Relocating costs more than staying put

Employee working on Ford assembly line in Kansas City

Ford has begun repatriating jobs from Mexico to the United States, Here, employee Denell Sadler works on an assembly line in Kansas City, Missouri. (@ Dave Kaup / Reuters)

Suzanne de TrévilleSuzanne de Tréville is Professor in the Department of Operations Management in the Faculty of Business and Economics.
Sonia Arnal / Allez savoir!
Following years of relocating, some companies are returning to the country. And for good reason: a new tool developed by UNIL proves that migration often costs more than business bosses imagine.

All political leaders, from Barack Obama to François Hollande and including Johann Schneider-Ammann, Swiss president and former economics minister, extol the benefits of reindustrialising their nations. Following an era of relocation to China and Bangladesh, the time for industries in Europe and the United States to return could shortly be here. This is not only because having factories at home helps limit unemployment but also because researchers, including Suzanne de Treville, professor in the Department of Operations Management at UNIL Faculty of Business and Economics (HEC), have developed tools which prove that relocating abroad is much more expensive than company bosses previously thought. Often it could be more costly than staying put. The Obama administration has, moreover, praised the software developed in Lausanne.

Relocating is still happening today

For a long time, relocating was the thing to do. As Suzanne de Treville explains, “It’s an automatic reaction which has always existed because it’s a very natural thing to do – we see it clearly here at individual level with people regularly crossing the border to go and shop in France or in Germany simply because it’s cheaper.” It is natural and so is still widely practised today. Taking a few examples at random, Sonova, a company specialising in hearing aids, has announced it is cutting one hundred jobs and relocating part of its activities to China; Wifag, which designs and constructs printing equipment for the packaging industry, is reducing its workforce at its Fribourg site by 85 in the coming months and will be moving part of its production to Thailand and Eastern Europe. In November, it was Tetra Pak which announced the likely loss of 123 jobs at its Romont production site and the relocation of its activities to Hungary. When the announcement was made, the communications director highlighted the fact that the salary of a team worker in the Eastern European country cost 70% less than in Switzerland.

Relocating also costs money

It is this gain and this gain alone that company bosses see, just like private individuals who see only the price attached to the steak or bread. They forget all the hidden costs, such as petrol for example, or the time families waste travelling abroad; for companies, there are dozens of other amounts which are never wholly taken into account when the decision is taken to relocate. Political leaders are sensitive to the social costs of these moves abroad, which take the form of increased unemployment in particular. “In certain cities in the United States, which have lost all their industries within a few years, we see people who used to earn their living as workers having to take on two or three Mac Jobs to survive; entire cities are heading for poverty and it’s terrible,” recounts Suzanne de Treville. She goes on to stress that “For every job in industry, around eight jobs are created in services – it is industry which supports this sector and we shouldn’t forget it.” This is what colours the vision of this Swiss female academic who is focused on the tertiary sector, research, innovation and development.

Ford, Siemens, Intel and DuPont are back

As Swiss president, Johann Schneider-Ammann has well understood the issue and regularly lobbies for industries to be maintained in Switzerland. He stresses the dangers of deindustrialisation, visible in other European countries such as France or the United Kingdom, which have, according to him, staked everything on the service sector. Like him, other political leaders wish to reverse the trend, check the flow of relocations and even convince certain industries to return home. It has been one of the flagship themes on the economic front during Barack Obama’s second term in office: the reindustrialisation of his country was a key element in his State of the Union address in 2013. The president readily refers in front of the media to the return to the United States of certain assembly lines and other manufacturing linked to the automotive industry. So companies which relocated to Mexico have, like Ford, chosen to return, with the whole sector creating some 500,000 jobs. But companies which are active in other fields are also returning, such as Siemens, Intel and DuPont.

Salaries represent just 20% of the product price

To encourage these returns and avoid further departures, the US president has devised a strategy which includes making an economic tool available to enable company bosses to assess the real costs and benefits of relocating to the other side of the world. “There are obvious aspects, such as transport and customs costs, and others less so, such as the question of translation and packaging: you can’t just put your product into merchant shipping containers any old how,” points out Suzanne de Treville. She emphasises that focusing to this extent on salaries is the wrong way of looking at the issue: ultimately, labour costs account for just 20% of the product price, which indicates that they are not necessarily a determining parameter, just one among 30 factors which the US government has listed.

For her part, she has worked on a very specific aspect, which until now has been overlooked in these calculations, namely the supply chain and what it costs to extend it by relocating. She explains the principle: “When a company based in Switzerland depends on parts supplied by a company in China, the delivery times are considerably lengthened, which obliges the company to place bigger orders. It is thus more exposed to fluctuations in demand and must take responsibility for stock-management problems: it finds itself facing either stock outs or stock surpluses. And that costs it dear.”

Lausanne attracts the interest of Barack Obama

It is easier to analyse these types of cost now that they have been modelled and now that the software developed by Suzanne de Treville in the HEC Faculty OpLab has been made freely available to all (at cdf-oplab.unil.ch). This contribution was noticed by the US Department of Commerce and by the economists responsible for implementing Barack Obama’s US reindustrialisation strategy. The CDF, which stands for Cost-Differential Frontier Calculator, is now promoted by his administration among decision-makers and company heads. The tool is, in addition, available on the website of the US Department of Commerce, alongside the Total Cost of Ownership Estimator, a tool which assesses thirty parameters alongside workforce wages. The two complement each other, a fact which has led to the CDF being described as “the piece of the jigsaw puzzle missing until now” by Obama’s economists.

Relocating rarely makes good business sense

Suzanne de Treville has made a strong impression in the United States, but is she also a prophet in her own land among SMEs who might be tempted by opportunities abroad? At present, the CDF has attracted the interest of the SECO (Swiss Secretariat for Economic Affairs), which has made it available on its website. Companies established in French-speaking Switzerland have also benefited from this tool via analyses carried out by Suzanne de Treville’s students at HEC as part of their Master’s programme of work. In particular, these young researchers have identified bottlenecks and other problems associated with production chain organisation. In one of the factories studied, they reduced the period between parts ordering and delivery from 30 to 3 days, leading to just-in-time production and significant accompanying savings.

So might we conclude that, by rationalising the chain of operations in Swiss companies, savings anticipated from relocating could be achieved without exile to Asia? “There are a few occasions when it can make sense to relocate,” Professor de Treville believes. “If you want to penetrate the Chinese market, it is not stupid to manufacture on site. But in other cases, it is almost never as economically worthwhile.”

The proof is in the racket

Challenged by her colleague Ari-Pekka Hameri, who is also a professor at the HEC Faculty, to prove that manufacturing in Switzerland can be as profitable even for mass-produced items with a very low cost price, Suzanne de Treville set about concrete calculations. “There are three factories in China manufacturing tennis rackets for all brands. Their cost price is less than 10 dollars apiece and their original selling price is around 400 Swiss francs.” To be competitive while producing in Switzerland, the researcher suggested the same market should be targeted but with a much more expensive and infinitely superior quality racket, which took advantage of research into new materials in particular. The low-cost supplier does offer a mass-produced item which retails at a high price, but he is vulnerable to competition from a more technically enhanced product. A flexible factory based close to both the target market and the centre of research and development can produce 10,000 different rackets or even a customised product. For these top-end rackets, which can be sold at more than the 400-Swiss franc price tag for the mass-produced rackets supplied by the low-cost producer, it is clear that remaining in Switzerland can be profitable. To be competitive, the Swiss factory must also design rackets offered at a much lower retail price.

Producing cheap and expensive

As Suzanne de Treville explains, “Demand for high-priced rackets will be very volatile. If the factory makes only these rackets, either the production time will be very lengthy or production capacity will be under-used. The ideal factory will be constructed to produce top-end rackets with a capacity to ensure demand is fully met. The cost of this capacity will be assigned to these rackets. As a good proportion of the capacity will not be required in order to respond to the demand for these items, the factory will use its surplus capacity to produce cheaper rackets, which can be profitably sold at the price of mass-produced rackets remaining unsold after the start of the season, namely 200, 100 or 50 Swiss francs. Simulation clearly shows how this strategy is potentially superior to a low-cost strategy.”

Combining manufacture of cheap, mass-produced items and high value-added products is a model which functions in widely differing sectors: Suzanne de Treville has used these same ideas to explain why the company Flexcell went bankrupt, when it firstly exclusively manufactured top-end products and subsequently manufactured only mass-produced products, when a portfolio of both types of product would have given this company a chance of surviving. She remains convinced that Tetra Pak has the opportunity to be more profitable by remaining in Romont rather than heading for Hungary, provided that the factory, which is based close to the research and development segment and which has experienced employees, combines innovative and standard products. This mix corresponds, moreover, to the Swiss economic model in which innovation and development play a significant role. “Not forgetting that in China and other countries of Asia, the issue of intellectual property and patents is a sensitive one,” the professor adds. “By developing innovations in Switzerland, you are sure of retaining ownership of the idea.”

The developer must get on the factory floor

Added to this is the fact that research and development are destined to fail unless the factory is located nearby. According to Suzanne de Treville’s analysis: “You will achieve nothing positive if you work in the abstract environment of your lab: everything always works in theory. Reality is more perverse and, as a developer, you need to get on the factory floor to put your prototype in the hands of the workers to see how production fares. When the factory is in China, you can’t do that and that leads to far less innovation in firms.” It is therefore an illusion to think of retaining high added-value sectors in Switzerland, such as research and development, in order to outsource mass production to Asia: in fact, decoupling the two sectors, as if they concerned two independent economic worlds, does not work.

In short, relocating, contrary to what we might think at first glance, is rarely the best way to increase profits. Optimising the production chain is a far more promising option and enables industries to be retained in Switzerland. So should we not be creating a company based on the tool developed in Lausanne, which would analyse the desire to relocate and put forward solutions to improve profitability without moving and destroying local employment? “There is very clearly a market for that,” replies Suzanne de Treville. “But frankly, launching a start-up based on this concept does not really interest me. My students can use the tools already created and I know that several would like to start such an enterprise. My role is to conceptualise the needs in my field and to reflect on how to provide solutions: research is my thing!”

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