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  Low-cost countries such as China and India are changing the competitive landscape so quickly and profoundly that every industrial company — even those already actively sourcing products and services overseas — needs to reexamine its overall operating strategy and be prepared to alter it radically, according to a new report by The Boston Consulting Group (BCG).
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According to the report, Capturing Global Advantage: How Leading Industrial Companies Are Transforming Their Industries by Sourcing and Selling in China, India, and Other Low-Cost Countries, the opportunities for competitive advantage are so large — and the potential missteps and penalties for inaction so costly — that all industrial companies must at least consider integrating low-cost countries (LCCs) into their strategic planning and keep in mind that LCCs can be optimal places for R&D; and other sophisticated activities.

The report discusses opportunities to create global advantage not just by cutting costs but by globalizing a company's entire operations –deconstructing and reconstructing them in a radically new form so every activity takes place where and how it is most advantaged.

“Seeking global advantage through LCCs is an imperative for all industrial companies. Those not yet examining LCCs need to begin now, and those already moving need to pick up the pace. The rub is that the task is daunting and painful, requiring tough thinking and the willingness to scrap current international and LCC strategies and write off seemingly important legacy facilities,” said BCG Senior Vice President Dave Young, co-author of the report and global head of the firm's Industrial Goods practice.

The report projects that industrial goods will travel the path consumer goods did over the past two decades. (Already, in the United States, some 70% of footwear, 60% of audio and video equipment and 45% of apparel now come from LCCs.) Industrial goods sourced from LCCs now account for more than 10% of industrial consumption in the U.S. and, even in a flat economy, are growing at a rate of 30% per year. Further, about 300,000 U.S. service jobs have already moved offshore, and about 2.5 million more will probably do so over the next decade.

Who's Seeking Global Advantage, and at What Pace?

The BCG report classifies industrial products into four categories in terms of seeking and realizing global advantage: moving early, growing fast, up and coming and globalizing slowly.

About 10% to 15% of U.S. industrial operations (namely automotive components) have been moving early into LCCs. About 15% to 20% of industrial operations (household appliances and motors, generators, relays and industrial controls) are moving fast into LCC production and will account for the next big wave of globalization.

Between 30% and 40% of industrial products (aerospace equipment, machine shops, architectural and structural products) are up and coming in terms of their being sourced from LCCs but are increasing by more than 15% per year. And about 25% to 30% of industrial goods (bulky, low value products like truck trailers) remain relatively shielded from LCCs and are in the globalizing slowly category.

Extreme Costs Savings: Labor and Beyond

The cost savings that an industrial company can realize from a global strategy that involves LCCs are dramatic.

In general, the biggest cost savings are in labor. While a factory worker in the U.S. typically costs between $15 and $30 per hour, a Chinese worker typically makes less than $1 an hour. For service employees — e.g., phone center employees – the savings are dramatic too. The labor cost savings a company realizes by outsourcing a service job to India can be as much as 60%.

Further, the capital investment requirements for companies operating in China are 30% to 40% of what they'd be in the home country – because machinery is less expensive and because the need for machinery is lessened by the greater availability of inexpensive labor.

Cost Savings Will Grow, Not Erode, Over Time

Capturing Global Advantage points out that, contrary to what some commentators have feared, the cost advantage offered by LCCs will persist and even expand, not evaporate as demand and modernization in LCCs inflate labor and other costs.

“We believe the cost gap won't narrow over the next decade, and, in many cases, it may widen,” said BCG Vice President Jim Hemerling, a co-author and leader of BCG's China region. “This is true even with significant currency adjustments.”

According to the report, companies can expect to realize annual cost improvements of as much as 10% for products relocated to China because of expanded scale, deepening relationships with suppliers and a competitive environment. And even if labor rates grow dramatically in LCCs and less dramatically in home countries, the gap in real wages may actually increase because the current base is so low in LCCs.

Seeking the Cost Advantage is a Must, But It's a Difficult, Expensive Undertaking

Seeking cost advantages is critical, but doing so is extremely difficult and requires big investments.

“If industrial companies aren't careful, they'll underestimate the cost of senior management time, environmental liabilities, business lost in the migration process and 'bad will' costs in the home country,” said BCG Senior Vice President Hal Sirkin, global leader of firm's Operations practice and a co-author of the report. “But the paradox is that if companies don't face up to these initial costs and risks, their long-term costs will devour the companies' competitive standings. The fact of the matter is that many companies key operations — their supply chains, manufacturing systems, innovation processes — are not yet geared to take advantage of some of the most compelling new opportunities.”

According to the report, one-time expenses — to identify suppliers in an LCC, establish a logistics chain, tool and train — typically add 10% to 40% of the cost of goods sold in the first year.

Beyond the Cost Advantages, Vast New Opportunities

In addition to cost savings, LCCs themselves represent major new markets for industrial companies sourcing production there.

The report notes that China is, overall, already the world's largest market. The market for machine tools in China is twice what it is in the U.S.- and growing much faster. China is the world's second-largest market for transmission and distribution equipment and the fourth-largest market for cars and trucks. While domestic companies meet some of the demand, international brands are often preferred, especially in the rapidly growing high-end market.

A specialty metals producer reports that half its global growth will come from China, and an electrical components manufacturer believes that half its new demand over the next two decades will be in China.

Even With Lower Costs, Better Quality

Beyond dramatic cost savings and new markets, companies operating in LCCs benefit from increases in skill, flexibility, quality, productivity and R&D; speed.

LCCs contain vast pools of talented, trainable workers, as well as large pools of skilled workers eager to apply “craftsman” talents. Accordingly, GE Medical Systems has designated India as its center of excellence to leverage sophisticated design and manufacturing skills.

The ability to rely on labor rather than automation results in valuable flexibility in manufacturing. Accordingly, companies can launch new products faster. Paradoxically, it's the smaller-volume, more specialized products that are often best manufactured in LCCs.

Said Sirkin, “One of the most intriguing LCC advantages we've come across is faster, and lower-cost, R&D.; Because companies established in LCCs have eliminated a lot of automation and tooling requirements, they can be more responsive to R&D; requests.”

The report says companies can increase the amount of research they do three to five times over — for the same budget they'd devote to it in the West.

Realizing Global Advantage Can Be Fraught With Risk and Potential Missteps

While the report underscores the importance of seeking new markets and increased capabilities via globalization, the research also emphasizes how difficult and complex that process is. Industrial companies have to grapple with key strategic and tactical questions, including what kinds of operations to relocate and how.

“One might think you should relocate the manufacture of 'sunset' products for which the market isn't growing and lowering cost is key. The reality is that you want to relocate the manufacture of high-growth-potential products in order to capture long-term global advantage,” said Young.

In addition, the amount of due diligence required for successful leveraging of LCCs is monumental — especially when developing a supply base. For example, Carrier, the air conditioning equipment manufacturer, has deep expertise in sourcing in China and obtained 1,600 quotes there before making its first order.

According to the report, common management lapses relating to global advantage include believing that having current 'international' revenue means the company is operating globally; postponing tough decisions around legacy assets and liabilities; thinking about markets rather than company-wide systems and pushing globalization responsibility too far down the org chart (it needs to be at the CEO level).
 
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