How Small Businesses Can Survive the Reshoring Wave
Even before the election of Donald Trump, reshoring was already in vogue. After decades spent moving factories from the U.S. to China, in recent years corporate America has been thinking of reversing this trend and bringing manufacturing back home. For small businesses, this may mean higher costs, especially in the form of wage inflation. To contrast this trend, small businesses should deepen their investments in automation and robotics, in order to lower labor costs and remain competitive in a tightening labor market.
What Is Reshoring?
According to the Reshoring Initiative, “Reshoring is the practice of bringing manufacturing and services back to the U.S. from overseas. It’s a fast and efficient way to strengthen the U.S. economy because it helps balance the trade and budget deficits, reduces unemployment by creating good, well-paying manufacturing jobs, and fosters a skilled workforce.”
Back in the 1980s, the frenzy of the day was offshoring, i.e. moving manufacturing and services from developed countries to developing countries, such as China. The idea was that the developed world should focus on advancing ever more technological skills, while shifting its traditional industrial base to the low-cost developing world.
After more than 30 years, the results of offshoring have been mixed. One thing that worked for sure was to bring inflation down. Actually, the last 10 years have seen the lowest inflation rate since the 1930s.
Now, with the pandemic disrupting the global supply chain, reshoring seems to have become a national strategic necessity more than an economic choice.
While reshoring may cause a rebound in U.S. manufacturing, it is not clear what effect such policy might have on small businesses.
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How Does Reshoring Affect Small Businesses?
Small businesses have lived a period of prosperity during the last 20 years. A combination of low inflation, low interest rates, and abundance of labor (although the job market has been tightening as the longest recovery in history took hold) have created an exceptionally good environment for small and medium businesses.
From 1997 to 2017 (the most recent figures from data provider Statista) the number of small businesses in the United States have grown 2.24% per year, in line with the average GDP growth, which suggests that small businesses have kept pace with America’s economic expansion.
However, small businesses have been contributing to two out of three jobs created by the private sector. This is partly attributable to many small businesses growing faster than large enterprises, but also to the fact that a good number of small businesses employ a large amount of labor, especially in sectors such as retail, hospitality, construction, and agriculture.
A research by J.P. Morgan Chase shows that labor represents 18% of the total monthly cash outflows for the average small business. Another research by Goldman Sachs reveals that the highest concern for small businesses are labor regulations.
Why?
Although some small businesses do offshore production, especially if they are fast-growing manufacturing companies, most of them do not, particularly the smallest ones or the ones providing front-facing services. Small businesses remain competitive in part because of their flexibility and strong relations with stakeholders, but also because they pay employees less than large enterprises, in some cases as much as 30% less.
This is possible because employment in the U.S. has been declining since the late 1990s, and since the early 1990s if we consider only male workers.
Supporters of reshoring would like to see this trend reversed and to re-create the millions of manufacturing jobs that have been lost since the de-industrialization began.
If that happens, the problem for small businesses could be that they would have to compete with large enterprises for employees.
The likely outcome could be wage inflation. Since companies tend to pass their increased costs to customers through higher prices, wage inflation could become outright inflation.
That would put an end to this prolonged period of low interest rates, as the central bank tries to fend off inflation by increasing rates. The result is higher borrowing costs for small businesses.
When asked about what they will do if costs rise, most small businesses responded they would try to pass costs along to customers.
But that is not always an easy thing to do. As the famous investors Warren Buffett said many times, businesses need a moat, i.e. some kind of competitive advantage, to raise prices more than their costs rise. While even small businesses may have moats, these are more common among large enterprises.
In a worst-case scenario, reshoring would mean that small businesses find themselves squeezed between competing for labor, rising borrowing costs, and not enough revenue growth.
How Can Small Businesses Prepare for The Reshoring Challenge?
If we take the case of Japan and Poland, two countries with stark labor shortages due to lack of immigration and too much emigration respectively, we see that in both cases small businesses have responded with investments in robotics and automation.
Automation is expected to lower the total cost of labor by 16% on average by 2025, but savings could be as much as 30% for the most advanced economies, where a large part of the supply chain becomes automated.
Even nowadays small businesses that have been most successful in automating their operations are seeing labor costs plunging to a tiny 3% of total costs.
Moreover, whilst the most effective usage of employing robots is in manufacturing and logistics, there are other areas where small businesses can automate their labor-intensive operations, such as marketing and sales.
For example, the rise of online B2B portals since the early 2000s has allowed small companies to dramatically cut the costs of sourcing a new supplier (especially from China) or finding a distributor.
Oftentimes small businesses refrain from investing in automation because of its costs. Indeed, while the average cost of an industrial robot has been declining for years, it is still significant at $50,000 to $80,000, but can go up to $150,000 with installation, which includes adapting the robot to the specifics of the business.
However, businesses can buy reconditioned, i.e. used, robots for as low as $25,000.
Given that borrowing costs are at their lowest level in decades, small businesses that have the financial soundness to navigate the current crisis should take advantage of the situation and invest in automation for lowering their future labor costs and avoid competing in a tightening labor market. So far, only 28% have expressed this intention. If reshoring really gains momentum, we may see this figure rise.
Conclusions
As it was the case with offshoring, reality may starkly differ from theory even when it comes to reshoring. Perhaps higher employment may mean that demand grows so dramatically that small businesses will benefit even at higher costs. Or perhaps automation may happen so fast that the U.S. will not see wage inflation at all! Anything is possible, but small businesses should think carefully about what risks they wish to take: so far, investing in automation seems a safe bet.
Author: Alessandro Lazzaro
