US vs. China Electronics Manufacturing

How viable is electronics manufacturing in the USA?  Is on-shoring of manufacturing a trend?  US manufacturing and off-shoring became a hot topic during the presidential election and it remains a hot topic, especially with the recent announcement by Foxconn of plans to build the first high volume LCD manufacturing plant in Wisconsin.

In reading various articles on the topic, I’ve noted many misconceptions and oversimplifications, so I thoughts I’d share my perspective based on my experience in electronics manufacturing.  I believe my perspective applies to other industries.

In a nutshell, I believe manufacturing in-source/out-source and location decisions are all too often made based purely on simple financial analysis using well-established quantifiable factors, making false assumptions and/or or neglecting factors that are very important, but difficult or impossible to quantify.  As a result, many poor decisions are made, negatively impacting the lives of many Americans.

Here are the details. I use China as the reference off-shore manufacturing location, but the general analysis applies to other non-US countries, though off course the details vary.

First the well-established factors:

Direct labor:  The China direct labor wage is still less than the US, but the gap has decreased dramatically as US real wages have stagnated over recent years while China’s wages have inflated due to increase competition for labor as a result of economic growth.  The now more modest direct labor cost disadvantage of the US can often be compensated for by investing in more automation, which reduces the direct labor cost per unit, but increases the depreciation per unit.  The increased automation can reduce the cost of poor quality which can offset the added depreciation.

Indirect labor:  The salaries associated with production line supervisors, quality staff, procurement, etc. is considerably higher in the US than China.  This is usually the factor that tilts things in favor of China.  However, what’s often not properly accounted for is the indirect labor costs of US-side management of the off-shore factory whether in-house or contract-manufacturer.  In addition, contract manufacturers are expert ensuring all costs are passed to the contracting company and overcharging is very common, but difficult and costly to police.  Contract manufacturers can allocate the same indirect labor to multiple customers and product types, adapting to variations in demand for each product.  This provides the contract manufacturers some efficiency advantage.

Property, plant and equipment: With globalization and improved market transparency, high quality production equipment costs are generally the same, whether purchased by a, American or Chinese company.  However, in many cases the Chinese government subsidizes property and buildings to aid favored companies.  The difference between US and Chinese government subsidies in certain industries creates a very serious unlevel playing field that certainly has driven huge amounts of production off-shoring and many politicians have been reluctant to acknowledge head-on.  The proposed US Foxconn LCD plant is a rare example of the US playing the same game.

Utilities:  There is relative parity between US and China here, but Chinese government subsidies for low cost water and electricity and lax regulations for waste disposal can changed the balance in many cases.

Raw materials transportation and inventory:  China currently has a big advantage now that much of the US high volume electronics and mechanical part supply base has been hollowed out and moved to China.  The raw material supply chains are short because most parts are produced relatively locally.  Transportation costs and raw material inventory can be kept low.  With well-conceived part packaging, transportation of China-made parts via ocean to the US can be kept reasonably low.  Still, China will have a clear advantage here until higher volume consumer electronic grade PCBA assembly and plastic and metal part production returns to the US.

Finished goods transportation inventory:  The US is often the largest market for higher end electronics and US production provides an advantage here.  The finished good supply chains are shorter in this case and transportation and finished goods inventory is lower in the US production case.

Cost of poor quality:  This cost is very difficult to predict a priori.  In-house production often affords more care about the product, better worker training and better employee retention which translates to lower cost of poor quality.  For products with well-established production equipment and processes, generally the difference between the US and China and in-house vs. out-sourced production is smaller, but this can still be significant and depends heavily on the particulars of the production worker environment and treatment.

Plant utilization factor:  The production plant’s fixed cost is amortized over the number of products produced.  High plant utilization factors minimize the fixed cost allocation per product.  Contract manufacturers can have an advantage here as they have the ability to load their factories with multiple products built for many companies.

Now the less-established, but very important factors that are often ignored because they are hard to quantify:

New product design quality:  It is generally well-understood that when developing a new category product or a product containing significant design and process innovation, there is an advantage in co-locating engineering and manufacturing.  The co-location affords faster prototyping and iterations using real production equipment and processes.  It affords much more flexibility to adapt to product design or quality problems and solutions are developed faster.  However, in most manufacturing strategy discussions, the value of the rapid protoyping and co-location is ignored.   Time-to-market cost differences are ignored.  It is difficult or impossible to estimate (or prove) that the product development schedules for different manufacturing strategies.  It is difficult or impossible to predict the cost of poor quality reduction if there

Engineering to manufacturing transfer costs: travel costs, program management (specification, change negotiation, babysitting costs)

Development time/time to market:  language, training, response time to fix problems,

Intellectual property capture, protection and market stealth:  it’s no secret there are no secrets in China.  Corporate webs, seasonal worker movement, technology diffusion, lack of respect for patents and NDAs

Recommendation:  US manufacturing is ideal for new category products, where there is serious new product and process technology involved and where the market size and adoption rate is difficult or impossible to know prior to production start.  If the capital and expertise are available and the product is very strategic (with expected roadmap), in-house US manufacturing can make a lot of sense.  If plant capital and production expertise are not available, then US contact manufacturing is a valid option especially if the contract manufacturer is reasonably close to the engineering team.  China outsourcing (ODM or CM) is ideal for products where there relatively little process innovation (e.g. PCB in a box, where software or service, for example, is the differentiator) and the market is predictable and sizeable.  Majority-owned China manufacturing is an option if you have the capital, China experience, time, and are confident of high plant utilization.

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