Real Options Valuation Model Vs. Discounted Cash Flow

In an article posted on hbr.org, “It May Be Cheaper to Manufacture at Home,” Suzanne de Treville and Lenos Trigeorgis delve into the discussion of the real options valuation model when sourcing locally.  Many manufacturers prefer to use discounted cash flow (DCF) to help in supply chain decisions, especially where to locate a new plant.  However, DCF ultimately undervalues flexibility. Therefore, if something unexpected occurs, the expenses can amount quickly.  The best way to avoid this is to pair DCF with a real options valuation.  This gives flexibility in the supply chain by putting a dollar amount on it.

The article looks at how Flexcell, a Swiss company that produces various lightweight solar panels, was looking to expand operations.  The CEO came to the conclusion to build a new factory on Swiss soil, rather than offshoring, by looking beyond the DCF model.

“If the plant were in Switzerland, he could delay production commitments and investments for several months, during which he could gather critical information about demand. This decision allowed him to use the real options valuation framework, which in turn let him put a dollar figure on flexibility.”

For the full article, please visit hbr.org.

Innovation Urgency: A Framework For Success?

Paul Tate, the Research Director and Executive Editor at Frost & Sullivan’s Gil Community, a leadership community for manufacturing, recently posted the article “Innovation Urgency: A Framework For Success?” It details what an organization needs to do to stay competitive and be considered one of the top innovators in today’s fast paced markets.  The competition is fierce with pressure from customers and stakeholders driving the high expectations.

At the Growth, Innovation and Leadership conference, Angel Mendez, Cisco’s Senior Vice President of Transformation and a member of the Manufacturing Leadership Council’s Board of Governors, shared his insights on how to effectively drive innovation:

“‘Right now there isn’t sufficient growth in most industries to put wind in a company’s sails by just focusing on internal business productivity initiatives,’ argued Mendez. ‘The fast moving turbulence of global markets, the short lead-times between new ideas and industrial commoditization, and the continuing explosion of customer demands for innovation excellence make innovation a huge issue today. This is not an intellectual exercise or a thought experiment any more. This is really urgent.'”

In the article, Tate outlines what Mendez considers to be the best way companies can allocate their innovative efforts: a systematic approach. By utilizing strategic alignment, successful idea generation, proactive management of innovation portfolios, and building a collaborative culture, manufacturers can overcome obstacles in their innovation pipelines.

A systematic framework as such has the potential to make a real market difference with new ideas more attainable.

To access the full article, click here.

Reshoring Depends on the Right Business Ecosystem

Precision Manufacturing, a trade publication operated by the Minnesota Precision Manufacturing Association, released an article titled “The Global View: Reshoring Depends on the Right Business Ecosystem”. The article suggests that businesses cannot thrive let alone survive without a stimulating environment including a workforce of specific skills, local suppliers, and access to customers.  Not only that, but a supportive community also plays a key role in successful reshoring expeditions.

The article highlights how the government’s misconception has been undermining the success of reshoring initiatives.  Many people in government refer to non-manufacturing jobs created from a reshore as “free jobs.” They fail to see that these jobs are necessary to sustain a healthy business ecosystem and are not just created out of thin air.

Governments and businesses must work together to enable reshoring.

“Governments and business leaders need to ask themselves what type of reshored manufacturing they want in their communities. Do you want to attract manufacturers that are competing to develop and build the next generation of battery technology? If so, you need to shift educational resources toward chemistry and math, and you need to improve your regulatory knowledge of chemicals and processes used in battery production. In short, you need to be smart and interact with the reshored business in a thoughtful way.”

For reshoring to flourish, governments also need to consider international supply chains, tariffs and logistic costs, visa policies, education, skilled workforce, regulatory environment, and transportation infrastructure. All of these combined provide the ideal structure for a business ecosystem that supports manufacturing.

To read the full article, click here.

Re-Shoring: Manufacturers Make a U-Turn

“Chesapeake Bay Candle never thought twice about offshoring its manufacturing when the company started 17 years ago…Four years ago, however, the company reversed that thinking, centering its operations domestically, and betting that as the global economy changes, the move will actually save it money.”

This is the developing trend noted by Chris Morris on a special to CNBC. The article, “Re-Shoring: Manufacturers Make a U-Turn” notes the reshoring of companies like Chesapeake Bay Candle, rising wages in China (15 to 20 percent a year), rising fuel costs, recent domestic manufacturing job growth, and global demand for Made in America products are all indicators that there is a change coming that will be very positive to U.S. manufacturing.

One of the benefits of reshoring is in how it makes customization and adaptation faster and more convenient. Companies can hold smaller inventories, save on logistics costs, generate good will, and rapidly implement new innovations and product lines. This allows businesses to stay more relevant, to adapt to an ever changing market, and even have more assurance during recessive periods.

‘”We have some new machinery and new methods that can be more competitive with China,” says Bruce Brandel, president of The Packaging Team, which supplies blister packaging for consumer product goods. “We’re starting to see people who moved to Mexico or China say ‘If you look at the total picture and cost, it’s not much of an advantage — and maybe a disadvantage — to be there’.”’

The full article can be found here.

Does America Really Need Manufacturing?

The Harvard Business Review published an article last year that focuses on how production is closely related to innovation.  However, companies fail to see the connection and largely view manufacturing as a cost center.  The article highlights the benefits of keeping manufacturing and R&D near each other, as well as provides a framework that helps managers assess the consequences of geographically separating the two.

“Part of the problem is that it’s devilishly difficult to determine when manufacturing is critical to innovation and when it can be safely outsourced to lower costs and reduce capital outlays.  In this article we’ll provide a framework that will help business leaders and government policy makers navigate this issue. Our hope is that it will lead to better sourcing decisions that will reinvigorate America’s innovation-driven economy.”

To access the entire article, please visit hbr.org.

 

The CEO of General Electric: On Sparking an American Manufacturing Renewal

HBR.org released an article “The CEO of General Electric: On Sparking an American Manufacturing Renewal” where CEO Jeffrey R. Immelt speaks about GE and the reason they are bringing advanced manufacturing jobs to the United States. While he did mention many common cost factors such as labor, shipping, and currencies, his main focus was on innovation. “At a time when speed to market is everything, separating design and development from manufacturing [doesn’t] make sense.”

The first main point was centered on human innovation. Immelt claimed that to stay competitive GE doesn’t just need a new investment, but “an entirely new approach – one centered on ensuring not only that [they] had the best people but also [they] empowered them to execute.” So at Appliance Park (Louisville, Kentucky) instead of restricting employee innovation by putting them in a box, employees were given the reigns. “Designers, engineers, and assembly-line workers together determine the best way to meet their goals; they own the metrics.” This has led to reducing production time by 68% and space required by over 80% on their 25 year old dishwasher line and more.

Technical innovation is another factor that brings manufacturing back to the United States. GE has found that its R&D development, especially in partnership with universities, has been an important asset for innovation. “But these partnerships…are vital not only for designing and producing the materials, systems, and processes that will come to define air travel but also for developing tomorrow’s engineers, who are critical to America’s competitiveness.”

Immelt denies the idea that industrial decline is unavoidable for the United States. He thinks that global competition from emerging markets is a challenge to face, but not an impossible one.  “To meet that competition, we’ll need a strong core of innovation and a stable financial system built around helping small and medium-size businesses and industrial companies to succeed. We’ll need an updated infrastructure to support manufacturing, which the private sector can help fund—better roads and airports, broadband capability, and a bigger and smarter electricity grid.”

“As a country, if we want to revive U.S. manufacturing and regain our competitive edge, we have to execute. But we also need confidence and the mind-set that we can outperform anyone. We should start by making a serious commitment to manufacturing and exports.”

To read a free preview of the article, you can find it on HBR’s site.

The Automation Element of Re-Shoring

Joel Hans, managing editor from Manufacturing.net, released an article, “The Automation Element of Re-Shoring.” Hans focuses on Automation GT, a company that designs and manufactures machines for automation, and the statements of its CEO and President Simon Grant.

“Simon Grant, Automation GT’s CEO and President, says the re-shoring issue has become more prevalent in during early and mid-2012. Even though most of the industry has been aware of the trend, Grant says only recently has there been a ‘re-awakening’ of the capital budgets among his company’s Fortune 100 customers. And while a post-Great Recession economy might give major corporations more flexibility in which to consider the prospect of bringing jobs back to America, it’s not the only reason to pursue the business case.”

Offshore manufacturing results in longer supply chains. As the chain gets longer, the risk for delays and high transportation costs rises dramatically. A specific case mentioned was Hurricane Sandy, which caused some of Grant’s customers to lose key market opportunities. While he admitted that re-shoring does not absolutely protect from these sorts of disasters, it does “significantly lower the barrier to finding a workaround that will get product where it needs to be to keep customers happy. With everything put together, Grant states, ‘From a financial and a logistical perspective, automated production in the U.S. just makes sense.’”

Grant goes on to mention more benefits of re-shoring with an emphasis on automation: precision, better quality control, increased workplace safety, cost-effectiveness, responsiveness to changing market demands, reduction of lead times, increased customization, intellectual property protection, creation of reliable high-paying jobs, and economic development.

“Grant remains optimistic about the prospects of re-shoring during 2013, and is even offering clients who aim to bring production back to the U.S. a free consultation and review of their manufacturing lines. He says, ‘We expect to see onshoring really pick up in 2013. We are excited and ready to consult with clients during their transition.’”

To read more from this article find it here on manufacturing.net.

“Reshoring” and “Nearshoring”: Why Manufacturing is Coming Back to the U.S. and Mexico

The Offshore Group posted the audio and transcript to a podcast entitled ‘”Reshoring” and “Nearshoring”: Why Manufacturing is Coming Back to the U.S. and Mexico’ which contained an interview with Harry Moser, director of the Reshoring Initiative.

The mission of the Reshoring Initiative is to “bring well-paying jobs back to the U.S. by assisting companies to more accurately assess their total cost of offshoring.”

Moser stated that the bulk of operations that will consider reshoring will be coming from Asia. He explained that this is due to Asia’s rapidly changing economy compared to North America.

“For example, Chinese wages expressed in dollars are rising up 20% to 25% per year vs. 2% to 3% here in the United States. Even though Chinese productivity is rising, it is doing so at nowhere near the pace to justify that huge wage increase. Therefore, their economics are rapidly declining relative to the U.S.”

According to Moser, many companies that sent work to China did not correctly assess the total cost of offshoring. These companies, and those who find China’s economic climate to no longer be advantageous, will find their way back to North America. Even some of Europe’s manufacturing could come to the U.S. depending on the direction of the Euro.

The Offshore Group asked Moser which types of products should be expected to consider reshoring.

“There is logic to what should come back. I would refer your listeners to a study done by Booz & Company. They will find that this international consulting firm identifies 30 different industries that are positioned to repatriate production when comparing the relative competitiveness of manufacturing in the U.S. and North America versus producing in China and shipping to the U.S.”

He identified automotive, metal, and machinery as the types of industries that are “in the tipping point” and that although it once made sense to produce these products in China, it now makes more sense to produce in the United States. Examples provided were GE bringing back water heaters and Wham-O bringing Frisbees, both back to the states.

“Bottom line, the best way to determine the total cost of manufacturing is to go to our website www.reshorenow.org and, for free, use the total cost of ownership tool that we have developed. This is the software that companies anywhere in the world can use to perform this analysis. That’s the way to do it…the estimator examines obvious factors like duties, freight, and other things that many companies consider in their analysis. Then it gets a little bit more complicated by factoring in costs from the suppliers, and the carrying cost of inventory en route.

A company can become quite inefficient when it has a long supply chain delivery. This affects quality, and IP risk and exposure to adverse effects occasioned by natural disaster. A long supply chain also can impact negatively on innovation…one of the reasons GE was able to bring the work back is because their engineers and manufacturing workers were able to work together to redesign the product and reduce the production of each unit by twenty dollars. By having the engineering and manufacturing close together it makes it easier for these types of things to occur.”

Another important point agreed upon by both Moser and The Offshore Group was the fact that even when companies move operations from China to Mexico, or anywhere in North America, it can benefit the United States. This is due to “when Mexicans produce something in Mexico, they buy machinery, supplies and components to do so from the U.S.” compared to when “a product is produced in China, there will be little direct economic, if any, gain for the United States. [Moser’s] first choice would be the U.S., then as a second choice Canada and Mexico as two much valued neighbors.”

To listen to the podcast or read the transcript, click here.

Chinese Labor Pool on the Decline

Scott Tong, from Marketplace, released a story in 2010 called “Chinese Labor Pool on the Decline.” This story examined Chinese labor and manufacturing in the past and compared it to present conditions. Tong reported that while at one time there was a surplus in Chinese labor, some factory owners can’t find workers to fill their production lines. A large factor in this labor shortage is the one child policy, which is expected to “shrink [the workforce] by half over the next decade.”

This shift in labor is causing not only shortages, but also rising wages. These rising wages are making it difficult for plants to be competitive, and many are losing business to countries like Pakistan and Vietnam.

Amidst these Chinese plants closing their doors and losing competitiveness, Tong shows doubt at the ability of stores like Wal-Mart to keep driving consumer prices down. Rising wages and labor shortages are both signs that “the era of cheap and plentiful Chinese labor is coming to a close.”

Read or listen to the full story here.

‘Reshoring’ gains momentum with U.S., KC manufacturers

The Kansas City Business Journal published an article, “‘Reshoring’ gains momentum with U.S., KC manufacturers.”  It focuses on KC based manufacturers and their reshoring experience in the Kansas City area.

The first manufacturer mentioned is Prier Products Inc.   To save on several months of inventory costs they are looking to buy a machine that will allow them to produce the parts in-house rather than overseas.  By reducing inventory, they can have a shorter, more responsive supply chain.

The second is Pride Manufacturing Co. Inc., located in neighboring Liberty, MO.  The director of business development, Nathan Goodpasture, says:

“We’re literally finding more opportunity for work than we can possibly handle right now, thanks to customers who would otherwise be in China,” Goodpasture said. “The prices have been rising incrementally overseas, and the spread is now getting small enough to where they are willing to pay a little extra to be in the U.S. It’s not just coming from the grass-roots, patriotic type of people who are torn about having anything in China at all, but from people who previously saw their business overseas as adding tremendous value. If it’s now only going to add a tiny bit of value, then they see it as not worth the costs and hassle.”

A survey done by Cook Associates Executive Search revealed 85% out of 3,000 manufacturing executives nationwide said due to rising costs overseas they are considering reshoring their operations in the near future.  As the gap in costs of doing business overseas narrows, Kansas City’s central location and skilled work force are permitting it to be a viable option for reshoring opportunities.

To access the entire article, click here.