Read a very interesting article yday- wherein the author built a case for changes he predicted in manufacturing services due to the increased crude prices. According to him the labour arbitrage opportunities that many companies/countries could exploit previously, would no longer be as profitable. Reason being that historically the increased shipping costs due to shifting of manufacturing facilities to far-off locations was a smaller percentage and the fruits of low labour cost were enjoyed. Now with increased transportation costs- the overall distance that the raw materials (to the facility) or finished goods (to the markets) travel will need to be contained.
The author predicted that this would lead to near-shoring and the likes of Mexico might again become destinations of choice.While I was kind of convinced (though am not sure at what price range will these tough decisions need to take place) with the logic, I was more tempted to take this line of reasoning a little further and see where it goes.
Assuming the crude price keeps soaring and we are unable to find viable substitutes…. this could lead to a scenario where probably one of the top optimization criteria would be to minimise transportation.Areas/regions that have both the raw materials and the market, will become the first choice for locating the production facility. But we all know these are very few… so what would happen to others:
– Create efficiencies in smaller scales also- Companies would be forced to set-up multiple manufacturing facilities- closer to either the multiple sources of raw materials or multiple demand/consumption zones…e.g. Coke already bottles its drink out of multiple bottling plants spread across the country.
– Investing in route optimization- I know from my friends who work in route/transportation optimization, that almost 70% of the players have not even looked at the possible benefits of deploying a routing optimizer.
– Precipitate process innovation- With labour cost arbitrage vanishing , the holders of the brand would be forced to innovate in their processes- to find a viable solution in their high labour cost economies.
– In an ideal scenario where all labour cost arbitrage has been exploited and where the transportation costs are simulatenously rising- the only option is to consume what you produce/process. What I mean to say is that in this scenario- a Chinese car shipped to US would cost the same as a US car, made in China and shipped to US. Now with shipping costs increasing, there would be a point beyond which a US car made in US will be cheaper than both the options above and this in my mind is the onset of closed economies.
Maybe I am wrong here, but I seriously thing that what could happen is that some regions will become closed economic regions. Imagine if India/China and a few SE Asian economies come together to create a closed economic zone/region:
We would have the raw materials (iron ore, coal,grains, meat etc), we would have labour to work on it (China), we would have the process improvements we would need (India, Japan, Korea etc) and most importantly we would have the market for these goods and services.