Bringing it home – Nearshoring can save costs

Nearshoring is the practice of transferring a business operation to a nearby country, especially in preference to a more distant one.

Many professional sourcing executives expect it to become more important in the coming years. Companies are considering nearshoring as a critical risk management tool.

The old way of doing business was to source product and materials overseas, particularly in China, and with only a few suppliers. The goal of reducing acquisition costs was partially achieved by beating up carriers and service providers in the quest to lower freight expenses.

The Covid-19 pandemic we have faced in the last 30 months – with residual impact heading into 2023 – has taught massive lessons in understanding the dangers of foreign sourcing and concentration in supplier bases. The consequences of old offshoring strategies were a huge uptick in supply chain risk and costs. These risks manifested themselves in delays; zero availability of certain materials, parts and finished products; increased costs; and significant uncertainties in demand planning models.

Lessons learned in the pandemic are inducing procurement and supply chain managers to consider new approaches to mitigate their supply chain risk.

New strategies leading the way are: Diversifying the vendor/supplier base by both company and country of origin; increasing the number of supplier/vendor options; considering nearshoring; and seeking cost reductions in overall landed costs – not just acquisition and freight costs.

Canadian and American companies impacted negatively by the pandemic have begun to seriously explore their options in all four areas.

Managing landed cost is a much-needed component of the nearshoring practice. To assess landed cost you need to know the acquisition cost of the goods; freight cost; customs clearance charges; duties and taxes on entry; and inland freight, warehousing and final distribution. Once you know these, it is then possible to model how nearshoring can provide a cost advantage.

Acquisition cost is defined as what we pay for goods acquired. It is usually expressed as the FOB price (Freight on Board). This brings the goods in the origin country to the port of export. So, it is the price we pay for the actual physical product, plus the cost of freight from origin to the outbound gateway.

As a general rule, the acquisition cost is likely to be higher in the nearshore model, thanks to higher labour costs. But the other four areas could be much cheaper, mitigating the impact of the higher acquisition cost.

Manufacturing is being slowly brought back to Canada and the United States. Labour shortages are a major factor here, along with environmental concerns. However, bringing manufacturing to a country like Mexico and working in the local Maquiladora Program, could potentially have a huge advantage in all five areas that make up landed costs. The Maquiladora system allows a US-owned factory to locate in Mexico, usually near the border, and send finished product north on a duty-free or reduced tariff basis.

In many instances, the acquisition cost is the same or a small amount higher. However, the freight costs are much lower, customs clearance is easier and less costly, import duties and taxes are significantly reduced or eliminated, and the cost of distribution, depending upon location may be the same or a little less.

However, the case study clearly demonstrates that when landed cost modeling is used, nearshoring is a viable, cost-effective option.

In a “Best Practice” scenario, we believe that overseas manufacturing has value in reducing cost, but we must also consider the risk when all of our manufacturing is dependent on one country, only a few suppliers that are thousands of miles away, and where economic, political, climate, and environmental concerns abound.

A best practice would be independence from foreign suppliers, such as in China. It would involve diversifying supplier management by bringing a certain percentage closer to home. This mitigates both risk and cost.

Nearshoring should be a serious consideration for any supply chain or procurement manager. It reduces the risk associated with foreign purchasing in single-source countries such as, but not limited to, China. When landed cost is brought into the assessment process, it may also provide an avenue for cost reduction. It diversifies the supplier/vendor base, which, in the long run, is a sound risk management strategy.

Foreign trade zones

Foreign trade zones allow companies in Canada and the United States to gain some leverage in returning manufacturing to home shores. US Foreign Trade Zones and the Canadian Duty-free Manufacturing Tariff Regime programs allow imports of raw materials and components duty free into specially designated manufacturing sites.

Duty deferral provides a big advantage. Duty is only due when the product is completed, and the assembly process may result in a lower tariff being assessed. The Tariff Manufacturing Program in Canada has no geographic restrictions. The entire country may have access to the benefits of duty-free manufacturing.

These programs, along with near sourcing, create a pathway for reducing both risk and cost to imported products. If all or some of the imported products are exported, additional financial benefits and incentives may also exist.

Friendshoring

Friendshoring has been described as the business strategy of running supply chains only through countries that are close political partners. Past and current trade disruptions caused by political events have promoted this strategy. Allied countries are more aligned to keep supply chains open, and working to the mutual best interests of the countries involved.

Countries that might fit the profile, as countries that Canadian enterprises might want to source from or trade with, are Mexico, South Korea, Vietnam, Malaysia, Indonesia, Japan and Brazil. We have various forms of trade agreements with all these countries. In some cases these afford more competitive trade, through duty mitigation, relaxation of barriers and trade facilitation mechanisms.

Any company seeking to bring risk management into their global supply chain procurement strategies would be best served by considering these “friendly markets”.

Procurement and supply chain managers need to deeply assess all the parts that make up their supply chain, with full anticipation of finding areas where risk and cost can be reduced.

Thomas Cook is managing director, Blue Tiger International