The Viewpoint: Nearshoring, a key corporate strategy

For much of the 1990s and 2000s, Western corporates spent significant amounts of time and capital offshoring their manufacturing and service operations to the East, especially to low-cost jurisdictions such as China and India.

This worked especially well for labour-intensive industries such as manufacturing and for certain business services that required large administrative infrastructures, IT development and customer support. Such corporates benefitted from a readily accessible, large pool of relatively cheap and skilled labour (in comparison to the cost of Western labour), enabling them to significantly reduce their costs of production, improve customer service and/or run their back office operations more efficiently. For example, while IBM is based in the US, its subsidiary in India currently employs over 130,000 people involved in consulting services and software development.

The global pandemic and the labour, skills and raw material shortages that followed, disrupted supply chains across geographies and sectors. As many companies struggled for supply of key components or services from countries experiencing extended lock downs, not only did the time they had to wait for these factors of production increase to levels not experienced before, but the costs also rocketed as demand far outstripped supply. Labour shortages and wage inflation became embedded in some economies.

Companies therefore have been forced to re-evaluate the risks in their supply chain. Russia’s invasion of Ukraine added urgency to this re-evaluation, as did the increasingly belligerent political relationship between the US and China.

Is it optimal to have all your production in one country when there is a greater than zero risk of that economy shutting down or suffering from a geopolitical disaster? Would it not be better to diversify one’s supply chain risk by multi sourcing key components, rather than relying on one partner? Should one be shortening supply lines by producing closer to home rather than relying on unreliable shipping lines/freight markets and dodging Red Sea drones? Furthermore, precipitous wage inflation in countries, once considered low-cost jurisdictions, has meant that it is no longer such a straightforward decision to relocate offshore. Besides, automation, robotics and technology advances mean that there are many industries and sectors that are increasingly less reliant on labour.

In response, companies have been turning to nearshoring as a way to mitigate some of these supply chain risks. Nearshoring brings production centres closer to home, reducing the risk and inefficiencies of extended supply lines, higher freight costs and the logistical challenges of moving goods long distances across different time zones.

This trend can best be observed in the manufacturing and technology sectors. For example, multinational industrial companies, such as ABB and IMI have been establishing production and engineering centres in Mexico to bring operations closer to their end customers in North America. With nearshoring, risk management is prioritised over cost effectiveness. These companies are still able to benefit from labour cost advantages (relative to domestic production) and wide pools of skilled labour, while proximity often brings cultural similarities, more flexibility in supply (shorter shipping time) and can also avoid certain trade barriers.

In the technology sector, nearshoring to Eastern Europe and Latin America has been used effectively by digital transformation consultants like Kin & Carta, not only to reduce costs and protect margins in a post pandemic era of rocketing wage inflation (particularly for IT engineers) but also to access a wider universe of skilled IT labour in a tight IT labour market (partly as a result of the pandemic fuelled rush to digitise). Others in software/hardware, like Spirent the telecommunications network testing business, have used countries such as Poland and Romania to boost cost effective research and development resources.

Nearshoring is a key corporate strategy being used by companies to protect themselves against the unpredictability of the future and shifting geopolitical dynamics. It is to some extent a backlash against the risk (experienced in the recent past) from ‘offshoring’. This evolution will have ramifications for capital allocation decisions but is likely to reduce supply chain risks and, if done well, can improve efficiency as well as protect margins.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.