April 2017 Monthly Article – Companies and the Total Cost of Business

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I recently had a student make a comment in a class that I was teaching that she was excited because a tax is going to be applied to all imports coming in to the U.S., and this would be forcing American companies that have moved operations to foreign countries to come back home. Her enthusiasm was so contagious that I felt like a heel when I broke down for her the many reasons why a company sets up foreign operations, and why or why not government policy becomes a driving factor in the retention or repatriation of jobs in the U.S.

In any business school, students are taught the basics of economics and profit maximization. Based on these concepts, companies will set up their operations where their total cost to produce their products is lowest, while considering access to their target markets. Although it tends to be the most popular reason, the cost of labor is but one factor in the decision in where to locate a manufacturing plant. The old industry standard was that if 40 percent of the cost of your production process was based in labor, you probably were better suited manufacturing in a lower-labor-cost country such as Mexico or China. Today, this percentage does not necessarily apply so readily to companies that use complex supply chains and logistical schemes.

Other factors include access to final markets, access to suppliers, utility costs, construction/leasing costs, political environment, a favorable business environment, and incentives. And yes, another factor considered in a site selection decision is tariffs. In my student’s case, she was referring to the 20 to 35 percent import tariffs that President Donald Trump mentioned during his campaign and tenure in office. It is uncertain the direction the Trump administration is going to take on trade issues such as tariffs or renegotiating the North American Free Trade Agreement. However, Trump has used his bully pulpit to castigate companies that have announced that they are moving operations to other countries.

Upon assuming office, he put pressure on companies such as Carrier Corporation, which was going to move 1,000 jobs from Indiana to Mexico, and Ford Corporation, which was contemplating another auto plant in Mexico, to announce publicly that they were scrapping these projects. However, Carrier later stated that 800 jobs would remain in Indiana, but 500 would still be outsourced. And although Ford scrapped plans for a new plant in Mexico, industry experts have stated that it simply will move more production to a plant it has in Hermosillo, Mexico, which has excess capacity.

The initial shock of having the President single out and publicly call out companies in the process of outsourcing jobs seems to have worn off, and more companies recently have announced the relocation of their operations to Mexico. These include Wisconsin-based Rexnord, which makes industrial bearings, couplings, and seals; General Motors, which wants to move more of its Detroit operations south; steel producer Nucor, which wants to outsource more production to Mexico; and Caterpillar, which will send production to Monterrey, Mexico.

The companies are not playing a game of “chicken” with the President, nor are they all announcing their moves at the same time like zebras sprinting across a river in a herd in order to get by a stalking crocodile. Rather, companies are following the simple economics of lowering their production costs in order to maximize profits and to stay in business. Some people might accuse firms of focusing too much on profits and too little on humans, but in the U.S. model of capitalism, the job of a board of directors is to maximize shareholders’ wealth. President Trump and his family understand this concept very well, having manufactured items such as clothing in foreign countries in the past. Currently, Ivanka Trump, the president’s daughter is producing and importing handbags, shoes, and accessories from China. Imposing a 20 percent import tariff on a product on which a company saved 50 percent by producing it in a foreign location still supports the case that the product is made there more efficiently and economically, all factors being considered.

On the other hand, the more automated a production process, the less of a factor that labor becomes. It is in this situation where the U.S. can not only retain jobs, but pull back home manufacturing that can operate more efficiently and cost effectively here. I have seen certain plastic injection plants, whose processes become automated, move back to the U.S. Likewise, I have seen certain steel fabrication and wire production facilities choose to locate or remain in the U.S. because of our advantages compared to other countries. More automation implies less need for American workers, and these workers will need more specialized skills to operate complex machinery. Labor skills will need to be enhanced or developed in order to create these manufacturing jobs in the future, which will offer higher salaries.

In the U.S., we should strive to improve our business environment, tax environment, infrastructure, and workforce skills in order to retain and attract industry. However, it is overly simplistic to think that slapping an import tariff on everything imported into the U.S. will magically make previously lost production return.