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Digital
Article
Economics
Bringing Manufacturing
Back to the U.S. Is Easier
Said Than Done
What will it take to reverse a decades-long shift to global supply
chains? by Willy C. Shih
This document is authorized for use only by Phuong Nguyen in Global Business Economics and Trade Fall 2023 taught by Katalin Marton, Fordham University from Aug 2023 to Dec 2023.
For the exclusive use of P. Nguyen, 2023.
HBR / Digital Article / Bringing Manufacturing Back to the U.S. Is Easier Said Than Done
…
Bringing Manufacturing Back
to the U.S. Is Easier Said Than
Done
What will it take to reverse a decades-long shift to global supply chains?
by Willy C. Shih
Published on HBR.org / April 15, 2020 / Reprint H05KD3
Bloomberg Creative Photos/Getty Images
The Covid-19 pandemic has raised a critical question: Why does the
United States not have the capacity to manufacture many products
for which there is a sudden urgent need — everything from critical
care ventilators, N95 face masks, and personal protective equipment
to everyday items like over-the-counter pain relievers? Of course, the
United States is still a manufacturing powerhouse in many sectors, but
it surprises many people that a huge number of everyday basic items
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have to be imported. The current pandemic-related shortages have
fueled calls from political leaders of both parties for U.S. manufacturers
to start producing critical supplies domestically. And long before the
pandemic, President Trump was pushing U.S. companies to bring back
production from overseas.
The issue is complex and defies easy solutions. The challenge lies in
a combination of how modern supply networks are structured and
the operational metrics applied to manufacturers. Taken together,
the United States and other advanced industrial economies have
evolved a highly efficient and productive product manufacturing-anddelivery system that provides them with a cornucopia of products at
relatively low costs. But inherent in that system are dependencies and
expectations that the pandemic has called into question.
Modern products require high degrees of specialization.
The days are long gone when a single vertically-integrated
manufacturer like Ford or General Motors could design and
manufacture all or most of the subassemblies and components it needs
to make a finished product. Technology is just too complicated, and
it is impossible to possess all the skills that are necessary in just
one place. Consequently, manufacturers have turned to specialists and
subcontractors who narrowly focus on just one area — and even those
specialists have to rely on many others. And just as the world has
come to rely on different regions for natural resources like iron ore or
lithium metal, so too has it become dependent on regions where these
specialists reside.
Even something as simple as an energy-efficient desk lamp has
sophisticated components like LED lights that are made in high-tech
factories. Devices like smartphones, medical equipment, and precision
instruments contain components whose design and manufacture
require a great deal of specialization. The design and manufacture
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…
of modern microcircuits involves sophisticated tools, and the people
using them need considerable training and experience to operate them
successfully.
The dependence on specialists is clear if we look at a typical notebook
computer. Companies like Dell and HP rely on a handful of Taiwanese
original design manufacturers to do the assembly work, but those
assemblers, in turn, depend on multiple subsystem manufacturers.
For example, the display is made up of a number of components. At its
heart is a thin-film transistor liquid crystal display (TFT-LCD) panel,
which is mated with a backlight assembly and bezel. The TFT-LCD
panels are made by a handful of Asian manufacturers in large, capitalintensive factories — the most recent of these cost more than $6 billion
each to build and equip. These panel makers, in turn, are dependent
on others who supply essential raw materials such as optically flat
glass sheets, polarizing films, flexible circuit connectors, display driver
chips, and a host of other inputs. The display driver chips are made in
semiconductor factories (“fabs”) spread around the world.
Other key subsystems require similarly narrow skill sets. The memory
chips are made predominantly by three global specialists in their multibillion-dollar fabs, and the hard drives by two firms with factories in
Thailand, Malaysia, and China. The microprocessor is generally made
by either Intel or AMD. Intel produces chips in the United States and
other locations, but sends them to Asia to be packaged. AMD has them
made in Taiwan.
The long-term trend towards specialization in most fields is increasing
because of the very different technological skills and capabilities
demanded of firms working on the leading edge. Whether you are
making computers, food ingredients, or personal care products, this
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division of labor helps firms incorporate new technologies and do so
more economically than ever before. Specialists are also able to exploit
scale economies both in production and design, making it harder for
firms who might wish to become self-sufficient to perform those tasks
economically.
The end result is that we have many suppliers scattered around the
world upon whom manufacturers depend for critical components.
Electronic product companies are heavily dependent on suppliers
across Asia (primarily China, South Korea, and Japan). Those
relying on industrial enzymes might have to turn to Denmark.
Indian pharmaceutical makers rely on Chinese suppliers of active
pharmaceutical ingredients. Many manufacturers have to rely on
precision toolmakers in Germany, Switzerland, or northern Italy or
robot makers in Germany or Japan.
A consequence of these complex interdependencies is a deep tiering
of supply chains, with manufacturers dependent on their first-tier
suppliers, which, in turn, are dependent on a second tier, which
are themselves dependent on a third tier, and so on. Visibility into
third, fourth, and more distant tiers is challenging, making wholesale
replacement of anyone in the chain, let alone the entire chain,
extremely difficult.
Thus, while it might seem appealing for President Trump to invoke the
Defense Production Act and force automakers to pivot to manufacturing
medical ventilators, it is very difficult for them to ramp up production if
key components like pressure sensors or valves are made by an offshore
specialist. Even something as simple as an N95 mask made in the
United States by 3M uses (according to the label on the box) “globally
sourced materials.”
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Scaling up production requires unique skills.
A manufacturer not only has to source all of the components of
a product, it also has to scale up production. This task is often
taken for granted, but it is part of the really hard work of taking a
product to market. The process includes setting up the supply chain
for all of the raw materials, designing an assembly process with the
appropriate tooling and fixtures, building or securing test equipment,
establishing testing and quality procedures, and working through
materials handling, staffing, and countless other details.
While there are many firms in the United States that know how to put
products into production, their number is much lower than what it used
to be. That is because the job of taking a product into manufacturing
has increasingly turned into one of sourcing from offshore producers.
One manufacturer that had offshored a lot of its production told
me, “Operations management leadership has turned into procurement
leadership.” Increasingly, the job has been to specify the product for
an offshore original-design manufacturer or to transfer the work to
a contract manufacturer. In an emergency, when a U.S. company
suddenly needs to scale up, the skills are hard to find.
Manufacturers want to maximize utilization of plant and equipment.
One of the characteristics of modern manufacturing operations is a keen
focus on operational efficiency. Factory managers might track a number
of key performance indicators, all of which motivate them to size their
operations with minimal surplus capacity.
Overall equipment effectiveness (OEE) is the percentage of time that
a factory is truly productive. A score of 100% means that you are
producing 100% good parts (no defects) as fast as possible and are
never stopping production. In practice, most production lines schedule
downtime for preventive maintenance or changeovers, so scores of
85% are considered good. But given their focus on OEE, managers are
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reluctant to install excess capacity. That means they size a factory to
handle the expected demand, with some surge capacity but not a lot of
excess capacity.
Capital efficiency — how much capital you have deployed in your
business — is another thing that is important to shareholders and
Wall Street analysts. Nobody wants to pay for idle or underutilized
capacity, and in sectors where the capital expenditures for plant and
equipment are extraordinarily high (think semiconductors, flat panel
displays, automotive assembly, materials processing), investors applaud
the outsourcing or offshoring to someone who is willing to invest or to a
geography where they can receive subsidies.
Another approach taken by many product companies is subcontracting
production work. They might retain a base load of work internally and
turn to contract manufacturers or outsourced manufacturing service
providers for variable capacity or seasonal needs. This way they can
keep their own plants fully loaded. The contracted suppliers, in turn,
use demand pooling across multiple clients to smooth out their own
workload and try to maximize capacity utilization, which is how
they can achieve lower operating costs. But product companies are
increasingly expecting their contractors to operate dedicated factories
just for them, taking away the demand pooling benefit and forcing those
contractors to keep capacity tight. This deprives the overall ecosystem
of production flexibility when there is a sudden need.
The desire to avoid capital investments also leads to risk aversion to
investing in new manufacturing technologies. I worked with a company
that was supplying quantum dot backlighting technology for LCD flatpanel displays. Manufacturers were insistent that any new technologies
had to fit into their existing capital-intensive workflows. I also heard a
leader of a U.S. Department of Energy R&D group worry about how the
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extensive battery-manufacturing infrastructure in China had moved so
effectively down the cost curve that it made it difficult for a potentially
superior new technology from several MIT spinoffs to compete let alone
raise the capital for a new production facility. The problem for the
United States is exacerbated by countries like China that subsidize the
construction and equipping of new production facilities.
The rise of lean production and its “inventory is evil” principle.
When Toyota first designed its Toyota Production System (TPS) in the
decades following World War II, one influence was the company’s lack
of resources to compete with well-capitalized large automakers in the
United States. Its TPS lean production system was truly a revolution
in manufacturing and was predicated on minimal inventory that was
pulled quickly from suppliers located nearby. It has been replicated
around the world in many different industrial sectors.
Efficient transport logistics have lulled major companies into building
globally distributed, lean production systems. Pronouncements by
industry leaders like Apple’s Tim Cook that inventory is “fundamentally
evil” reflect the prevailing view that inventory along the supply chain
not only risks obsolescence, it represents cash that is tied up that
could be used for better purposes. So as companies have moved from
a “Toyota City” model with suppliers clustered in a tight geographical
area to supply chains that span the globe connected by dependable and
predictable logistics links, firms have continued to squeeze inventory
out of their supply chains whenever and wherever possible.
The end result is when we experience a supply shock or sudden
disruption in raw materials, components, or whole product supply,
there is little buffer inventory around to absorb that shock. When Indian
drug manufacturers started running short of active pharmaceutical
ingredients manufactured in China, the Indian government responded
both by offering to fly materials in and restricting exports of finished
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products. It would have made more sense to carry six months of buffer
inventory in a strategic stockpile.
The relentless drive to reduce costs.
Leaders of product companies go to their plant managers or their
outsource manufacturing providers every year and ask for “greater
productivity,” which is another way of saying, “I want it cheaper.” Many
procurement managers are measured on how much productivity they
can deliver every year, and their bonuses are tied to it.
These pressures lead to a race to the bottom in production costs
in which product companies have minimal incentives to maintain
production locations in high-cost locations or to worry about geographic
diversity in production. And that behavior is encouraged by consumers
and business end users. If an N95 mask sitting on a rack at Home Depot
that is made in China looks equivalent to an adjacent higher-priced
one made in the United States, consumers typically opt for the lessexpensive one.
Many managers consider the global pandemic to be a “black swan”
event, one which occurs so rarely that we can’t really price it or factor it
into our thinking on production systems. Few are willing to pay the cost
premiums that diversifying sources of supplies or carrying more safety
inventory would entail. So when we have a supply shock or demand
spike like we are currently experiencing, the surge capacity isn’t there.
But the current pandemic is not the only black swan event of the last 15
years. Arguably there have been several — including the 2008 financial
crisis, the 2011 Tohoku East Japan earthquake and tsunami, the flooding
in Thailand, and the U.S.–China trade war. The trade war got some firms
to relocate some of their production out of China, but movement has
been slow, and supplier risk is still largely undiversified.
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Never Waste a Good Crisis
The pandemic has been and will continue to be a major shock to global
supply chains and sourcing strategies. It is as if we suddenly lowered the
level of the ocean and exposed all kinds of risks and obstructions that
were previously hidden from view. Managers should use the unfolding
disruptions to assess their supply strategies and initiate actions that will
improve their resilience in the future. Some steps to consider include:
Plan to diversify sources for critical components and materials.
This might include geographic diversification, either partnering with
the same supplier or using second sources where economically feasible.
As an example, Taiwan Semiconductor Manufacturing Company has
spread its most important fabs across three science parks in Taiwan.
Intel uses multiple fabs across the United States, Ireland, and Israel
to produce its microprocessors. Many manufacturers are wary of the
expense of duplicate tooling and the challenges in balancing production
workloads across multiple sites, but they may wish to reconsider as
more weak links are exposed.
Where diversification is not possible, reconsider what levels of
safety stock or strategic inventory reserves are appropriate. Raw
materials or intermediate goods that are earlier in the value chain are
less costly to carry, and it may make sense to have larger reserves on
hand. If it will take time to replace lost capacity, larger inventories of
finished goods could make sense. Novo Nordisk, who makes a large
percentage of the world’s supply of insulin at its facility in Kalundborg,
Denmark, maintains a five-year inventory to supply critical needs in the
event of disruption.
Examine logistics bottlenecks and plan alternatives. The current
crisis is wreaking havoc with container shipping and air cargo and
now is spreading to domestic trucking. To safeguard themselves against
such disruptions, companies either need to have suppliers closer to
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their production locations and markets where products are consumed,
or they need to understand where critical bottlenecks exist in their
logistics systems and develop back-up plans.
Reconsider capacity-planning strategies for strategic commodities
like medical supplies. This will likely have to be in collaboration
with national governments, which may be willing to subsidize extra
capacity by making purchases for a national stockpile. Alternatively, a
government might subsidize surge capacity via something like the U.S.
Department of Defense’s Trusted Foundry Program or Civil Reserve Air
Fleet program.
The pandemic and trade wars together highlight the brittleness of our
global supply chains and trading system. Managers should heed the
lessons and build more resiliency into their operations.
This article was originally published online on April 15, 2020.
Willy C. Shih is a Baker Foundation Professor of Management
Practice at Harvard Business School.
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