Rising Labor Costs And The Decline of Domestic Manufacturing

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A new report is offering insight into what North America's top finance executives are thinking and doing, and why they are betting on America despite concerns about 2016. Included in the 2015 Q4 CFO Signals report from Deloitte is a quarterly survey of chief financial officers from large, influential companies throughout North America that are predominantly over $3B in annual revenue. This survey measures perspectives across the business environment, company priorities and expectations, finance priorities and CFOs’ personal priorities.

CFO survey respondents stated one of the most worrisome risks for 2016 is emerging labor cost increases. With a presidential election looming and an increasing focus on “fair living wages,” it is only natural for company executives to have concerns over how wage changes could affect company revenue. Many states have already implemented measures to make incremental increases on the minimum wage over the next few years. New Fair Labor Standards Act regulations and minimum wage laws also cause concern for declining domestic manufacturing.

Rising Labor Costs

According to the most recent report from the U.S. Bureau of Labor Statistics U.S. employment cost index, employment costs rose 0.6% in the quarter ending September 30, 2015. Over the past 12 months, compensation costs for civilian workers have risen 1.9%, while benefit costs have risen 1.8%. For private industry workers, wages and salaries rose 2.1%, while benefits rose 1.4%. Healthcare cost inflation increased from 2.6% in 2014 to 3.0% in 2015.

The National Conference of State Legislatures states that 14 states began 2016 with higher minimum wages.  Of those 14 states, 12 states increased their wages through legislation passed in the 2014 – 2015 sessions, while 2 states automatically increased their rates based on the cost of living. There is a strong opinion across company executives and business owners on how this will affect company operations, as many have concerns over revenue and profitability when raising hourly wages to the $15 mark. Whether these fears will be offset by a stimulation in the local economy has really yet to be seen or measured.

With changing regulations leading to new 2016 concerns and priorities, it is important to look at the perception of CFO’s across North America. Nearly 50% of CFOs in the Deloitte survey responded that they plan to work to lower and control labor costs to improve their company’s profitability in 2016, and 75% say a top priority is to reduce direct/indirect costs or focus on becoming more efficient.  89% of manufacturing respondents reporting efficiency as a top priority in improving profitability.  Higher employee efficiency relates to less overtime for companies, a major chunk of labor costs. Some major companies have already taken action with fears of rising labor costs.  As a result, we have seen a decline in domestic manufacturing activity and continuing fears moving forward into 2016.

Decline in Domestic Manufacturing Activity

Recently in Indiana, Carrier Corporation announced plans to move 1,400 jobs from its Indianapolis location and an additional 700 jobs from another plant in Huntington, IN to Mexico in 2017.  Carrier Corporation’s plant owner has stated he expects to pay Mexican workers $3 an hour compared to an average of more than $20 an hour for the U.S. workers. With a wage differential that large, there is not much that can be done by union representatives in terms of fighting the move and keeping the jobs here in Indiana.

There is a strong case to keep manufacturing in the U.S. Companies that make products geographically closer to their customers are able to meet customer demands, react to trends, and ship faster. Companies can also consider lower shipping costs, environmental issues, quality assurance control, political risks, and more as part of the relocation decision making process. Government incentives and a skilled U.S. workforce are top factors, as well. Even with the abundant factors that should make domestic manufacturing more appealing, labor costs continue to be one of the biggest expenses a company has to absorb. 

Are company executives taking into account all factors? Labor and transportation will make an overseas location look like a cost-effective solution for a manufacturer.  However, the increased direct costs including customs, duties, fees, insurance, intermodal handling, licenses and transportation, decreased productivity, and more play a major factor in costs.  Another top factor for efficient manufacturing operations is the ability to manufacture products near their markets. In order to keep manufacturing operations at home, many manufacturers find they can beat overseas costs with increased productivity. By evaluating multiple deciding factors in offshoring a manufacturing operation, it’s easy to understand why increasing efficiency and reducing the direct/indirect costs came out as top priorities for many of the 2016 CFO survey respondents.

Larry Gigerich is managing partner with Ginovus.

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