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HVAC Industry Reversing Faulty Outsourcing Strategies

Posted February 19, 2014 9:00 AM by larhere

In 1982 I got my first real exposure to "Globalization" and "Outsourcing" when I was named team leader of a Technology Transfer project to manufacture unitary air conditioners and hermetic recipricating compressors in two Chinese factories on the outskirts of Shanghai. The reason for going to China was the right one - to Serve the Chinese Market.

The project was a moderate success depending on who you talked to and what criteria you used. Financially, not great. Strategically, a successful first step.

Today, we are seeing a growing reverse-trend of reshoring some of this manufacturing capacity back to the US - because it was/is over there for the wrong reasons. The HVAC industry is not the only one doing such backtracking as Apple, GE, Ford, Cat and a growing list of others acknowledge their mistakes (as well as the changes that have taken place over time).

Some companies promote these activities widely as being patriotic and saving American jobs; others quietly analyze their decision making processes trying to figure out how they got there anyway. The short answer - misguided worship at the altar of low costs. Nothing wrong with this admirable goal, if one truly looks at allcosts holistically and objectively.

This did not occur rigorously as manufacturers tripped over each other trying to get "deals" done and factories churning out their products using labor costs that were just pennies on the dollar. Due diligence studies were performed addressing currency risks, inventory and shipping costs, cultural differences, travel expense increases, etc which placed a negligible offset to all those fantastic cost reductions about to be harvested in labor savings.

So, here we are today with factories across the developing world turning out products of widely varying success. Those factories building your products in their countries for their markets are typically the most successful. Those building "low cost" products and shipping them back to your country, among the least profitable. Why? because the "low costs" have failed to include a litany of hidden costs and inefficiencies, and changes that occur over time.

Energy costs have risen dramatically around the world making transportation costs sky-rocket. One exception is in the U.S. where shale gas and oil brought about lower transportation and lower manufacturing costs.

Did we really understand the increased travel costs and inefficiencies in communicating and traveling between our factory in China and our R & D facility in the states? Is that plane ticket more expensive now? Did we recognize the travel timeas a component in our cost calculations?

And then there is this issue of quality. Harder and more expensive than we expected.

We can add in the increased expenses of protecting and defending our technologies.

And those low labor costs? Escalating at +20% per year it does not take a lot of years to eat up those earlier advantages. And why didn't anyone tell me about differences in worker productivity levels and rates of productivity growth between U.S. and developing countries? With labor averaging 10% of total product cost the gains are disappearing.

Other "minor" issues such as political instability, major disaster (preparedness), etc. just never seem to come at the right time.
...and the logistics...the distance between component/material suppliers and your factory and your U.S. markets - did you ever hear of the slow boat from China? They just don't make fast ones and "ouch" again on costs if we have to air transport. Even when using a factory in Mexico US companies are seeing border delays of two or more days. Allinternational transport has faced increased border delays due to drug traffic and terrorism threats.

But the distance factor has been adding another one of those difficult to calculate costs I'll just label as Innovation Loss - those which occur when R & D is not located near the factory - a known detriment to rapid discovery and implementation of new ideas and cost reductions.

And the other half of the distance factor is the distance between the factory and the customer. Close is good. You hear the customer much better when he is nearby. He visits your factory. There is a relationship. He has confidence in you. You understand him better. He buys your products.

HVAC Industry Reaction

So what is the HVAC industry doing about reshoring? Well, most are doing it quietly, not wanting to shed light on earlier decisions that may or may not have had all the thought they should have. Smaller companies such as AirGuide in Mississippi got tired of a 75 day delay between order placement and receipt of delivery from their China source. They brought it home.

GE is building a water heater plant in the US to bring production back from China. Webster Valve is building a new 30,000 ft2 plant in New Hampshire which will bring 100 jobs home from China. HessAir Products is bringing production of their fan blades back home to Alabama. These companies and many more are cashing in on the wave of nationalism across the US. But, the trend and the driving factors behind it gain further credibility with the plans by Gree, one of China's largest manufacturers of HVAC products, planning to construct a plant in the US to manufacture air conditioners for the North American market by the end of this year. It is unlikely they are chasing low labor costs to the US. They understand the importance of being close to the customer.

According to a 2012 study by BCG "seven key industries in which the rising costs of producing in China would make it more economical to shift to the United States the manufacture of goods consumed in the United States...include....

  • Appliances and electrical equipment including refrigerators and dishwashers
  • Systems and small appliances such as microwaves
  • Computers and electronics
  • Heavy machinery including air conditioning and heating systems,..."

In Summary,

  • Do you really know the performance of your outsourcing strategy?
  • Do you effectively account for all the costs?
  • Is your "China" factory focused on serving the China market requirements?
  • Are risks carefully evaluated?
  • What opportunities await the reshoring leaders?
  • Do you have the leadership and resources to be a reshoring leader?

For more on this topic read the report Reshoring US Manufacturing: A Wave of the Present by BusinessClimate.com.

Editor's Note: CR4 would like to thank Larry Butz, President of GEA Consulting, for contributing this blog entry.

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#1

Re: HVAC Industry Reversing Faulty Outsourcing Strategies

02/20/2014 11:35 PM

...the tide goes OUT, then the tide comes IN...

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...and the Devil said: "...yes, but it's a DRY heat..!"
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