early adopters can currently secure advantages such as economic policy incentives. Countries like Portugal, Turkey, and Morocco offer attractive subsidies or other tax advantages. To make a well- informed decision, however, cross-company analyses must be carried out.

Nearshoring Survey 2023 – Regionalization Trend

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Nearshoring: An optimal process might look like this

Companies that consider nearshoring will ideally begin by carrying out an analysis of the current situation, which they can then use to determine the next steps. This could be establishing a second regional supplier, or by giving production as a whole a more regional focus. Both options need to be initiated at C-level and checked against the company’s overall strategy and the supply chain strategy.

Successive conversion of product groups to alternative cash markets

Opportunity & Risk Analysis
  • Structured analysis to identify supplier risk
  • Pre-selection of relevant categories
Market Research & Selection
  • Identification and reseach of relevant nearshoring procurement markets
  • Supplier long- and short list per category
Assessment & Audit
  • Joint definition of evaluation criteria
  • Quality and risk assessment per supplier and category
Sourcing
  • Tender preparation and execution
  • Offer and scenario analysis
  • Negotiations/Auctions
Ramp-Up & Enablement
  • implementing new suppliers
  • e.g. order processing, quality inspection and price verification
Continuous Supplier Management
  • Run process for other categories
  • Selection of categories based on nearshoring potential

Step 1: Analyzing the risks

The first step toward possible regionalization is to carry out a risk analysis. In doing so, it is important to analyze exactly which product groups are suited to a nearshoring process. A comprehensive review of the Total Cost of Ownership is an important part of the evaluation. Alongside the purely product-related costs, this figure should also include the costs for logistics and overheads, e.g. for compliance and administration. In addition, the calculation needs to take risk and sustainability premiums into consideration.

This step should include an overarching review and evaluation of the risks: What are the risks? How likely are they to occur? And what alternatives already exist in the supply chains today that could potentially be developed further? Furthermore trade policy risks and sustainability criteria must also be taken into account. Most companies currently still focus on their immediate suppliers, but not on upstream suppliers. However, this is often where the risks that may become important in the future can occur. Only a comprehensive risk analysis will fully consider this aspect.

As part of checking and evaluating the risks, a structured overview of the entire supplier pool can be created. This then serves as a basis for decision-making.

Checklist

Total Cost of Ownership perspective(TCO)
• Product price incl. cost breakdown and pricing of individual cost components
• Transport prices through
altered supply chains, in part also including transport routes of certain upstream products (Important: Analyze different transport route scenarios to reflect fluctuations in the real world as accurately as possible)
• Overhead costs due to reduced or increased regulation, administration, employee training, product tests, etc.
• Sustainability costs: Reductions in CO2 emissions, potentially on the basis of the current CO2 price
• Risk-related costs: Quantifying default risks

Step 2: Evaluating the alternatives

Once a risk analysis has been carried out, the next step is to look at procurement. This is where you ascertain the location of other potential suppliers. They might be in Eastern Europe for the European sales market, for example, and in Central America for the USA. In both regions, labor costs are still considerably lower. Strategies like friendshoring should be included. This has come to the fore more than ever given Russia’s invasion of Ukraine. Essentially, it is better to choose a trustworthy country with stable political ties and where costs are a little higher rather than be caught off-guard by a political crisis down the road that could have far-reaching consequences for your own company’s supply chain, reputation, and, ultimately, its very existence.

Depending on the industry, increased automation may even open up the possibility of bringing the majority of production to high-wage countries like Germany– as was the case with Gigaset. The office telephone manufacturer has built an ultra-modern facility where virtually everything is done automatically in Bocholt, in the north-west of the country. Kitchen accessories manufacturer Fackelmann has also brought part of its production back to the Franconian countryside.

Including new suppliers in these considerations is just as important as constructing new production sites with trusted suppliers. A parallel infrastructure could be set up with a supplier previously located in Asia. The advantage is that processes and standards are already established and this type of collaboration can strengthen supplier commitment.

Friendshoring

Friendshoring, or “allied shoring” is a new concept originally from the United States that is designed to make supply chains more resilient. Limiting the manufacture and procurement of raw materials and products to friendly nations is a way to avoid supply disruption on account of geopolitical risks, such as China’s zero-Covid policy or the Russian invasion of Ukraine. Friendshoring does entail certain risks, however, including
more expensive production costs and lower economic output. For most companies, it makes more sense to strive for a multi-source strategy with as great a diversity of suppliers as possible.

Step 3: Putting together a pool of suppliers

Complete regionalization will only make sense in a small number of cases, however. Firstly, certain raw materials only occur in particular regions or are mainly mined and processed in those areas. Certain upstream suppliers, too, are mainly located in one area because a cluster has formed there. This shouldn’t be disregarded when planning regionalization, because relocating your own production makes little sense if the majority of raw materials need to come from Asia. Especially with regard to rare earths, a certain dependency on suppliers will be unavoidable, and the West will continue to be dependent on Taiwan for chip and semiconductor production as it will take several decades to build up sufficient production sites of their own. Secondly, a multi-sourcing approach is also the most effective means of spreading supply chain risk.

So, what is the best way forward? The goal is to create a healthy mix of regional, national, and international suppliers. Where regionalization is feasible and makes economic sense, this can be considered. If it makes economic sense to keep part of production in a country close by, e.g. because of very low wages, this can also be a building block in the strategy. For raw materials and primary products that cannot be procured from elsewhere, despite lengthy delivery times and high dependency on one region, the objective should be to create as resilient a supply chain as possible across the continents and to draw up an action plan to implement in case of any disruption.

Step 4: Establishing partnerships

 

Alongside the dependence on certain regions, for raw materials for example, problems can also rise because particular products are simply unavailable in that region. This applies, for example, to textiles or ingredients for cosmetics and pharmaceuticals, where Asian markets dominate. In order to avoid this reliance, it can make sense to build up your own capacities on site.

These types of projects require considerable planning and time, however. For instance, setting up a sole proprietorship in France to produce batteries for electric vehicles would entail significant investment and additional risks. These can be minimized through collaborations and partnerships. Suppliers with whom production facilities have already been set up in other parts of the world can act as partners. Moreover, businesses within the industry should exchange information and check with interest groups whether such projects can be implemented with other companies, so as to share the planning and investment risk.

Step 5: Implementing

Once all of these aspects have been taken into consideration, we move to the final step of implementing the strategy throughout the company. This initially involves integrating the new strategy into individual product groups that then serve as flagship projects in the future. If converting or expanding the supply chain to additional suppliers nearby works well, this can be the starting point for further relocations.

Success must be continually monitored from this point on. In addition to monitoring completely new suppliers in the supply chain, this includes liaising with existing suppliers that have built up new production capacities for their own company, or who want to expand. Since change like this is always associated with risks, it’s important to safeguard the business through control management systems. Firstly, these create transparency and the option to step in should any issues arise during implementation. Secondly, they help to derive learning insights and best practices that can be helpful for future initiatives.

 

 

 

CONCLUSION

Procuring individual product groups regionally – as well as relocating entire production sites – can be an economically logical and strategic decision, depending on the industry, degree of automation, and risk profile. Shortening the supply chain results in a lower risk profile and makes the chain more resilient.

Nearshoring creates a genuine competitive advantage through stricter regulations and increased requirements for decarbonization and sustainability. This has been neglected by many companies up to now, since risk and sustainability premiums are often left out of the Total Cost of Ownership analysis. Early adopters can also benefit from economic and political incentives, meaning they stay one step ahead of impending regulations.

Authors

Patrick Lepperhoff

is a Principal at INVERTO in Cologne. As head of the Supply Chain Management Competence Center, he mainly supports customers from industry and consumer goods production.

patrick.lepperhoff@inverto.com

Jasmin Mikl

is a Project Manager at INVERTO in Vienna. She supports clients across a range of industries in analyzing and optimizing SCM and logistics processes, as well as in drawing up logistics and warehousing strategies.

jasmin.mikl@inverto.com

Experts on nearshoring

Spain and Portugal
Morocco as sourcing market