Reshoring as a Strategy

Charlie Reid:

There are a lot of disadvantages to tying up your working capital and your brand value in an uncontrolled source that's on the other side of the world from you.

Narrator:

Welcome to Accounting for the Future, a BDO Canada podcast for financial leaders to navigate change and achieve business growth. We'll uncover the challenges financial leaders may not have dealt with yesterday, but we'll definitely have to manage for the future.

Anne-Marie Henson:

Hello, and welcome to BDO's Accounting for the Future. I'm Anne-Marie Henson and today, I welcome Charlie Reid, Director of Operational Improvement at BDO Canada. He has over 40 years of experience advising the manufacturing sector through consulting work, as well as holding various executive and board positions. Charlie, welcome to Accounting for the Future.

Charlie Reid:

It's a pleasure to be here, Anne-Marie.

Anne-Marie Henson:

Great. Well, I'm really looking forward to our topic on the risks and benefits of reshoring. So, the pandemic really changed the way that Canadian companies do business, and so, our discussion today is going to focus on what I think is a really important aspect of any company that sells goods, whether it be a manufacturer or a direct-to-consumer wholesaler, and that's the supply chain. Prior to 2020, we'd all noticed a really significant change in how materials and products were sourced in Canada, with a lot of raw materials being sourced from countries outside of North America, namely Asia. Before we start, Charlie, why don't you tell us a little bit about the history of when and how this move to international importing even just started occurring?

Charlie Reid:

Well, it's been going on for decades, really. I think the pandemic shined a big spotlight on the whole supply chain as a thing. A lot of people just never even used the term before. And now, it's normal to say, "Oh, and our bathroom renovations late. Supply chain, right?" "Yeah, yeah. Supply chain." Everybody knows the term now. But I would say we were looking at seeing significant volumes being offshored to China in the late '80s early '90s, that far back for sure. When I was working principally in the automotive parts sector back then, we were very well aware of the pressures that were coming from China. And certainly, the OEMs were the original equipment manufacturers, the main auto manufacturers were certainly aware of it.

If anything, they understood really the value of having your vendors closer to home than most do; most did. What you saw was primarily a shift to A, raw materials being sourced in China, and then commodity parts, things like screws, and hardware brackets, and things like that, which were easy to make, inexpensive to make for China. They were basically buying a lot of the capacity in North America that could produce those parts. So, yeah, it's been going on for, say, three decades, I think.

Anne-Marie Henson:

Right. And I guess perhaps we just read more about it today than we have in the past because you're alluding to the auto manufacturers, which may have been very acutely aware of the benefits of keeping your suppliers nearer. But we've been hearing more and more these days because of perhaps ESG and all these supply chain issues that we have been seeing throughout the pandemic, that companies are questioning whether the strategy of importing is the best one to ensure the long-term growth and viability of their company. Before we dive into the risks and the benefits, I've heard a lot of terms being thrown around, and I'd like to hear from an expert about what those terms mean and whether they're interchangeable. In the past several months alone, I've heard about reshoring, nearshoring, onshoring, and could you tell someone who's not in that line of business what those all mean and whether they're interchangeable?

Charlie Reid:

So, onshoring and reshoring are essentially interchangeable. They both mean taking products that you offshored and bringing them back home. So, the opposite of offshoring is onshoring, and the reshoring is basically another euphemism for doing the same thing: taking something that is offshore and bringing it back home to your home territory. Nearshoring less common term, and I don't know if there's a specific correct definition for it, but I think it means, like, if I'm going to search from the United States, and I'm in Canada, I could be considered to be nearshoring that product. It's still far away if I'm sourcing from... Or even Mexico, for example, could be considered an attempt to gain the advantage of the low-cost labor that we were trying to exploit through Chinese sourcing. Onshoring and reshoring are essentially the same thing.

Anne-Marie Henson:

Okay, great. Well, for the purposes of this discussion, I can use the terms interchangeably. So, I wanted to start getting to the discussion about reshoring and what are the risks and the benefits to companies? But before that, I did want to get your thoughts on whether continuing to import could be a good decision to take. Looking back at that strategy now with hindsight, given everything that's happened over the past couple of years with supply shortages, really high shipping costs, and a lot of more scrutiny on sustainability, climate-related impact of importing from a country as far away as China, what do you think companies should be considering or thinking about today when they're trying to decide whether it's a good idea to continue sourcing from China?

Charlie Reid:

There was never a one-size-fits-all answer to the question of whether or not you should offshore or not. I think that what we tended to see was a general tendency to assume that sourcing in China, or India, or some other low-cost labor jurisdiction was going to be good for your business regardless of what your business was. And that simply is not the case. There are instances now where it was the same as 15 years ago; you shouldn't have been offshoring 15 years ago, you shouldn't be offshoring now. And those are primarily related to the size of the company that you are. If you're a mid-market entrepreneurial-run manufacturing company, and you make... I can also say you've got sales of 30 million, or 40 million, or something like that, and you make 10,000 of a thing or 20,000 of a thing. That's not a lot of volume in the world of Chinese outsourcing to lower-cost labor jurisdictions.

If you've got hundreds of thousands of things, then it's, generally speaking, going to make sense for you to offshore those products. But when you start looking at 5,000, 10,000, 15,000 things, there are a lot of disadvantages to tying up your working capital and your brand value in an uncontrolled source that's on the other side of the world from you. And now, as we see more and more pressure on ESG, and it's the whole idea of sourcing close to where you actually manufacture for other good reasons, which were, by the way, good reasons 15 years ago too, but they've just become more popular now, we're starting to see just a little bit more awareness on some of these other factors that come into play and that really should have been coming into play all this time.

Anne-Marie Henson:

Absolutely. No, thanks. And it's really helpful to at least start having that conversation and looking at what options might be best for them, understanding that the lower volume of orders that you make as an organization, as a company, the lower priority you are, and the lower negotiation power you have when you're looking at offshoring. So definitely, though, this is a decision that for companies, regardless of their size and regardless of the amount of goods that they order overseas, if that's what they've been doing for 10, 15 years, it's a decision that can take time, and it's a lot to undertake if you're deciding to completely change your strategies. So, we want to talk a little bit today about the real pros and cons of a reshoring or onshoring strategy. And with your experience in this field and all the companies you've advised in your past about a reshoring strategy, can you just talk to us about what you'd say would be, let's start with the cons in this conversation. What would you say would be the biggest risks or pitfalls that could occur either during or after the reshoring process?

Charlie Reid:

The risks that you have are basically managing the in-process supply chain while you're winding down a business relationship with a offshore vendor. It has been known to happen where you make a good faith business decision to stop using a vendor, and then that vendor suddenly remembers they've got a bunch of quality claims against you or they've got some charges, additional charges for you to handle that are basically made up. But your inventory is in their hands. So, there's some risk that inventory you think is free and clear that you've even got a letter of credit on or is paid for, or otherwise will be held hostage by that vendor. I've seen it more times than I care to tell you. It's a little bit of a travesty. And the problem is you don't have any leverage over, generally, a vendor that's that far away. And the legal system in China is not very friendly towards outsiders looking in.

I heard a lawyer who specialized in China, doing business in China, advising a group of auto parts manufacturers that in China, the laws are considered state secrets. So that's why there aren't very many lawyers in China. So, you talk about the risks of the onshoring process; you probably want to be sure that you don't really, really, really desperately need the material that you do have on route or in process and that you execute the plan to reshore very cautiously and deliberately would be one of the suggestions I make. And again, there's lots of fine suppliers in China that are completely above board and do business the right way. It's just there are a few bad actors out there, and some of them are represented by Canadians who also participate in this. I hate to use the word blackmail, but that what it is.

I had a trading company that I dealt with in Ottawa, for example, who shall remain unnamed, that held a gun to one of my clients' heads in a reshoring activity. And there are all kinds of extra charges for packing up the tooling, and even though they own the tool, my client owned the tools, all kinds of extra charges associated with it. You know, eventually, you're going to pay those things, but it can happen, I guess, is the point.

Anne-Marie Henson:

Right.

Charlie Reid:

It's not to say that it will happen, but it can happen. Any other cons? It's like any other business relationship. You don't want to burn any bridges; you can avoid it. If you treat your vendor with disrespectfully, then there's always a chance that they will drag their feet. Even though they're going to comply, they may drag their feet. Yeah, I would say really just managing the in-process orders and making sure that you're aware of the fact that they could be threatened.

Anne-Marie Henson:

Right. And I guess one takeaway is that it's not a decision that should be taken lightly or be made in haste, meaning to definitely just plan in advance and understand what your needs are going to be, where your goods are in that chain so that you try to minimize the risk of loss as well or the risk of delays. Definitely, some good things to think about. And let's move on to the pro side then, in terms of looking what the advantages are because although there is some risk and it's important to consider all the potential negative implications, I think that generally, there are a lot of benefits to reshoring. So, could you maybe walk us through what you've seen in experience as having been some of the major advantages of this kind of strategy?

Charlie Reid:

One of the advantages you're not going to find is that it's probably not going to be less expensive on a purchase price per unit from an onshore vendor. So, I guess that's a con. But it's not the purchase price that you need to worry about; it's the cost of usage that you need to be worried about. One of the huge disadvantages of dealing with a far away vendor is the length of the supply chain, and the length of the supply chain means, by definition, that you have to order months of stock at one time, sometimes as much as a year's worth of stock. And depending on lead times, which we saw negatively impacted through the pandemic, they can get crazy long, which means that you're having to use a crystal ball to forecast what your demand is. So, there's always this cost associated with having way too much inventory.

And the bigger risk with having too much inventory isn't necessarily the working capital aspect of it, though that's not insignificant. It's the threat that the inventory that you have is actually no good, that there's something wrong with the inventory that you have. Not that it would be defective on purpose because you may have used the vendor for a long time. But the problem with very large order quantities is what we call the time to detect a defect is very, very long. So, you could have a defect in your product, then it's halfway down your six-month supply, and then everything after that has the potential of being defective. And now, what do you do? Well, you don't have any leverage, so you can't get them to immediately air freight you more stock, which would be the right thing for them to do. They'll be happy to have you air freight it, by the way, which I've seen lots of my clients do.

So, if we look at the pro side of onshoring is you don't have to worry about that sort of thing. You don't have to worry about having six months' worth of inventory unless that's the norm for whatever component it is you're purchasing. But if that's all your competitors will be in the same boat. You don't have to worry about that nasty thing called air freight, premium freight other than perhaps premium trucking freight, which is much less expensive. You, generally speaking, don't have to worry about not being able to deal directly with your vendor on quality concerns. The laws that they operate under are the same laws that you operate under. So, you do tend to have more recourse if you're dealing with a domestic supplier. And chances are it's never going to come to that with a domestic supplier anyway.

Again, famous last words can happen. I'm sure there are 25 lawsuits that are being started right now as we speak between suppliers and customers and vice versa. But yeah, in general, you're going to have, if you do it right, you're going to be focused on developing a relationship with your vendor, your new onshore vendor. They're going to be motivated to make sure that you're happy. They're going to be motivated to make sure you're well-served. You're not going to have to order six months' worth of stock. You're going to maybe able to order a month's worth, maybe even two weeks' worth, depending on how close they are. I had one client in Kingston that we reshored product from China to Ottawa and some to Toronto. So, we brought everything that was offshored to China and brought it within 150 miles of Kingston. And in some cases, there was a net cost decrease, thankfully enough, which makes you shake your head.

But other than that, the quality of the products that being manufactured were fine. The immediate attention to defects and problems was super fast. The quality of the relationship with the onshore vendor was very high. Because I refer to it as vendor, but there were vendors, some producing electronics, some producing plastic parts and producing steel parts. But in the end, all of them were highly motivated to secure another account and a good Canadian account. It's as comfortable for a vendor to supply somebody locally as it is for somebody locally to have a vendor that's close by as well.

Anne-Marie Henson:

No, that's fantastic. Actually, it's really interesting, and I think you've partially answered at least a little bit of my next question, but I want to ask it anyway because one thing I've heard from clients who are, they feel like their hands are tied with their international suppliers, is that they're concerned that there's no way they can remain competitive in their pricing when they move with a reshoring strategy. And you talk a lot about these hidden costs. But tell me, is that a myth that you cannot remain competitive if you have more locally sourced vendors? And what do you say to companies who have this barrier and who are afraid of moving forward?

Charlie Reid:

Well, again, some of these things are circumstantial. If you, for example, have a product that you change frequently, it's super beneficial to have a locally available source because that then decreases your obsolescence and that sort of thing. So, avoiding obsolescence is actually another one of those pros that you can have from having a local source. Let's say you don't make a lot of changes to your product, maybe you want to be thinking about that. Because making changes to your product on a continuous basis actually causes your competitors to have to react to you. And to the degree that you get very good at making changes to your product with minimized inventory losses, you always have competitors that are in an attempt to follow your lead. But again, that's circumstantial. If you have a product that is well-suited to engineering changes, for example, or it's an electronic product that you want to tweak and add features to, it's really, really beneficial if you can do that super fast, and you can't do it super fast if you're sourcing from China. You can't.

And again, the client I had in Kingston made an electronic device, we ended up having it engineered in Ottawa, manufactured in Ottawa, and assembled it in Kingston. So, it was win-win, and we made multiple design changes to that product over the years that caused that particular client to be a leading provider of the particular device that they made. So, how much of that was related to onshoring? I like to think that it was a significant factor.

Anne-Marie Henson:

Oh, that's really interesting actually. And something I haven't necessarily thought about, but it's so important these days with the rapid changes in technology, which impact every aspect of any industry today. So, even if perhaps 10, 15 years ago, maybe you didn't need to make a lot of changes to your product, but today, with the competitive environment and things moving so quickly with the use of technology and integrating that into your product, that maybe it's a good strategy today, even if 10 years ago, you didn't have to make all those rapid changes. I think one thing I've taken away is just the importance of considering the benefits to reshoring outside of just the product cost itself. And being a podcast that talks about accounting for the future, I did want to take a step back and ask myself where else could this reshoring strategy have an impact on a company's financial statements is financial reporting.

And obviously, when you look at the company's financial statements, a big line is the cost of sales, which is right under your revenue line, and it derives your gross margin. But outside of that, even if, let's say, it was more expensive due to higher product or labor costs to if you were sourcing from Canada, I think there's some other areas to consider where there could be some savings or some implications, one of them being foreign exchange.

Charlie Reid:

Yes.

Anne-Marie Henson:

If you are a Canadian manufacturer and you're buying from Asia, a lot of times, you're buying in US dollars. If your customer base happens to be mostly Canadian, you're not benefiting from that natural hedge by selling in US dollars, but you're incurring all the risk in paying US dollars.

So, I think that's another thing that companies should consider as they're going through this strategy is not just what's impacting my margin or my cost of sales, but what are all the other implications throughout the financial statements? Another one we talked about a little bit was shipping costs. It's a lot more expensive, and often, you can't secure that or commit to a specific fixed price on shipping. So, you're subject to the fluctuations that are occurring in the market. And obviously, as we've seen in the past couple of years, those costs have doubled and even tripled for some companies who are importing from overseas.

And then, finally, I thought as well about interest costs. You referred to working capital. And I think it's something that's very important to consider as well because interest doesn't necessarily factor into your cost of sales, but if you're having to pay your suppliers six months in advance for product that you're not selling sure for another six months, and then, not getting paid for another, say, I don't know, 60 days after that, you're paying well in advance for goods that you're not getting the cash flows to pay off your debt. So, assuming you are paying for your suppliers through your line of credit or through any sort of external financing, you are paying interest on those which can add up over time. Is there anything else, I guess, that we haven't covered that you think companies might want to consider?

Charlie Reid:

There's this whole potential that your customer base might actually find it valuable that you are sourcing in Canada. So, that worked in one of the instances of my client that sourced all the stuff from Ottawa and Toronto, from China. They made a big splash about that. 'Now, all our products are sourced within a hundred miles from Kingston', and it was received very favourably by their customer base, who happened to be more of a homegrown customer base. You don't want to dismiss that brand value. Just to reiterate that interest is one of those cost of usage factors that can be invisible, just to underscore that. You need to make sure that you're taking that into account.

Some of the other downsides of being an offshore sort of situation is just the lack of respect for intellectual property can be a real threat to a Canadian vendor. So, regardless of your volume of stuff to make, you should never offshore your secret sauce, never, because it will be copied, and it may not be copied by your supplier, but it will be copied by the supplier that lives next to them. And they're complete lack of shame associated with that. I've seen my clients' products advertised, including brand marking, but it couldn't be their product because they didn't make that colour in their company. So, you do have counterfeiting as a routine threat. You do have some risk of counterfeiting even on something as important as material specifications, which can be a safety concern. You do have environmental concerns that because it's China, you don't necessarily know that the environmental standards that something is made to are actually being enforced, whereas you do know that if you're purchasing from Canada. So, it's a big ESG advantage.

And I did want to touch briefly on the whole aspect of anti-dumping, and this is a little bit of a political football, but anti-dumping has been sadly placed in the lap of the manufacturing companies themselves to prove a case of dumping against a Chinese competitor. And this, really in my mind, is a lack of stewardship on the part of government. It really that should be their role to protect their constituents from companies selling products for less than their cost. And I don't know if that's been dealt with. I'll be honest; I haven't heard of anybody claiming dumping any time in the last 10 years, but it was always a sore point with me. Smart things to purchase from China? Tooling. They tend to be exceptionally well-made very well-engineered. Even the plastic injection moulding companies I deal with in Ottawa get their tools from China. There are a few exceptions to that, but that's generally speaking, you shouldn't necessarily avoid purchasing your tooling from China. They're long lead items, anyway. What else? Anything? I can't think of anything else off the top of my head.

Anne-Marie Henson:

No, that's great. Honestly, really useful information and very relevant for companies to start at least trying to get an idea in terms of what the risks and the benefits are and some of the considerations that I think are really important. I love what you said about intellectual property. Business owners, entrepreneurs work so hard to build up a company and like you said, to build their... Write up that secret sauce and differentiate themselves in the market. So, losing that it would be really unfortunate and definitely something that they should consider when they're looking at various importing strategies.

So, Charlie, I'd really like to thank you for your valuable time and your input today. I hope our audience appreciated this discussion. I'd also like to thank you, our listeners, for tuning in and to all of our episodes. I'm Anne-Marie Henson, and this has been BDO's Accounting for the Future. Please let us know if you found the topic interesting and useful, and remember to subscribe if you liked it. We'll see you next time.