Klaus Tiedge/Blend Images/Getty Images
In the United States, as in most other developed economies, labor costs are fairly high. Therefore, many companies with facilities in the U.S. find it advantageous to move their factories to countries such as China and India, where labor costs, as well as some raw materials, are significantly cheaper. While such a move can reduce costs, it carries significant drawbacks as well, which must be carefully considered.
When you bring in something form abroad to sell in the local market, you are exposed to currency rate fluctuations. Whether you manufacture the item you import in your own facilities or purchase it from a supplier in the foreign nation makes no difference with regards to currency risk. Say you have a facility in Turkey that makes leather jackets. The jackets cost you 120 Turkish liras to make. When 2 liras equal 1 U.S. dollar, the item costs $60. If the lira appreciates so that 1.5 liras equal a dollar, the same item will cost you $80. Manufacturing in the same country where the goods will be sold completely eliminates currency risk.
As more companies move their facilities to a particular country, the local labor market in that country takes notice and wages begin to climb. With more employers to choose from, workers begin to seek alternative jobs and employers are forced to offer higher wages to retain talent. Other critical items, such as the land where you can build factories and even utilities, become more valuable as demand for them rises dramatically. This inevitably results in higher costs for these items, which can negate much of the cost advantage offered by the foreign location.
Despite dramatic advances in information and transportation technology, a factory located thousands of miles away still poses huge logistical challenges. First, bringing in products by ship from across the Atlantic or Pacific takes several weeks. As a result, urgent, unforeseen orders cannot be filled as quickly as would be possible if the manufacturing facility was only a few hundred miles away. Quality problems are also harder to solve, since it takes much longer to send executives to survey the plant or gather product samples to analyze in your labs.
Many developing countries have fairly unstable or volatile political landscapes that can change quickly. When a new government takes over, it might make it harder to do business in that country. This can range from imposing new regulations on businesses or raising utility prices or taxes to nationalizing production facilities. In many cases it is difficult, if not impossible, to predict how a new government will act, which makes it hard for companies to take countermeasures. In fact, even political developments in unrelated corners of the world can impact costs. For example, a sudden crisis in the Middle East that results in higher oil costs might inflate the shipping costs of moving products from India to the United States.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.