Michael Barbella , Managing Editor06.02.15
It seemed like a good idea at the time.
In 2002, China’s rise as an economic powerhouse was well underway, with the sovereign state finally gaining admission to the World Trade Organization (WTO) after 15 years of ardent lobbying. The long-coveted prize also came with a sweet signing bonus from the United States government: permanent normalized trade relations—a historic (and controversial) decision that likely helped advanced globalization.
China’s integration into the worldwide trading system was a godsend for U.S. companies, offering them a rare opportunity to escape the seesawing economy of their own developed market and start anew in unconquered territory. The Middle Kingdom beckoned American and European firms with the promise of low wages, stable politics, improved infrastructure, higher profits, and the capacity to produce goods on a global scale.
Western corporations scampered east in droves, eager to flee the fiscal fallout from a burst Internet stock market bubble. Ostensibly overnight, China became the default choice for offshore manufacturing; many companies made the move blindly, without seriously considering other countries.
“You went to China because it was just so cheap you couldn’t help it,” Harold Sirkin, a senior partner at Boston Consulting Group, noted.
Rhythmlink International LLC certainly couldn’t resist the temptation. The Columbia, S.C.-based medical device developer jumped aboard the Chinese bandwagon fairly early in the exodus, establishing a manufacturing facility in the Communist nation for its electroencephalography, polysomnography, nerve conduction, critical care unit and ambulatory medical devices. But growing labor and cost of living increases in China over the last several years has prompted the company to bring its manufacturing capabilities back home.
“After careful analysis, it made sense to take some of our production processes out of our facility in China and move them closer to home,” said Michael O’Leary, Rhythmlink’s chief operating officer. “We looked at Costa Rica, Mexico, Puerto Rico and even a couple of other states. After working with and receiving support from our partners at the State of South Carolina, Richland County and Capital Bank, in the end it was less expensive and clearly more practical to invest in automation for a new packaging line right here in our own facility in Columbia. As Rhythmlink continues to grow, we keep looking for ways to stay competitive.”
Rhythmlink is one of a growing number of companies that are finding a competitive edge in their own backyards. Rising production costs and increasing competition for talent as well as intellectual property risks and dwindling government incentives are reducing China’s appeal for export-oriented manufacturers and compelling many companies to explore nearshore locations closer to their customers or even repatriate production to low-cost regions in their homeland.
Though it is still a highly desirable offshoring destination, China no longer is the most practical choice for controlling costs and growing profits. Nearshoring has become significantly more prevalent in the medtech industry of late as companies attempt to reduce their supply chain risk and streamline operating costs. To better assess the trends and market forces driving nearshoring in the sector, Medical Product Outsourcing spoke to several device manufacturing professionals and consultants over the last few weeks. They included:
MPO: Nearshoring has become a buzzword in the medtech industry over the last few years. Is this becoming a trend? If so, why?
Dave Busch: Offshoring is the transfer of a product or process produced or provided from a location offshore of the end-market-region for which the product or process is destined—e.g., manufacturing ultrasound devices in the China for the U.S. market. The primary reasons for doing so include lower labor and lower material costs. “Nearshoring” is the transfer of products or processes produced or provided from a location far from the end market to a location near to the end market—e.g., manufacturing medication management systems in Mexico for the U.S. market. Over the past five years, medical device manufacturers have moved devices destined for North American and European end markets from manufacturing centers in Asia to locations nearer to the product’s end market. There are three primary reasons for this trend. The first reason is reduced cycles of learning, which is a key driver in product innovation. The second factor is reduced supply chain risks—risks ranging from events in the physical supply chain such as tsunamis and port closures to more abstract risks such as IP (intellectual property) security. And the third is lower total landed cost (TLC). It is now less costly to source, build and fulfill products nearer to the destined end market than to source, build and fulfill from regions remote to the end market even if that region has lower labor costs.
Jim Carnall: I’m not sure trend is the right word. I think it’s becoming more popular and I think the reason why is that people moved a lot of manufacturing offshore, especially to China. At that point, it was trendy—if you wanted to be doing business you’d be doing business with China because of the low-cost labor. So, a lot of things moved to China—some probably for the right reasons, some probably because it was a trend, and contract manufacturers (CMs) thought they had to. But I think things are changing now. Product is moving back—including possibly some product that never should have left. I believe part of the reason for this is because the labor rates have certainly gone up in China over the last 10 years. We’re finding our operation in Nicaragua, which is nearshore, competitive with China when looking at the total cost. What you get from nearshoring is a much shorter supply chain.
For example, in our operation we get dock to dock shipments in an average of seven to eight days, whereas getting product from China may take seven to eight weeks or more. Those are a couple of the reasons I think nearshoring is gaining momentum
Eduardo Saavedra: There is no doubt that companies that set up a manufacturing footprint in China 10, 15 or 20 years ago as a means to lower costs for goods that were ultimately consumed in North America, have and still are evaluating the option of nearshoring some or all of their production to North America, which includes Mexico. The steadily rising cost of labor in China is the main reason but reasons also include the difficulty in solving manufacturing and supply chain problems from a long distance and long lead times for delivery. And while this “evaluation” is taking place, I would not categorize it a major trend because moving certain types of manufacturing operations is often a costly, disruptive, complicated, and long process.
MPO: Have emerging markets (BRICs) fallen out of favor with manufacturers? If so, why?
Carnall: I think you’re going to still see people offshoring but I think it will involve more of the suitable products and for more of the right reasons than for some of the reasons people went in the past. I don’t think offshoring is going to go away by any means. It will continue to be attractive to people who have products where there’s a large volume and high labor. It’s very good for products that don’t have a lot of variety, where you’re making the same thing over and over and over in a large volume. That lends itself to lower transportation costs because of a long supply chain. In those countries—using China as an example—growth will continue. But I think you’ll see some products that shouldn’t have gone there—those that don’t fall into the high-volume, high-labor, no-variety category—coming back to the area, maybe even coming back to the United States. The things that won’t come back are electronics like cell phones, computer parts and other items that are being made in the same world region they plan to be distributed in. Command Medical has some of our products going into Shanghai [China] out of our Nicaragua facility. When you have labor that can compete more locally, you don’t have the long supply chain to the United States, which is where the larger manufacturers still reside. There’s just no reason to take it to China, and there’s a reason to bring some product back that you went chasing the labor for. In my opinion, you really can’t chase labor rates anymore. I think Costa Rica might be a good example of that. It was trendy for people to locate into Costa Rica for low labor rates and a location that is relatively close like Nicaragua, but then the big companies like Intel went in there and drove labor rates up. So then you get a lot of turnover and you lose some of the advantages of being there in the first place.
Saavedra: There isn’t a market in the world that is resilient to the effects of supply and demand. Each of the BRIC countries however have different reasons for loosing competitiveness which include government and trade policies that ultimately either add a compliance burden and/or cost or the more obvious increase in labor costs as a result of rapid growth. In some markets, even in China, certain skills are not easy to come by and the educational system is either not prepared or can’t keep up with the demand for higher-skilled labor.
Busch: Other than China, none of the BRICS (Brazil, Russia, India, China, South Africa) ever became a major offshoring manufacturing center. This is primarily due to the fact that of the BRICS, only China met the two objectives for offshoring. Generally, you pick locations to manufacture because they have great manufacturing capabilities you can use and/or they are a good end market for the product. China is both a great market for most products and it has great manufacturing capability. Brazil has a pretty good manufacturing capability—not like China but pretty good in different industries for different products—but it’s not a great end market. Romania is a great manufacturing center but there’s not much of a market there. There are many countries with great manufacturing capabilities but they are not good end markets.
MPO: Why are device manufacturers attracted to nearshoring? What advantages does it hold for companies?
Saavedra: Staying close to the ultimate consumer has always been and still is an advantage. It has taken many companies years to validate the comparative advantage of proximity to market versus lower manufacturing costs and in the case of commodity items where there is lots of competition and low profit margins, the cost advantage may still prevail. This is where Mexico provides the best of both worlds. The proximity of Mexico to the United States and Canada is especially advantageous when not only the ultimate consumer but the supply chain is located near the manufacturing site; and for medical device firms whose supply chains are still largely located in the United States and Canada.
Carnall: There are many advantages to nearshoring. For example, if you’re going to Costa Rica, you have the short supply chain, you still have a relatively low cost and you have a fairly skilled workforce, from what I understand. The other thing I haven’t mentioned yet that plays in here is language—Costa Rica, Nicaragua and other Central American countries are Spanish-speaking countries. In the United States, we have a lot of Spanish-speaking people or bilingual people, so communicating with those locations is easier than finding people or talking with people that speak Chinese. So, in general, I think proximity, labor rates, language and skilled labor are some of the advantages. We’ve found that people in Central America are reasonably educated. Any time you go into another country, whether it be China, India or Brazil, you have to deal with cultural differences and I think that gets compounded when you’re dealing with not only cultural differences but distance and the language as well. Trying to get through cultural differences from a long distance with language issues makes it more difficult. I’m sure that’s not specific to the medtech industry but it certainly heavily impacts medtech where not only are manufacturers focused on quality manufacturing, there is a high level or specificity meeting regulatory and compliance requirements.
Busch: Nearshoring is gaining over offshoring because offshore locations are not fulfilling the two objectives of offshoring —lower-cost manufacturing and good end market. Nearshoring fulfills the two objectives with the added advantage of fulfilling a third objective. So, it offers labor and material costs comparable to offshoring with the added benefit of accelerating innovation, protecting IP and lower TLCs.
MPO: Are there any disadvantages associated with nearshoring? How can companies overcome these challenges?
Carnall: I think the only disadvantage is the cultural differences that may exist. And it’s not really a big disadvantage. It’s a disadvantage as opposed to keeping it in the United States, but it’s not necessarily a disadvantage if you’re talking vs. offshore. If you’re doing something in the United States, the disadvantage of moving it to a nearshore site—even if you’re talking about Mexico—is that you do have some cultural differences and you may have some language differences. I think those would be the challenges. Here is an example of what I mean about cultural differences: In some countries that are less economically developed, their culture is to try to use and save everything. But in a medical device business, that’s not always the case. Let’s say you drop something on the floor. Well with a Developing World culture mind-set, you would not throw that away, you’d clean it up and use it again. In the medical device industry you can’t do that. That’s what I mean about cultural differences—you have to educate people to understand that yes, you are trying to the right thing but in the medical device industry that may be unacceptable.
Busch: Because nearshoring’s benefits are primarily due to proximity to the product’s intended end market, there are a limited number of sites to choose from, which is beneficial from a supply-base perspective. There is a greater concentration of suppliers, but this will typically lead to increased labor costs as the supply of labor close to the manufacturing center tightens as manufacturers and supplier compete for resources, a disadvantage compared to offshoring for lower-cost labor. Being close by gets factored into total landed cost. For instance, Tijuana [Mexico] has become possibly the leading medical device manufacturing center in the world because of its easy access to U.S.-market in general and proximity to the growing southern California medical device market. Deliveries to regional distribution centers in San Diego/Orange County can be made several times a day. If you have a site in Guadalajara, you’re two days away from the border by truck, and you’ve lost the proximity competitive advantage. Your shipping costs are not equal to China but they’re not cheap like they are in Tijuana. Proximity is what drives nearshoring, not just a move to another offshoring site that is just as far away but may be in a different country. The cost drivers are what we’ve discussed; distribution and logistics as well as opportunity-lost-costs and supply chain risks. You also avoid what I call “parts tourism”—flying parts all over the world to assemble them in different places and then ship them back to where the parts came from. Nearshoring helps reduce this cost.
Saavedra: The biggest challenge is overcoming the fear of the unknown or the unfamiliar. While there are regions of Mexico with plentiful labor, the specific skills required by a manufacturer may need to be developed by the manufacture. As the technology content of a manufactured good increase so does the need for qualified engineers and the understanding and adherence to industry specific quality standards and practices. The U.S. Food and Drug Administration can also play a role certifying certain manufacturing sites and processes. While large multinational companies may have more experience opening operations in foreign countries, smaller companies may be intimidated unless they form alliances and receive reliable advise and support from bona fide service providers that are well established in places like Mexico.
MPO: What nearshore markets are particularly popular with medical device companies? What attracts firms to these markets?
Saavedra: Mexico and Costa Rica have been popular host countries for medtech manufacturing operations. Mexico has a slightly lower labor cost structure and 25 times the population of Costa Rica and is of course adjacent to the United States where freight can travel over the road or by air at relatively lower costs. Cost Rica however has a relatively well-educated workforce and the Costa Rican government has removed barriers to entry and is an effective facilitator to foreign companies.
Busch: Tijuana is particularly attractive to medical device companies whose products are destined to the U.S. market, where the majority of medical devices are consumed, because of its proximity to the U.S. border, large pool of labor with medical device manufacturing experience and a robust localized supply base. Romania, Hungry, Poland, Czech Republic are all good near-shoring to Europe locations. In Asia, China is now outsourcing to Vietnam, from cars to crops. The Chinese are building plants in Vietnam, so Vietnam is a nearshore example to China.
Carnall: We’ve been in Nicaragua for eight to nine years. My understanding is that David Slick, our current CEO, and his due diligence team looked at different countries—they looked at Mexico, the Dominican Republic, Costa Rica, etc. I think part of the reason why they didn’t choose a country like Mexico is because of the high turnover rate. The violence didn’t exist back then like it does now. In medical devices, you want to have a low turnover rate because it’s important that people understand what they’re doing and how to do it. They looked at the Dominican Republic, which would have been good, but the infrastructure there at that time wasn’t it is today or what we needed. In Nicaragua, we are in a government free trade zone right by the airport, so while the country may have some rolling blackouts from time to time, the free trade zone is hooked up to the airport, which gets auxiliary power. We always joke somewhat seriously, somewhat facetiously with our power suppliers here in the United States that the power in our Developing World country is more reliable than the power we see here sometimes. That’s not far from the truth. Those are the reasons we went to Nicaragua. If you look today, the same thing might apply to Mexico, and the Dominican Republic might look a little better. We wouldn’t go to Costa Rica because our labor rates are significantly lower and we don’t have the competition in Nicaragua that we would have in Costa Rica from other CMs and for attracting educated labor talent. People move around a lot in Costa Rica from what I’m hearing. If we had to choose now, I don’t think we’d go there, but the advantage of Costa Rica to a lot of companies is almost the opposite of what I said.
MPO: How can companies determine the best nearshore market for their needs?
Busch: Run an optimization model that determines the lowest TLC based on labor, material, transport and regulatory costs. That includes the cost of the product, which is comprised of labor, materials and overhead, plus all the shipping, freight, duties, taxes, licenses, scrap, loss in transit and such. The optimization model will vary by product and the product’s end markets And risks associated with the product. Heavy devices such as medication management systems or in-vitro diagnostics devices lend themselves to being built closer to their end market. High-volume products like blood glucose meters might be better built in an offshore location. You can also use a mixed mode model where you make lower-risk, smaller—less expensive to ship—parts of the product such as printed circuit boards in Asia because it’s a lot less expensive and they can be air freighted—and do the final assembly in Mexico.
Carnall: There probably isn’t a one-size fits all. But in general you are going to look at labor rates, and supply of labor—are there people there that are capable of doing what you need to do in enough volume depending on how many people you need? We are in Managua, Nicaragua, which has 2 million people, so there’s plenty of potential labor. You have to look at political stability. Some people look at Nicaragua as not a good place because of the Sandinistas and the 1980s volatility. The opposite is true. The government and economic business development team have been nothing but supportive. Command is the poster child of what they envision as ideal growth in the manufacturing sector because it’s mostly textiles there right now. I think they [Sandinistas] would like to develop a high-tech business sector in their country, so they’ve been very supportive. I also think the Sandinistas and Daniel Ortega learned some things from the first time around—that you need to leave the businesses alone, let them do their thing because that’s good for the country and good for him [Ortega]. Labor rates are important as is distance and your supply chain. It’s nice to get your product in a week. I think you have to look at turnover too. Both Mexico and Costa Rica have turnover issues; you have to look at power supply, and language as well. We have a lot of people down there [Nicaragua] that speak English and a lot of people up here that speak Spanish so being able to communicate with your nearshore site is important.
Saavedra: They need to start by obtaining and compiling the right questions to ask. The best advice is given by the companies that operate successfully in the nearshore market and while governments and consultants have information to impart, there is no substitute for information from those have manufacturing staff on their payroll, who pay rent, and who interact day to day with logistics, utilities and compliance entities in those countries. Often, the driver is a combination of skills sets required and proximity to either the end customer and/or the supply chain. Proximity to sterilization capabilities and capacity can also be a challenge. The site selection process will reveal that labor characteristics could vary significantly within just a few miles. We also recommend that companies not automatically assume that rapidly growing cities within nearshore markets for manufacturing will be the optimum place 15-20 years down the road; and carefully evaluate the value that tier-two and tier-three cities can offer.
MPO: Is nearshoring a passing trend—will the pendulum swing back to emerging markets again—or is it a viable (lasting) way for device manufacturers to reduce costs?
Saavedra: As supply chains develop throughout the important manufacturing venues of the world, nearshoring will likely pass and companies will develop manufacturing footprints that are close to their customers and suppliers and perhaps less due to labor cost. The one trend that will continue is manufacturing automation, which may put more emphasis on finding venues with energy provision that is lower in cost and of higher efficiency.
Carnall: Good question. I think it’s going to be lasting. Early on in the conversation I said people moved things for the wrong reasons to China and other areas, and I think people have learned to be more discriminating as to what moves and why. I also mentioned earlier that it’s hard to chase labor rates because of how quickly it changes. Costa Rica is a good example of that. I don’t think you’re going to go back the other way. I think things will be going where they should be going, for lack of a better way of putting it, and then they’ll stay there for those reasons. When I said people moved things for the wrong reasons, what I mean is I think offshoring was really the trendy thing to do at the time. Everybody was thinking, “Oh, you have to go to China because you can’t compete unless you go to China.” And some people moved product that didn’t meet the criteria—the high-labor content, the large volume, the non-complex product, devices that do not contain sensitive IP. They tried to move manufacturing that was a little more complex, that had a little more variety to it, and they might have moved items that didn’t lend themselves to leveraging the advantages. So, it was the trendy thing to do and some people jumped on that bandwagon that shouldn’t have. Now, having done that, companies are reassessing what manufacturing site offers the best solution based on more than just straight production costs. Global sourcing managers are putting models together that capture all aspects of conducting business inclusive of risk, IP confidentiality, continuity planning, ease of doing business as well as quality and product cost. This puts nearshore contract manufactures like Command Medical in a great position to offer low cost production while also meeting the other needs and wants of prospective clients.
Busch: Companies should evaluate a country not only on its manufacturing capabilities but on the country’s attractiveness as a market. Management consulting firms have built complex models taking into account the different variables—political stability, currency stability, etc. As I’ve said, Vietnam is a good manufacturing country but its end market is small. As companies design and build in region, for region, offshore plants in China and other offshore countries will switch from building products for export, to building products for local region consumption.
In 2002, China’s rise as an economic powerhouse was well underway, with the sovereign state finally gaining admission to the World Trade Organization (WTO) after 15 years of ardent lobbying. The long-coveted prize also came with a sweet signing bonus from the United States government: permanent normalized trade relations—a historic (and controversial) decision that likely helped advanced globalization.
China’s integration into the worldwide trading system was a godsend for U.S. companies, offering them a rare opportunity to escape the seesawing economy of their own developed market and start anew in unconquered territory. The Middle Kingdom beckoned American and European firms with the promise of low wages, stable politics, improved infrastructure, higher profits, and the capacity to produce goods on a global scale.
Western corporations scampered east in droves, eager to flee the fiscal fallout from a burst Internet stock market bubble. Ostensibly overnight, China became the default choice for offshore manufacturing; many companies made the move blindly, without seriously considering other countries.
“You went to China because it was just so cheap you couldn’t help it,” Harold Sirkin, a senior partner at Boston Consulting Group, noted.
Rhythmlink International LLC certainly couldn’t resist the temptation. The Columbia, S.C.-based medical device developer jumped aboard the Chinese bandwagon fairly early in the exodus, establishing a manufacturing facility in the Communist nation for its electroencephalography, polysomnography, nerve conduction, critical care unit and ambulatory medical devices. But growing labor and cost of living increases in China over the last several years has prompted the company to bring its manufacturing capabilities back home.
“After careful analysis, it made sense to take some of our production processes out of our facility in China and move them closer to home,” said Michael O’Leary, Rhythmlink’s chief operating officer. “We looked at Costa Rica, Mexico, Puerto Rico and even a couple of other states. After working with and receiving support from our partners at the State of South Carolina, Richland County and Capital Bank, in the end it was less expensive and clearly more practical to invest in automation for a new packaging line right here in our own facility in Columbia. As Rhythmlink continues to grow, we keep looking for ways to stay competitive.”
Rhythmlink is one of a growing number of companies that are finding a competitive edge in their own backyards. Rising production costs and increasing competition for talent as well as intellectual property risks and dwindling government incentives are reducing China’s appeal for export-oriented manufacturers and compelling many companies to explore nearshore locations closer to their customers or even repatriate production to low-cost regions in their homeland.
Though it is still a highly desirable offshoring destination, China no longer is the most practical choice for controlling costs and growing profits. Nearshoring has become significantly more prevalent in the medtech industry of late as companies attempt to reduce their supply chain risk and streamline operating costs. To better assess the trends and market forces driving nearshoring in the sector, Medical Product Outsourcing spoke to several device manufacturing professionals and consultants over the last few weeks. They included:
- Dave Busch, vice president of corporate development at OnCore Manufacturing Services LLC, a Fremont, Calif.-based provider of product commercialization services for low-medium volume, high-complexity products to international blue-chip medical, industrial, defense and aerospace firms. The company has manufacturing facilities in Springfield and Wilmington, Mass.; Longmont, Colo.; San Marcos and Fremont, Calif.; Suzhou, China; and Tijuana, Mexico.
- Jim Carnall, president and chief operating officer at Command Medical Products Inc., a privately held contract manufacturer that serves customers from its 56,000-square-foot headquarters in Ormond Beach, Fla., and a 30,000-square-foot plant in Managua, Nicaragua. The company opened its nearshore location in September 2005.
- Eduardo R. Saavedra, executive vice president of business development for The Offshore Group, a Tucson, Ariz., company that provides nearshore solutions for manufacturers looking to expand into Mexico. More than 58 companies currently leverage The Offshore Group’s infrastructure, knowledge and expertise, resulting in the employment of more than 16,400 people in the United States and Mexico.
MPO: Nearshoring has become a buzzword in the medtech industry over the last few years. Is this becoming a trend? If so, why?
Dave Busch: Offshoring is the transfer of a product or process produced or provided from a location offshore of the end-market-region for which the product or process is destined—e.g., manufacturing ultrasound devices in the China for the U.S. market. The primary reasons for doing so include lower labor and lower material costs. “Nearshoring” is the transfer of products or processes produced or provided from a location far from the end market to a location near to the end market—e.g., manufacturing medication management systems in Mexico for the U.S. market. Over the past five years, medical device manufacturers have moved devices destined for North American and European end markets from manufacturing centers in Asia to locations nearer to the product’s end market. There are three primary reasons for this trend. The first reason is reduced cycles of learning, which is a key driver in product innovation. The second factor is reduced supply chain risks—risks ranging from events in the physical supply chain such as tsunamis and port closures to more abstract risks such as IP (intellectual property) security. And the third is lower total landed cost (TLC). It is now less costly to source, build and fulfill products nearer to the destined end market than to source, build and fulfill from regions remote to the end market even if that region has lower labor costs.
Jim Carnall: I’m not sure trend is the right word. I think it’s becoming more popular and I think the reason why is that people moved a lot of manufacturing offshore, especially to China. At that point, it was trendy—if you wanted to be doing business you’d be doing business with China because of the low-cost labor. So, a lot of things moved to China—some probably for the right reasons, some probably because it was a trend, and contract manufacturers (CMs) thought they had to. But I think things are changing now. Product is moving back—including possibly some product that never should have left. I believe part of the reason for this is because the labor rates have certainly gone up in China over the last 10 years. We’re finding our operation in Nicaragua, which is nearshore, competitive with China when looking at the total cost. What you get from nearshoring is a much shorter supply chain.
For example, in our operation we get dock to dock shipments in an average of seven to eight days, whereas getting product from China may take seven to eight weeks or more. Those are a couple of the reasons I think nearshoring is gaining momentum
Eduardo Saavedra: There is no doubt that companies that set up a manufacturing footprint in China 10, 15 or 20 years ago as a means to lower costs for goods that were ultimately consumed in North America, have and still are evaluating the option of nearshoring some or all of their production to North America, which includes Mexico. The steadily rising cost of labor in China is the main reason but reasons also include the difficulty in solving manufacturing and supply chain problems from a long distance and long lead times for delivery. And while this “evaluation” is taking place, I would not categorize it a major trend because moving certain types of manufacturing operations is often a costly, disruptive, complicated, and long process.
MPO: Have emerging markets (BRICs) fallen out of favor with manufacturers? If so, why?
Carnall: I think you’re going to still see people offshoring but I think it will involve more of the suitable products and for more of the right reasons than for some of the reasons people went in the past. I don’t think offshoring is going to go away by any means. It will continue to be attractive to people who have products where there’s a large volume and high labor. It’s very good for products that don’t have a lot of variety, where you’re making the same thing over and over and over in a large volume. That lends itself to lower transportation costs because of a long supply chain. In those countries—using China as an example—growth will continue. But I think you’ll see some products that shouldn’t have gone there—those that don’t fall into the high-volume, high-labor, no-variety category—coming back to the area, maybe even coming back to the United States. The things that won’t come back are electronics like cell phones, computer parts and other items that are being made in the same world region they plan to be distributed in. Command Medical has some of our products going into Shanghai [China] out of our Nicaragua facility. When you have labor that can compete more locally, you don’t have the long supply chain to the United States, which is where the larger manufacturers still reside. There’s just no reason to take it to China, and there’s a reason to bring some product back that you went chasing the labor for. In my opinion, you really can’t chase labor rates anymore. I think Costa Rica might be a good example of that. It was trendy for people to locate into Costa Rica for low labor rates and a location that is relatively close like Nicaragua, but then the big companies like Intel went in there and drove labor rates up. So then you get a lot of turnover and you lose some of the advantages of being there in the first place.
Saavedra: There isn’t a market in the world that is resilient to the effects of supply and demand. Each of the BRIC countries however have different reasons for loosing competitiveness which include government and trade policies that ultimately either add a compliance burden and/or cost or the more obvious increase in labor costs as a result of rapid growth. In some markets, even in China, certain skills are not easy to come by and the educational system is either not prepared or can’t keep up with the demand for higher-skilled labor.
Busch: Other than China, none of the BRICS (Brazil, Russia, India, China, South Africa) ever became a major offshoring manufacturing center. This is primarily due to the fact that of the BRICS, only China met the two objectives for offshoring. Generally, you pick locations to manufacture because they have great manufacturing capabilities you can use and/or they are a good end market for the product. China is both a great market for most products and it has great manufacturing capability. Brazil has a pretty good manufacturing capability—not like China but pretty good in different industries for different products—but it’s not a great end market. Romania is a great manufacturing center but there’s not much of a market there. There are many countries with great manufacturing capabilities but they are not good end markets.
MPO: Why are device manufacturers attracted to nearshoring? What advantages does it hold for companies?
Saavedra: Staying close to the ultimate consumer has always been and still is an advantage. It has taken many companies years to validate the comparative advantage of proximity to market versus lower manufacturing costs and in the case of commodity items where there is lots of competition and low profit margins, the cost advantage may still prevail. This is where Mexico provides the best of both worlds. The proximity of Mexico to the United States and Canada is especially advantageous when not only the ultimate consumer but the supply chain is located near the manufacturing site; and for medical device firms whose supply chains are still largely located in the United States and Canada.
Carnall: There are many advantages to nearshoring. For example, if you’re going to Costa Rica, you have the short supply chain, you still have a relatively low cost and you have a fairly skilled workforce, from what I understand. The other thing I haven’t mentioned yet that plays in here is language—Costa Rica, Nicaragua and other Central American countries are Spanish-speaking countries. In the United States, we have a lot of Spanish-speaking people or bilingual people, so communicating with those locations is easier than finding people or talking with people that speak Chinese. So, in general, I think proximity, labor rates, language and skilled labor are some of the advantages. We’ve found that people in Central America are reasonably educated. Any time you go into another country, whether it be China, India or Brazil, you have to deal with cultural differences and I think that gets compounded when you’re dealing with not only cultural differences but distance and the language as well. Trying to get through cultural differences from a long distance with language issues makes it more difficult. I’m sure that’s not specific to the medtech industry but it certainly heavily impacts medtech where not only are manufacturers focused on quality manufacturing, there is a high level or specificity meeting regulatory and compliance requirements.
Busch: Nearshoring is gaining over offshoring because offshore locations are not fulfilling the two objectives of offshoring —lower-cost manufacturing and good end market. Nearshoring fulfills the two objectives with the added advantage of fulfilling a third objective. So, it offers labor and material costs comparable to offshoring with the added benefit of accelerating innovation, protecting IP and lower TLCs.
MPO: Are there any disadvantages associated with nearshoring? How can companies overcome these challenges?
Carnall: I think the only disadvantage is the cultural differences that may exist. And it’s not really a big disadvantage. It’s a disadvantage as opposed to keeping it in the United States, but it’s not necessarily a disadvantage if you’re talking vs. offshore. If you’re doing something in the United States, the disadvantage of moving it to a nearshore site—even if you’re talking about Mexico—is that you do have some cultural differences and you may have some language differences. I think those would be the challenges. Here is an example of what I mean about cultural differences: In some countries that are less economically developed, their culture is to try to use and save everything. But in a medical device business, that’s not always the case. Let’s say you drop something on the floor. Well with a Developing World culture mind-set, you would not throw that away, you’d clean it up and use it again. In the medical device industry you can’t do that. That’s what I mean about cultural differences—you have to educate people to understand that yes, you are trying to the right thing but in the medical device industry that may be unacceptable.
Busch: Because nearshoring’s benefits are primarily due to proximity to the product’s intended end market, there are a limited number of sites to choose from, which is beneficial from a supply-base perspective. There is a greater concentration of suppliers, but this will typically lead to increased labor costs as the supply of labor close to the manufacturing center tightens as manufacturers and supplier compete for resources, a disadvantage compared to offshoring for lower-cost labor. Being close by gets factored into total landed cost. For instance, Tijuana [Mexico] has become possibly the leading medical device manufacturing center in the world because of its easy access to U.S.-market in general and proximity to the growing southern California medical device market. Deliveries to regional distribution centers in San Diego/Orange County can be made several times a day. If you have a site in Guadalajara, you’re two days away from the border by truck, and you’ve lost the proximity competitive advantage. Your shipping costs are not equal to China but they’re not cheap like they are in Tijuana. Proximity is what drives nearshoring, not just a move to another offshoring site that is just as far away but may be in a different country. The cost drivers are what we’ve discussed; distribution and logistics as well as opportunity-lost-costs and supply chain risks. You also avoid what I call “parts tourism”—flying parts all over the world to assemble them in different places and then ship them back to where the parts came from. Nearshoring helps reduce this cost.
Saavedra: The biggest challenge is overcoming the fear of the unknown or the unfamiliar. While there are regions of Mexico with plentiful labor, the specific skills required by a manufacturer may need to be developed by the manufacture. As the technology content of a manufactured good increase so does the need for qualified engineers and the understanding and adherence to industry specific quality standards and practices. The U.S. Food and Drug Administration can also play a role certifying certain manufacturing sites and processes. While large multinational companies may have more experience opening operations in foreign countries, smaller companies may be intimidated unless they form alliances and receive reliable advise and support from bona fide service providers that are well established in places like Mexico.
MPO: What nearshore markets are particularly popular with medical device companies? What attracts firms to these markets?
Saavedra: Mexico and Costa Rica have been popular host countries for medtech manufacturing operations. Mexico has a slightly lower labor cost structure and 25 times the population of Costa Rica and is of course adjacent to the United States where freight can travel over the road or by air at relatively lower costs. Cost Rica however has a relatively well-educated workforce and the Costa Rican government has removed barriers to entry and is an effective facilitator to foreign companies.
Busch: Tijuana is particularly attractive to medical device companies whose products are destined to the U.S. market, where the majority of medical devices are consumed, because of its proximity to the U.S. border, large pool of labor with medical device manufacturing experience and a robust localized supply base. Romania, Hungry, Poland, Czech Republic are all good near-shoring to Europe locations. In Asia, China is now outsourcing to Vietnam, from cars to crops. The Chinese are building plants in Vietnam, so Vietnam is a nearshore example to China.
Carnall: We’ve been in Nicaragua for eight to nine years. My understanding is that David Slick, our current CEO, and his due diligence team looked at different countries—they looked at Mexico, the Dominican Republic, Costa Rica, etc. I think part of the reason why they didn’t choose a country like Mexico is because of the high turnover rate. The violence didn’t exist back then like it does now. In medical devices, you want to have a low turnover rate because it’s important that people understand what they’re doing and how to do it. They looked at the Dominican Republic, which would have been good, but the infrastructure there at that time wasn’t it is today or what we needed. In Nicaragua, we are in a government free trade zone right by the airport, so while the country may have some rolling blackouts from time to time, the free trade zone is hooked up to the airport, which gets auxiliary power. We always joke somewhat seriously, somewhat facetiously with our power suppliers here in the United States that the power in our Developing World country is more reliable than the power we see here sometimes. That’s not far from the truth. Those are the reasons we went to Nicaragua. If you look today, the same thing might apply to Mexico, and the Dominican Republic might look a little better. We wouldn’t go to Costa Rica because our labor rates are significantly lower and we don’t have the competition in Nicaragua that we would have in Costa Rica from other CMs and for attracting educated labor talent. People move around a lot in Costa Rica from what I’m hearing. If we had to choose now, I don’t think we’d go there, but the advantage of Costa Rica to a lot of companies is almost the opposite of what I said.
MPO: How can companies determine the best nearshore market for their needs?
Busch: Run an optimization model that determines the lowest TLC based on labor, material, transport and regulatory costs. That includes the cost of the product, which is comprised of labor, materials and overhead, plus all the shipping, freight, duties, taxes, licenses, scrap, loss in transit and such. The optimization model will vary by product and the product’s end markets And risks associated with the product. Heavy devices such as medication management systems or in-vitro diagnostics devices lend themselves to being built closer to their end market. High-volume products like blood glucose meters might be better built in an offshore location. You can also use a mixed mode model where you make lower-risk, smaller—less expensive to ship—parts of the product such as printed circuit boards in Asia because it’s a lot less expensive and they can be air freighted—and do the final assembly in Mexico.
Carnall: There probably isn’t a one-size fits all. But in general you are going to look at labor rates, and supply of labor—are there people there that are capable of doing what you need to do in enough volume depending on how many people you need? We are in Managua, Nicaragua, which has 2 million people, so there’s plenty of potential labor. You have to look at political stability. Some people look at Nicaragua as not a good place because of the Sandinistas and the 1980s volatility. The opposite is true. The government and economic business development team have been nothing but supportive. Command is the poster child of what they envision as ideal growth in the manufacturing sector because it’s mostly textiles there right now. I think they [Sandinistas] would like to develop a high-tech business sector in their country, so they’ve been very supportive. I also think the Sandinistas and Daniel Ortega learned some things from the first time around—that you need to leave the businesses alone, let them do their thing because that’s good for the country and good for him [Ortega]. Labor rates are important as is distance and your supply chain. It’s nice to get your product in a week. I think you have to look at turnover too. Both Mexico and Costa Rica have turnover issues; you have to look at power supply, and language as well. We have a lot of people down there [Nicaragua] that speak English and a lot of people up here that speak Spanish so being able to communicate with your nearshore site is important.
Saavedra: They need to start by obtaining and compiling the right questions to ask. The best advice is given by the companies that operate successfully in the nearshore market and while governments and consultants have information to impart, there is no substitute for information from those have manufacturing staff on their payroll, who pay rent, and who interact day to day with logistics, utilities and compliance entities in those countries. Often, the driver is a combination of skills sets required and proximity to either the end customer and/or the supply chain. Proximity to sterilization capabilities and capacity can also be a challenge. The site selection process will reveal that labor characteristics could vary significantly within just a few miles. We also recommend that companies not automatically assume that rapidly growing cities within nearshore markets for manufacturing will be the optimum place 15-20 years down the road; and carefully evaluate the value that tier-two and tier-three cities can offer.
MPO: Is nearshoring a passing trend—will the pendulum swing back to emerging markets again—or is it a viable (lasting) way for device manufacturers to reduce costs?
Saavedra: As supply chains develop throughout the important manufacturing venues of the world, nearshoring will likely pass and companies will develop manufacturing footprints that are close to their customers and suppliers and perhaps less due to labor cost. The one trend that will continue is manufacturing automation, which may put more emphasis on finding venues with energy provision that is lower in cost and of higher efficiency.
Carnall: Good question. I think it’s going to be lasting. Early on in the conversation I said people moved things for the wrong reasons to China and other areas, and I think people have learned to be more discriminating as to what moves and why. I also mentioned earlier that it’s hard to chase labor rates because of how quickly it changes. Costa Rica is a good example of that. I don’t think you’re going to go back the other way. I think things will be going where they should be going, for lack of a better way of putting it, and then they’ll stay there for those reasons. When I said people moved things for the wrong reasons, what I mean is I think offshoring was really the trendy thing to do at the time. Everybody was thinking, “Oh, you have to go to China because you can’t compete unless you go to China.” And some people moved product that didn’t meet the criteria—the high-labor content, the large volume, the non-complex product, devices that do not contain sensitive IP. They tried to move manufacturing that was a little more complex, that had a little more variety to it, and they might have moved items that didn’t lend themselves to leveraging the advantages. So, it was the trendy thing to do and some people jumped on that bandwagon that shouldn’t have. Now, having done that, companies are reassessing what manufacturing site offers the best solution based on more than just straight production costs. Global sourcing managers are putting models together that capture all aspects of conducting business inclusive of risk, IP confidentiality, continuity planning, ease of doing business as well as quality and product cost. This puts nearshore contract manufactures like Command Medical in a great position to offer low cost production while also meeting the other needs and wants of prospective clients.
Busch: Companies should evaluate a country not only on its manufacturing capabilities but on the country’s attractiveness as a market. Management consulting firms have built complex models taking into account the different variables—political stability, currency stability, etc. As I’ve said, Vietnam is a good manufacturing country but its end market is small. As companies design and build in region, for region, offshore plants in China and other offshore countries will switch from building products for export, to building products for local region consumption.