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Ideas for Leaders #709

The Cost Advantage of Reshoring

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Key Concept

Reshoring is the decision to return business activities to a firm’s domestic market. Analysing the impact of reshoring announcements on stock prices indicates that the benefits of reshoring outweigh the costs.

Idea Summary

Despite the well-known and well-documented financial benefits of outsourcing and offshoring business activities, a growing number of U.S. companies are changing direction: they are moving their business activities, including manufacturing and service operations, from foreign markets back to the U.S. — a process known as ‘reshoring’.

Reshoring entails both benefits and costs. On the benefit side, reshoring allows companies to:

  • Manage their production capacity and inventory more efficiently. For example, companies have less need to keep safety stock at offshore distribution centres. They can also postpone production more easily until they have a better knowledge of demand, thus reducing the potential for overstocked items.
  • Lower the risk of supply chain disruptions. Quality failures or intellectual property theft are more common in offshore locations.
  • Reduce costs. Packaging, travel and communications costs are lower with domestic business activities.
  • Increase customer responsiveness. Reshoring brings production closer to the end user. Companies can respond faster to changing customer demands.
  • Enable innovation. Cross-functional collaboration between design and manufacturing, now physically and even culturally closer to each other, can spur innovation.

On the cost side, reshoring requires companies to:

  • Incur significant switching and set up costs. New factories or inventory facilities may need to be built.
  • Pay more for labour. Labour costs are typically higher in many domestic markets, including the U.S.
  • Pay higher taxes and deal with currency risks. Despite tax credits and other subsidies, the tax and currency implications are likely to be unfavourable.

Do the benefits outweigh the costs? One way to find out is to analyse the stock market reactions to reshoring announcements. A study featured in the Journal of Operations Management describes this type of analysis. The research team from the University of Bath and the University of Manchester calculated the abnormal stock returns (actual stock returns minus the expected returns had there been no event) immediately following reshoring announcements for 37 major reshoring events between 2006 and 2015. 

The resulting figures are compelling. On average, reshoring announcements led to an average positive stock price reaction of 0.45%, representing an average positive valuation increase of more than $320 million. From the perspective of investors, an offshoring announcement is good news.

Business Application

Based on this research, the time may have come to rethink assumptions about the benefits of offshoring activities. The attraction of lower labour costs can hide some of the less evident disadvantages of offshoring as well as the advantages of domestic business activities. Companies making decisions on either moving business activities to offshore locations or reshoring business activities currently in foreign locations must take the time to calculate all of the nuances of potential costs and benefits. For example, increased labour costs can be offset by increased productivity. Or savings from shortened supply chains can offset increased costs of manufacturing at home. 

The positive response of investors to reshoring announcements indicates that so-called ‘high-cost’ locations may actually be lower cost than anticipated.

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Authors

Institutions

Source

Idea conceived

  • January 2017

Idea posted

  • June 2018

DOI number

10.13007/709

Subject

Real Time Analytics