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Introduction

In the past decade, several trends in the U.S. economy have led policymakers and industry leaders alike to question U.S. international industrial competitiveness. Though the relevant issues can be framed in many contexts, an important underlying concern has been the future of the United States as an industrial power. Can competitive manufacturing still be achieved in the United States or is the future one of low-volume, high-value production with diminishing employment opportunities? At first glance this question may be a sensible one. Two trends, in particular, seem to indicate that the United States has become less attractive as a location for mass market products:

  • U.S. firms have lost market share in industries they once dominated, such as consumer electronics, semiconductors, and automobiles. The corresponding gains in market share by foreign companies have often been attributed to production cost advantages that cannot be matched in the United States (see Figures 1-1 to 1-3).

  • American manufacturers have been steadily locating manufacturing capacity offshore over the past two decades to serve both foreign and domestic markets. Often such moves are made to take advantage of low-cost labor. More recently, however, firms have gone offshore to find skills, technologies, and materials that are either unavailable in the United States or too costly.



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1 Introduction In the past decade, several trends in the U.S. economy have led policymakers and industry leaders alike to question U.S. international industrial competitiveness. Though the relevant issues can be framed in many contexts, an important underlying concern has been the future of the United States as an industrial power. Can competitive manufacturing still be achieved in the United States or is the future one of low-volume, high-value production with diminishing employment opportunities? At first glance this question may be a sensible one. Two trends, in particular, seem to indicate that the United States has become less attractive as a location for mass market products: U.S. firms have lost market share in industries they once dominated, such as consumer electronics, semiconductors, and automobiles. The corresponding gains in market share by foreign companies have often been attributed to production cost advantages that cannot be matched in the United States (see Figures 1-1 to 1-3). American manufacturers have been steadily locating manufacturing capacity offshore over the past two decades to serve both foreign and domestic markets. Often such moves are made to take advantage of low-cost labor. More recently, however, firms have gone offshore to find skills, technologies, and materials that are either unavailable in the United States or too costly.

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Figure 1-1 Foreign penetration in U.S. market: consumer electronics. Source: Department of Commerce, U.S. Industrial Outlook 1986, 1988, 1990, and 1991. Figure 1-2 World production of semiconductors by region. Sources: National Advisory Committee on Semiconductors Report 1991 and Dataquest. The quick conclusion often drawn from these trends is that the United States can no longer host competitive manufacturing: the cost of wages and benefits is too high and U.S. workers are too inflexible (with respect to work rules and production practices) to compete with their foreign counterparts. Given the disturbing implications of such a conclusion, the Committee on Comparative Cost Factors and Structures in Global

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Figure 1-3 Foreign penetration of the U.S. automobile market. Source: Motor Vehicle Manufacturers Association of the United States, Inc., Economic Indicators Report, 1992, p. 12. Manufacturing was formed to examine the relationship between manufacturing costs and global factory site selection decisions and to improve the level of understanding of the evolving environment for international manufacturing competition. Changes in technology, the dynamics of international trade and investment, and continued advances in manufacturing efficiency have altered the cost structures faced by manufacturers and the priorities given to various investment criteria. Although all the activities that comprise the product realization process—design, engineering, purchasing, production, marketing, distribution, and sales—determine the full costs of bringing a product to market, manufacturing costs incurred in the factory are typically what affect decisions to shift production offshore. These costs are, therefore, the focus of the committee's analysis. THE STRATEGIC BUSINESS DECISIONS MODEL Given the complexity of these issues and the multitude of factors affecting factory location decisions, the committee developed a strategic business decisions model (Figure 1-4) as a tool to structure its analysis. The model links site location decisions directly to an overall business goal, broadly defined as maximizing "total business potential." On a continuing basis,

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Figure 1-4 Strategic business decisions model. firms need to make certain strategic and operational decisions to guarantee their longevity and to maximize their total business potential. Although no model can capture all of the factors involved in such decisions, this simplified model highlights the relevant factors generally considered at any given time and how those factors are weighed in different circumstances. For the sake of simplicity, the model starts with the premise that firms seeking to maximize total business potential have two strategic options: they can reduce costs (and so, potentially, increase margins) or expand the business. The emphasis placed on each of these strategies often depends on how the firm's production costs compare to competitors' costs. If the firm's costs are too high, it will not have sufficient margins (at the selling price defined by the market) to expand the business or to meet the many requirements (e.g., product features, performance, variety) imposed by competition. However, if production costs are competitive, that is, low enough to maintain strong margins, the firm has the resources and gains the flexi-

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bility to compete On a basis other than price. Factors such as product quality, features, and availability become key to competitive strategy; product differentiation and penetration of new markets needed to expand the business become more feasible. Essentially, lowering production costs provides the means to be a stronger participant in dynamic, competitive markets. Clearly, this is a simplified model. The two strategies are not mutually exclusive. Firms may reduce costs and expand the business simultaneously, effectively adding more value to existing products while creating new products and markets. In fact, it may be necessary to pursue one strategy to achieve the other. A firm may find it needs to expand the business to reduce costs because of minimum scale requirements. For instance, Digital Equipment Corporation has built external sales of magnetic heads for disk drives because its internal requirements were insufficient to justify the cost of plant and equipment. On the other hand, a firm may find that market pressure to reduce costs leads to greater use of outside suppliers who have lower production costs, resulting in diminished in-house production. For these reasons, these strategic options should not be seen as an either-or approach to maximizing business potential. Firms use a combination of the strategies articulated in the model, often with synergistic effects. It should also be emphasized that a firm's strategy for maximizing total business potential is affected by a large number of variables not reflected in the model. For instance, firms must realize certain margins in order to keep investing in new products, facilities, skills, technologies, and equipment. Margins are determined in part by how low a firm can drive costs, but also by the price that the manufacturer can command for a product. Producers who can realize higher prices for their products may reap the same profits that other producers might achieve by lowering costs. Prices are driven up or down by a wide variety of forces. Downward pressure on price, for example, can be the consequence of an increase in the number of competitors, the introduction of cost-saving manufacturing processes, or a competitor's access to lower-cost inputs (the latter two allowing a producer to lower prices while still achieving acceptable margins). Access to technologies, skills, and processes can help a firm shift its supply curve (effectively

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allowing it to produce the same product at a lower cost or to produce more of the same product at the current cost). On the other hand, the acceptable price of a particular product can be driven up because of its quality, brand, features, or uniqueness. Improvements in these product attributes will affect demand consumers will be willing to pay a higher price if they perceive a product to be of high quality, if it is available, or if it meets their unique needs. Firms that can simultaneously drive down production costs (supply enhancements) while adding value for which customers will pay more (demand enhancements) can radically change the terms of competition in a given market. For example, the arrival of low-cost Japanese automobiles in U.S. markets during the 1970s and 1980s and the subsequent Japanese success in a variety of market segments forced many U.S. manufacturers to pay attention not just to cost (in which the Japanese were more competitive) but also to quality and features (in which the Japanese were also more competitive). The entrance of new competitors who had different cost structures and a different manufacturing philosophy changed—for the entire industry—both the acceptable price an automobile could command and the levels Of quality, features, and availability customers would expect. Similar changes have taken place during the same period in consumer electronics and, more recently, in the semiconductor industry. Despite its simplicity, the strategic business decisions model provides a useful tool for analysis of the factors affecting factory location decisions. Because of the charge to the committee to examine the effects of costs on site selection, the analysis focuses on the decision chain that emerges under “reduce costs,” rather than decisions needed to "expand business." One way to reduce costs is to reduce expenses—the costs of doing business that are not directly associated with production. Examples include marketing, legal expenses, communication systems, insurance, and other overhead functions. Though critical in the overall cost structure of the firm, they do not typically change very much with changes in production location and therefore have not been a focus for the committee. More germane to the committee's analysis is reduction in the manufacturing cost of goods sold (COGS).1 How managers

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Target Costing There are several ways in which a firm can calculate the acceptable cost of manufacturing. Some firms look at costs as a given, which, when subtracted from revenue, will indicate margins. Business strategy then focuses on what is done with the resultant margins. There is another way to deal with costs, however. Target costing, a technique developed by Japanese manufacturers, starts with margins. A firm builds a business strategy on the basis of the margins it will need if it is to make key investments and remain competitive. After deciding what future investment needs will be (in the context of a strategic business plan), a firm looks at the potential product revenue. By subtracting the needed margin from revenue, a firm calculates a "target cost," the cost it must achieve if it is to remain competitive, In this way the business strategy, not the cost structure of production, drives a company to set production goals and product prices in a proactive way. address this objective is profoundly affected by their understanding of what drives production costs. Traditional mass producers tend to define production costs narrowly—managers focus on minimizing input costs defined in narrow accounting terms. Because standard accounting practices allocate indirect costs on the basis of labor content, labor costs tend to be greatly exaggerated as a component of COGS. Consequently, in practice, minimizing input costs has meant minimizing labor costs. The result is that investment decisions have often been put in the context of investing in automation to reduce labor content or moving production offshore to reduce labor costs. Historically, automation has been applied most readily to tasks in which the size, accuracy, or hazardous nature of the operation preclude manual labor—automobile painting, for instance—or to tasks that are so repetitive that boredom affects quality. Broader applications were limited because the flexibility required for effective production was beyond the capability of the technology. Consequently, many assembly operations, particularly those using a variety of small parts such as

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electronics, could be done only by humans. In these cases in which direct labor remains a major cost factor, offshore production continues to be an attractive, and sometimes essential, option. Two developments over the past 10 to 15 years have changed the historical role of automation. First, advances in manufacturing process technology, engineering design, and computer control have rapidly expanded the capabilities and applicability of automation. Products are designed with fewer parts, so they require less assembly; advanced sensors and precision control allow automation of a wider range of manufacturing operations; and increased process flexibility has diminished, though by no means eliminated, the cost and risk of automating the production of products with shorter and shorter market lives. Whether to automate and determining the appropriate level of technology to use remain difficult decisions—factors to consider include the cost of the equipment versus its benefits in terms of improved safety, precision, quality, yields, and volume of production, as well as potential labor cost savings—but the rapid pace of technological progress has certainly made automated production a viable option in an increasing number of cases. Second, increased understanding of the interrelationships throughout the manufacturing system has resulted in greater productivity, tighter control of processes, and a more effective combination of humans and machines on the factory floor. Spurred by Japanese competition, a growing number of firms are treating manufacturing as an integrated system and using new management techniques such as just-in-time inventory systems, total quality management, and concurrent engineering. Their understanding of the drivers of COGS expands dramatically, multiple opportunities to improve existing facilities are recognized—in fact, continuous improvement of the existing manufacturing system becomes the driving force of the total enterprise—and site location decisions for greenfield factories are based on many criteria besides input costs. Firms taking such a broad view of manufacturing recognize the costs associated with poor design, an inflexible development cycle, or a poorly managed production floor. When these firms seek to reduce COGS, they first look at the effec-

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tiveness of their design, engineering, and manufacturing processes in existing facilities for sources of improvement. Decisions to expand or change the location of capacity are based on assessments of the degree of improvement possible and how long it would take to achieve. The decision to establish new production facilities may be intended to accelerate the pace of change as well as to expand capacity. When considering prospective manufacturing locations, they are not looking simply for low-cost production labor, engineers, or materials. They are looking for an environment that will allow them to address all of the drivers of cost—one that allows them to manage an enterprise to maximize product value with the most efficient use of resources. In today's global manufacturing environment, treating manufacturing as an integrated system and applying the full combination of techniques, methodologies, and technologies provides distinct advantages in meeting consumer/market demands. Indeed, the high quality, low-cost, and responsiveness associated with advanced manufacturing practices have actually reshaped the demands and expectations of the market. When traditional mass producers try to compete simply by further compartmentalizing the manufacturing process and maximizing volume, they are responding to new challenges with old tactics. In this situation the traditional mass producer is more likely to make a poor site location decision that translates into noncompetitiveness. REPORT STRUCTURE With the strategic business decisions model providing context, along with the committee's understanding of advances in manufacturing process technologies and manufacturing as an integrated system, the committee examined three industries— consumer electronics, semiconductors, and automobiles—to elucidate trends in production costs and patterns of foreign investment. These three industries were chosen, first, because data were available (though to varying degrees) and, second, because each represents a different experience in offshore manufacturing. Consumer electronics was one of the first and more extensive practitioners of moving abroad to cut labor costs.

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Semiconductors has moved offshore for packaging but otherwise has dispersed to developed countries for market access. Finally, automobiles has, in fact, experienced relatively little movement of production; the major incidence is Japanese producers coming to North America and Europe for market access. The industry studies focus on large corporations because, with their resources and knowledge, they have more options than small firms have regarding where they perform production. Issues of global manufacturing, in fact, may look much different to the small manufacturer. Given the extremely diverse characteristics of small manufacturers, generalizations are inappropriate, but several conditions of the small firm's competitive environment are common enough to note. First, they often are vitally connected directly or indirectly to larger firms as suppliers. Their prosperity, even survival, depends on their ability to adapt to an environment that is constantly being shaped by their larger customers. Second, small firms often do not have the same options as a large firm to adjust to global competition. In many cases their processes are more labor-intensive because they lack the resources to automate and their products may be too diverse to make affordable automation viable. Small firms producing parts and subassemblies, therefore, may be significantly more vulnerable to foreign competitors with low-cost labor, particularly if their large-firm customers base their buys on price. In the context of small firms, "moving offshore" often means losing business to foreign suppliers. On the other hand, small firms face the same issues as large corporations in managing their manufacturing operations for high-quality, responsive, cost-effective output. As suppliers they often have an intrinsic advantage in their proximity to their customers that foreign competitors cannot match. To the extent that moving offshore is less of an option for small firms, the incentive to get their processes in control and to maximize value to their customers should be all the more apparent. In this context the committee's findings regarding what is necessary for competitive production in the United States applies equally to small and large firms. The three industry analyses are intended to chart how certain factors have influenced site location decisions in indus-

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tries where costs, markets, management strategies, and manufacturing processes are changing. To the extent data are available, manufacturing costs in each industry are disaggregated into different components and then linked to site location decisions and manufacturing competitiveness. In particular, the committee has tried to demonstrate how new approaches to driving down costs have significantly changed the criteria that companies use to decide on manufacturing locations. Chapter 5 of this report describes what the committee has learned from its examination of the three industries. Chapter 5 also dispels a number of misconceptions about the strategic role of overseas production, summarizes the attributes that are drawing manufacturers to certain locations, and explains the reasons those attributes are attractive under various conditions. From these observations the committee offers several conclusions about the attractiveness of the United States as a future location for different kinds of competitive manufacturing. Recommendations for appropriate government and industry action also are made. There is a danger in this kind of analysis of letting the assumptions drive the conclusions. The committee's starting point was and is cost, but it is clear that cost is not the sole or even the determining factor in site location decisions or competitiveness. It must be understood that cost data used in the industry analyses serve as a point of departure. Perhaps one of the most important insights that can be drawn from the committee's work is that the more cost data are scrutinized, the clearer it becomes that a strict cost analysis cannot capture all the variables that determine where firms manufacture or how competitively they manufacture. This experience reveals the dangers of taking a limited view of costs or of letting cost analyses drive strategic business decisions. NOTE 1.   COGS reflects a variety of direct and indirect costs required to bring a product to market. It includes direct factory costs (e.g., labor, load, materials, and scrap); transportation costs; duties; and indirect costs and expenses (e.g., depreciation, R&D, and administration).

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