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Is The South Losing Its Edge?

Thu, 09/22/2011 - 4:11am
Joel Hans, Managing Editor, Manufacturing.net

The current economy is tough on manufacturers. Between high unemployment rates, fewer skilled workers to fill high-tech positions,Joel Hans disasters in Japan that wreak both human and supply chain damage, and more, American manufacturers are always seeking ways to reduce their in-plant costs, and in turn, help boost their bottom line. At times, the financial situation becomes dire enough that these companies begin to look at moving to states that promise reduced tax rates or incentive packages to move work. Traditionally, this movement has been toward the American South, which has long been the “promised land” of less expensive manufacturing. 

The trend has been coined “rural-sourcing,” and has been legitimized, in a way, by the likes of Honda and Hyundai, both of which have enormously successfully, and very large, manufacturing facilities in Alabama and Georgia, respectively. Proponents of the trend say a move southward can prevent outsourcing to Asia while still reducing costs enough to stay viable.  

Certainly one of the most popular manufacturers from Manufacturing.net’s home state of Wisconsin is Harley-Davidson, who has repeatedly threatened to close its Milwaukee-area assembly plant. Early reports recognized Missouri, Tennessee, and Kentucky as possible candidates for a new facility, but at this point, it appears the threats were a little “tough love” for its Milwaukee employees. 

In our volatile economic climate, however, no single trend can remain dominant for too long. New economic data from the American Institute for Economic Research suggests the West or the Northeast -- not the South -- are among the cheapest places for a manufacturing facility. How did this happen? 

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If we look at what is generally perceived as the most important factor in a move such as the one Harley-Davidson was considering -- labor costs -- it’s clear that the South is still winning. The man responsible for this survey data, Lei Chen, a research fellow with the American Institute for Economic Research (AIER), says, “There is no denying that wage rates in southern states are generally lower. Firms in labor-intensive industries may have incentive to locate/move their production facilities to the South to take advantage of the low wage rate.”

The problem for the South, however, is that labor costs are actually a very small component in a much larger equation. Chen says that the wages for production amount to, on average, only 10 percent of total production costs, while input materials add up to a colossal 70 percent. Clearly, the most significant factor in this data is not labor costs, as varied as they might be between states like Wisconsin and Kentucky. More likely than not, labor rates won’t actually swing the total cost equation in the South’s favor. 

What is the South doing wrong, then? 

Chen says it’s all about productivity and efficiency. His data looks at profit margins, which, of course, are the function of the total revenue minus the total production costs -- labor included. And the South seems do be losing in this regard. Chen suggests that in states with higher input costs -- essentially any non-South state -- worker productivity must rise in order to compensate. Oftentimes, the productivity of these workers will overcome higher input costs, which allows the company to operate profitably. Chen says, “It’s very possible that firms in a high-cost state would do better than their counterparts in a low-cost state, because the former have to be more efficient in order to remain competitive in the market.”

Chen also says, “It seems like manufacturing firms in Mississippi in general were lacking in managerial employees and didn’t utilize energy and material very well.”

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Clearly, this data moves in opposition to the common-sense rule that has been in place among rural-sourcing’s advocates. For a company like Harley-Davidson, it might just be enough to convince them that a move isn’t in the company’s best financial interest. If they moved work down to a plant in Kentucky, the labor would likely be non-union, unlike Milwaukee. This would help Harley save money in the short-term, and might even provide some kind of foreseeable ROI. 

Here’s where productivity and efficiency come back into play. Assuming an equal labor force in Milwaukee and Kentucky, doing equal amounts of work in a 40-hour work week, Harley would come out ahead in paychecks to those Southern employees. But the moment they see a precipitous decline in productivity compared to their old plant floor staff, they’ll start losing out. Unless managers are able to wring precisely the same amount of productivity out of a new set of workers -- a monumental task, to say the least -- they might lose on at any potential ROI. 

Chen suggests that manufacturing companies located in the West or Northwest, in particular, shouldn’t be so quick to consider moves to another state. They already have productive labor, and other costs -- such as energy usage and input costs -- could be accomplished by a re-engineering of the supply chain. 

What about a company in the South, who might be looking at more cost-efficient state in order to decrease costs? Should they move to a place like Oregon? That is a little more complicated.

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To illustrate this scenario, Chen imagines a manufacturing company in the least cost-effective state according to his data: Mississippi. If this company wants so move to a more cost-effective state, they certainly could, but the expenses involved in making such a transition -- from capital purchases to dealing with the labor force -- would likely overshadow any gains in the short-term. In other words, the return-on-investment would be a number of years out -- perhaps even a decade. What are they to do, then?

Chen would be quick to remind these companies that his data is the combination of two figures: unit costs due to the price in inputs, for example, and production cost-efficiencies. So if a company cannot move to a less costly state, Chen says they should streamline their input costs. Chen says: “The DEA result shows, to make Mississippi 100 percent cost efficient, it should reduce employment of production workers by 4.8 percent, capital by 4.5 percent, energy use by 66.7 percent, material use by 40 percent, but increase employment of non-production workers by 108.3 percent.”

Clearly, energy usage is a problem for the average manufacturer in the South, and it appears their supply chains need to be reconfigured in an effort to bring down prices. Simple solutions, such as reducing energy consumption through more efficient LED/fluorescent light bulbs, for example, or a new HVAC system, could provide substantial ROI for both the piece of equipment, and overall costs. On the supplier side, manufacturers can do more to consolidate their relationships or seek out more value-added services that some suppliers bundle with their goods.

Either way, the newest economic data suggests that the South can no longer rest on the assumption that their lower costs of living and wage rates will alone be able to entice manufacturers from the rest of the country.

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In general, the absolute rule for any manufacturer is that any significant movement -- whether relocating to a different state or simply attempting to increase in-plant efficiency -- needs to be fully vetted with an analysis of the total cost. Chen’s data shows that currently, places like Oregon, New York, Massachusetts, and Connecticut are among the cheapest when it comes to manufacturing. Manufacturers in those states should breathe easy for a moment, and then dive back into their continuous improvement initiatives to preemptively counteract any swings in this data.

Those in the South, on the other hand, need to take a serious look at their relative inefficiency.  There’s no doubt that a large amount of companies in the South are extraordinarily well-managed, and have already embarked on a number of sustainability programs, or implemented Lean in their facilities, or have been practicing continuous improvement for years. But it appears, by parsing the data, that some of their cost-effectiveness has been outweighed by excess.

The West- and Northeast-based manufacturers have been struggling through the opposite problem: Their excess was previously outweighed by their effectiveness as manufacturers. Instead of taking this news as a dig against manufacturing in the South, more should be hunkering down and looking for new ways to make their region the next best place to house a manufacturing facility. Chen says, “My guess would be it will shift back to the old pattern, given that this pattern hadn’t changed much in the past.” If nothing else, the South should be looking for more ways to expedite that process.

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The original survey release can be found here, and more information on the economics behind the data, and the AIER, can be found on their website.

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