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(originally published by Booz & Company)


Relocate? Transform? Which Option Is Right?

How to make smart decisions that will maximize manufacturing efficiencies.

A few companies in the West have stubbornly and successfully refused to bow to competition from low-cost countries. One example is an industrial materials producer in Europe, which was facing an onslaught of competition from cheap Korean and Chinese imports. Instead of simply assuming it was overmatched, the company refocused its product portfolio so that its customer base would be only the leaders in their sectors — in other words, manufacturers that were interested in product quality and willing to pay a premium for it.

To make its prices more competitive, the industrial materials producer installed new continuous production technology in its European plants and outsourced a small number of technical and engineering operations to the East. In addition, the company took an aggressive stance against predatory pricing by suing its Korean and Chinese competitors for dumping in European markets.

It was a risky strategy, but it worked. Since beginning its campaign against its Eastern rivals, the industrial materials producer has been more than holding its own in Europe. And although it is likely that in time the company will have to shift some operations to the East to continue to meet customer price demands, when it does so, it will be in the advantageous and uncommon position of being able to operate thriving plants in both the West and low-cost nations.

The industrial materials producer is a distinct exception, however. Today, it is hard to imagine a strategic manufacturing agenda that does not have offshoring and outsourcing to low-cost nations as its primary components. The opportunity to leverage the favorable labor costs that low-cost countries offer is simply too enticing to pass up, especially when the low labor costs are so near Western markets (for example, Eastern Europe’s proximity to the more developed part of the continent).

As a result, since 2001 there have been significant increases in capital investment inflows into Asia and Eastern Europe. (See Exhibit 1.) These capital investments typically seek the lowest-cost manufacturing environments and ultimately reject regions that rise above this standard. Take Eastern and Central Europe, for instance. Although both areas are experiencing GDP and export growth on par with India and China — the paradigmatic low-cost nations — the standard of living in Central European countries (particularly the new European Union member states) has increased along with prosperity, making these countries less desirable for foreign investments than their lagging neighbors in Eastern Europe.

But in the headlong rush to take advantage of lower costs, many companies underestimate the hidden potential of improving productivity in Western brownfield locations as well as the risks and complexity associated with offshoring. And they overestimate the promise of manufacturing in low-cost countries. Moreover, businesses often believe incorrectly that they have no strategic choices except those two opposing possibilities. But between the extremes of brownfield transformation and relocation lies a world of options, a territory that only a few creative companies have explored. For most others, these intermediate strategies remain uncharted terrain.

Offshoring May Not Be a Panacea
Booz Allen Hamilton believes that when economic trends seem to support relocation, it is often only because companies are treating short-term expense reduction as the sole consideration. However, by taking this view, organizations fail to assess the effects of relocation on their long-term strategic objectives, and the potentially high costs involved. For example, many companies outsource portions of their production to low-cost nations because they believe it will help them save money and get a leg up on rivals. But in doing this, they may overlook the risks of creating future market adversaries, which before long could seriously weaken their competitive position around the world.

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