Tariffs and the trade war with China create uncertainty in any supply chain that begins or ends there. Business planning becomes difficult and forecasts become highly speculative. Import duty assumptions in financial models change with every tweet. Sensitivity analyses must illustrate wide ranges to capture the many potential outcomes. So how do business leaders make supply chain decisions involving China? Easy: based on customers.
In August 2019, the Business Roundtable, an association of chief executive officers of America’s leading companies, published a statement on the purpose of the corporation. Mainstream media headlines touted a fundamental shift from solely maximizing shareholder value, but this headline missed the main point which was a commitment to all stakeholders. To summarize the one-page statement signed by 200 CEO’s, corporations are committed to all stakeholders: customers, employees, suppliers, environment and shareholders.
Companies that off-shored production to China in the late 20th century did so in order to maximize shareholder value by reducing costs – primarily reduced piece price due to labor arbitrage. Today the reasons to re-shore are to maximize stakeholder value. Making decisions that maximize stakeholder value will maximize shareholder value. And one stakeholder is the most important when it comes to re-shoring: the customer.
Which came first the customer or the shareholder? The argument is like the chicken and the egg. Some say customer and others say shareholder. Both shareholders and customers are equally important stakeholders – you can’t have one without the other. But when it comes to decisions about reshoring production, customers are the most important stakeholder.
In 1954 Peter Drucker wrote that the purpose of a business was to create a customer, someone who pays for your product. Without a paying customer you do not have a business. People make buying decisions based on their perception of the value your product provides compared to its alternatives. A mathematical way to visualize this customer decision is the equation made popular by Larry Miles: Value is equal to Function divided by Cost (Value=Function/Cost). The higher the quotient the better the value. The numerator in this equation, function, is how well the product meets the customers’ needs. Customers want products their way (customized), the best quality and as soon as possible. How do you supply a high quality, customized product quickly? You manufacture closer to your customer.
Almost a century ago Henry Ford famously declared, “You can have any color car you want as long as it’s black.” Today, customization is the new black. No more make-to-stock; make-to-order is the new norm. Sales and accounting love it because product is destined for a customer before it is manufactured. But manufacturing hates it because of the supply chain complexity. The supply chain challenges are magnified by the length of your supply chain. The longer it is, the longer it takes to produce to customer needs which decreases value.
There’s an old adage in production that says “fast, good or cheap but you can only pick two.” Today customers demand all three. If they do not see it in your product they will move to an alternative. The best way to achieve all three is to design, produce and distribute in the same geographic market as the customers you serve.
The product offering of a consumer product client missed a market-segment-price-point. Initially it was assumed the only way to hit the price point was to produce in China or another low wage country. The management team took a stakeholder approach – what’s good for all stakeholders is good for the shareholders. After prototyping and market testing, the management team designed a product which could be sourced and produced locally. The customer response exceeded volume projections making shareholders happy.
Another client took a shareholder only approach when faced with excess capacity and rising costs. Consolidating volume into one facility appeared like the right decision as fixed costs were going to be spread over a much higher volume. However, little consideration was given to the effect on order-to-delivery lead time which grew considerably as a result of the extended supply chain. The consequence was some customers migrated to competitors which meant no stakeholders were happy.
In the context of the purpose of the corporation, the best way to manage any result is to manage the process. Stakeholders are like the process and shareholders the result. When faced with the decision about where to manufacture, make sure the algorithm includes the total landed cost plus the effects on all stakeholders (customers, employees, suppliers, environment and shareholders), giving customers the highest weighting, to ensure you are creating shareholder value.
Countries don’t lose trade wars; customers do. Countries don’t pay tariffs; customers do. So really, the three reasons to re-shore production from China are: customers, customers and customers.