Product characteristics, such as weight and mode of transport, determine transportation costs. Most goods move around the world in 40-foot-long shipping containers that hold a maximum of 40,000 pounds. The containers can be transferred seamlessly between ships, trains, and trucks. Shipping a container across the Pacific Ocean costs about $4,000, depending on the ports used. Transportation by truck from the West Coast to the Midwest could add another $2,000. (Air freight is far more costly than other transport methods and is rarely used except for high-value products, such as small electronics components.)
How does a company factor transportation costs into its global footprint decision? Companies can’t afford to ship products long distances when transportation costs significantly increase the product’s total cost. Although item size is important, a key consideration is the cost of transport relative to the value of the product: It’s clearly much easier to justify shipping costs for an $80,000 Mercedes-Benz than it is for a $20,000 Chrysler. Shipping a $100 microwave oven is an entirely different decision.
One way to calculate the relative significance of transportation costs in an offshoring decision is to use a metric we call revenue per product pound (RPP). Now, RPP might seem like an overly simplistic measure. How can one compare a computer wafer with, say, a hunk of steel? But these are exactly the kinds of measures that should be considered by operations strategists to assess the impact of logistics on global sourcing decisions.
Consider Intel’s range of products. Its Pentium chip sells for several hundred dollars, but weighs only a few ounces; Intel’s motherboard assemblies weigh far more than a chip but cost less per unit. Based on the data available, we estimate that Intel garners around $1,000 in revenue per product pound of goods produced across its range of products. With such a high RPP, transportation costs are less critical in Intel’s global footprint decisions.
Compare that with U.S. steel producer Ispat Inland Inc., the former Inland Steel Industries, which produces flat-rolled steel. Although price varies with the grade and overall demand for steel, flat-rolled steel typically sells for $400 to $500 per ton, or well under a dollar of RPP. Transportation costs are significantly greater in the overall “delivered cost” of steel than they are in the cost of chips and motherboards. Despite high U.S. labor costs, Ispat Inland has good justification for locating plants near its stateside customer base so it can lower its transportation costs.
Even when transportation costs are not a major factor, offshoring may still be inappropriate because of the relative costs of capital and labor, a measure known as capital intensity. As we have already noted, the savings from low-wage laborers can be largely irrelevant for highly capital-intensive businesses.
A simple way to understand capital intensity is to look at the ratio of sales to assets (one form of this, DuPont Analysis, was used by Alfred P. Sloan in the 1920s to run the General Motors Corporation). Our version of the ratio compares sales to net fixed assets, or the amount invested in property, plant, and equipment to generate those sales. The ratio can be deduced from a publicly reported company’s income statement and balance sheet.
A look at the consumer electronics industry’s value chain helps clarify the role capital intensity plays in determining global location decisions. Intel generates less than $2 of sales per year for every $1 of net fixed assets on its books, due to the size of the capital investment required to stay competitive in semiconductor manufacturing. Ispat, by contrast, has less need to invest in rapidly improving process technologies. Whereas the speed and power of computer chips is continually increasing, changes in steel manufacturing occur far more slowly. But because the cumulative capital investment in the mature steel industry rivals that of semiconductor manufacturing, Ispat also generates less than $2 of sales annually for each $1 of net fixed assets on its books.