Low Labor Wage Issues in Moving Manufacturing Outside of America

26/10/2011

The low wages offered by many countries like China, Mexico, India and others are considered as one of the main reason for the decline of manufacturing in America. I agree that they do have a significant role to play in shifting manufacturing from America to many of these and other low wage countries. However, as discussed earlier this is not the only reason albeit a significant one. Lets take a closer look at these.

Many of my accounting friends may disagree but generally it is difficult to calculate the exact labor cost that goes into the manufacturing cost of a product for our discussion purposes. For example, do we include the cost of product designers and supply chain managers? To simplify the discussion let’s consider just the labor cost accrued within the four walls of a plant. This would include people working on receiving and shipping docks, on machines, testing, quality controls etc as well as the direct plant management like shift supervisers.

From the past experience, I have seen these costs range anywhere from 10% for a highly automated plants like chip making to 30% or so for a high manual content products like making a shirt or a shoe. of course the exact number varies with the products made, skill level of the work force involved, worker productivity and currency exchange rate among other things. For this discussion let’s assume that the range of 10-30% works for most of the products.

There are numerous organizations (like Bureau of Labor Statistics) who collect a lot of data and do a ton of analysis of various cost factors. You can draw a fairly decent picture of various cost scenarios. One thing is for certain that lower the skills required the lower the wages whether it is in US or in China or anywhere else. The salaries for unskilled factory workers could be as low as few hundred dollars per month in countries like India and China. The number is even lower in countries which are further down the economic developemnt ladder.

It is not uncommon to find a labor cost saving in the range of 75-90% for unskilled work force and 40-60% for skilled work force when compared to the salaries in US and other developed countries like Japan and Germany. This is a wide range but then we are talking in general range of numbers and not for a specific situation in a specific country.

So what is the potential for manufacturing cost saving by moving the manufacturing to a low wage location?

For a low complexity, high manual content product like garments, It is conceivable to achieve a manufacturing labor cost saving of approximately 25% (or more). For an average complexity, average manual content product like simple electronic products a saving of 15 to 25% is reasonably achieved. For highly complex, low manual operation manufacturing operations like IC chip the saving can at best be in single digits.

Once again these are fairly general numbers and for a specific product and a country and the manufacturing process involved they could vary tremendously. The numbers above are just what I have observed in the past.

As you can see that for many of the products just the saving in manufacturing labor cost may not be sufficient to move a plant away from US (or to loacte a new one). The risks and added supply chain costs may not justify such an action. There has to be more to this labor cost equation than just the savings from making the final product.

If you look at the savings on manufacturing cost recursively down the bill of material (or the components that make up the product), you can see that labor cost savings could accrue quite nicely if a company could source much of the needed components from the same general geography and reduce the cost of inbound logistics as well. For example consider you are assembling a computer in China, there is a potential for labor cost savings at the final assembly line. However, if you could also source the components like hard drives and mother boards which also have labor cost saving during their manufacturing (or assembly) step, the savings add up quickly.

So, I believe it is not the cost savings, in the manufacturing plant for the final product, alone but the accrued labor cost savings with sourcing and inbound logistics that matters. The total supply chain cost. This is one of the reason why we see many of the manufacturing plants move to China even though many other countries have much lower labor cost and are closer to us geographically.

It is the total manufacturing eco-system that matters!

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  1. 27/10/2011Impact on Inventories in Moving Manufacturing Outside America for Domestic Demand « Mani Agrawal says:

    […] Mani Agrawal Thoughts that keep me awake Skip to content ← Low Labor Wage Issues in Moving Manufacturing Outside of America […]

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