For more details on this topic, make sure to tune in to our podcast "Reshoring as a Strategy" where we discuss the utilization of reshoring as a strategic approach.
Published: August 27, 2023
Updated: August 27, 2023
In an era marked by unprecedented supply chain shortages, inflated shipping costs, and heightened scrutiny over sustainability practices, businesses across the globe are re-evaluating their sourcing strategies and challenging whether it is still a good idea to continue offshoring purchased components.
While offshoring typically offers the immediate gratification of lower unit prices and direct material cost savings, it carries a number of hidden costs and risks that are often overlooked and can be significant. For some businesses, the cost reduction makes the risk worthwhile as with companies that buy very high volumes of components for example, but for many businesses, particularly small to medium-sized, the net disadvantage suggests the need for a different strategy. A fulsome consideration of the life cycle cost to use, as opposed to the cost per unit to buy, will often indicate that companies are better off repatriating their purchasing, or so-called reshoring.
In this article, we focus on the effect of shifting your sourcing strategy and analyze the risk avoidance and benefits associated with such a decision, offering key considerations that you should weigh when determining the optimal strategy, and how it eventually translates into financial reporting.
Onshoring, reshoring, or nearshoring?
Onshoring, reshoring, and nearshoring are distinct strategies typically deployed for the purpose of relocating products from remote/offshore sources to jurisdictions that are physically closer to the consuming plants.
Used interchangeably, onshoring and reshoring refer to the practice of repatriating business activities to the home country from which they were previously outsourced. In the case of Canada, reshoring typically does not just mean bringing products back to Canada but back to your home base. For example, a Toronto-based manufacturer will typically reshore to Southwestern Ontario, while a Vancouver-based company will reshore to the lower mainland.
On the other hand, nearshoring—just as the name suggests—involves the relocation of business activities to a neighboring or nearby country. This approach allows businesses to benefit from lower labour costs, reduced logistical complexities, and cultural similarities while still maintaining some level of geographical proximity that facilitates collaboration and responsiveness. An example would be when a Canadian business is nearshoring to either the U.S. or Mexico. Where free trade agreements are in place, it can dramatically simplify import and export activities.
What to consider when reshoring
In a post-Covid era of lengthening supply chains, rising shipping costs, and higher interest rates, the advantage of offshoring is eroding. Reshoring is now being considered as businesses weigh the pros and cons of relocating material purchases. While the purchase price advantage still exists and appeals to many companies, there are hidden risks and costs that are often overlooked. These risks can be especially detrimental for small to medium-sized companies, quickly erasing any gains in the purchase price.
Reshoring can offer a way to mitigate those costs and risks, but it still presents challenges and drawbacks that necessitate careful evaluation and understanding of your business size and needs.
There are a lot of disadvantages to tying your working capital and your brand value in an uncontrolled source that is on the other side of the world.”
The hidden costs and risks of offshoring
There are some distinct advantages offered by reshoring, mostly those that relate to avoiding the disadvantages of offshoring. Here are a few of the central risks and costs of offshoring:
The longer the supply chain, the more inventory you need to carry, the more you need to count on paying in interest carrying costs, and the more space you require or need to secure to hold that inventory. Rising interest rates increase carrying costs while soaring industrial floor space expenses prompt many companies to reduce operational footprints. Higher inventories make this challenging.
With reshoring
Effective supply chain management of a domestic source can result in raw material inventories measured in weeks not months. All the above disadvantages are avoided or significantly mitigated.
With order lead times of 3 to 6 months, accurately predicting demand for offshored components is almost impossible for companies. Most companies will either overestimate or underestimate demand. Overestimating demand leads to higher inventories, increased carrying costs, heightened obsolescence risks, and exposure to potential hidden quality issues. Underestimation is worse and results in the need for expensive expedited premium freight methods like air freight, offsetting cost savings from ocean shipping. In the worst case, suppliers may fail to meet demand, resulting in lost revenue and potential loss of customers. Due to these risks, companies often lean towards overestimating demand when planning for offshored components.
With reshoring
The proximity of vendors means that forecast periods can be shorter, and the risk of over or underestimating inventories is greatly reduced. Also, the risk of incurring premium freight due to forecasting errors is next to nothing, but if necessary, it would be premium trucking and not premium air freight.
Phasing out production or introducing product design changes are particularly challenging in an offshoring environment. With the higher inventories associated with offshore production, it is far more likely that a company will end up having to write off a chunk of inventory that can no longer be used. Here again, the complete loss of as much as several months' supply of raw material can easily offset any purchase price per unit enjoyed to that point.
With reshoring
The exposure to inventory write-offs due to excessive inventory on hand is extremely low if not nothing. In most domestic supply situations, product end-of-life and design changes can be managed with running changes in which the low amount of inventory on hand is what the customer agrees to use up.
When a quality issue is detected, it is assumed that all current and future inventory will have the same defect. This includes completed inventory and products in the manufacturing process. With large inventories, it becomes the responsibility of the company to sort through the affected and any subsequent inventories. There is also a risk that overseas vendors may not take responsibility for these quality issues, especially if the buyer has limited leverage as in the case of small to medium-sized buyers, leaving them with very limited avenues of legal recourse. This lack of accountability can lead to additional costs, impairment of the balance sheet, and reduced effectiveness in purchased components, thereby increasing the overall cost to use the components.
With reshoring
Quality problems may still arise, but the level of inventory reduces the containment cost; and the proximity, time zone, and language of the vendors will almost always result in a more productive, prompt resolution. While disagreements and disputes may still arise, they can be dealt with within a legal jurisdiction you understand and can navigate. It is unlikely that any meaningful impairment of balance sheet inventory would result from a vendor quality problem.
The lengthy overseas supply chain is susceptible to various uncontrollable disruptions. Unfavorable weather, strikes, and political unrest can cause shipping delays or container losses. Uncontrolled overseas holiday periods can lead to inaccurate supply rate assumptions. Even within Canada, when containers arrive at a port, they must go through customs, which can introduce additional delays. The current labour unrest in the port of Vancouver is a prime example of a domestic supply chain disruption to offshore purchases.
With reshoring
These sorts of delays will simply not be a factor.
Counterfeiting and theft of IP is a well-known occurrence in offshore jurisdictions. While this can occur whether the component is sourced overseas or not, it is much more likely if it is sourced overseas. There will be little a company can do about this as many offshore jurisdictions simply do not respect intellectual property rights.
With reshoring
You are less likely to experience counterfeiting, and unlikely to experience IP leakage. But if you do, and the source is isolated to a domestic supplier, legal recourse would be available to you in a system you understand and can navigate.
Another key advantage of reshoring is the company's brand image. There has been a noticeable surge in demand for locally sourced products observed in today's market. This shift reflects a growing trend where customers are increasingly prioritizing goods that are sourced from their local market, a preference that signifies an increased appreciation for local businesses and fosters a stronger sense of community and sustainability.
The sense of nationalistic pride should also not be underestimated. “Buy Canadian” impetus can have a positive impact on your company's brand value.
Reshoring disadvantages
Direct material purchase price per unit increase: It is likely that your purchase price per unit will increase when or if you reshore a product. Factors such as higher domestic labour costs, stricter regulatory compliance, and more expensive raw materials in the home country can contribute to a higher-cost environment. When considering reshoring, you need to carefully analyze the impact on the overall cost structure to ensure the benefits outweigh the additional expenses and risks and help sustain your pricing competitiveness. It is advisable to take a life cycle cost-to-use approach to ensure you consider all costs created by offshoring, as well as all events that lower frequency but entail very high costs, like premium freight, and one-time/infrequent inventory write-off costs. As noted above, for some companies, offshoring is still the right strategy as the savings outweigh the risks and costs.
If you are a small to medium-sized company purchasing a custom product, a very close look at the risks noted above is in order.
It is worth pointing out that even for small companies, there is little risk associated with offshoring commodity items such as nuts and bolts and very simple hardware, as these are relatively easy to redeploy/repurpose should you end up with too much and are relatively easy to source elsewhere should you end up with too little.
Specialization and expertise challenges: Some regions have developed specialized manufacturing clusters and ecosystems that offer unique expertise, access to skilled labour, and established supplier networks. Shifting production away from such regions may result in a loss of these advantages, potentially affecting the company's ability to innovate, optimize processes, and compete in the market.
A good example of this is hard tooling. Some overseas jurisdictions produce exceptionally high-quality tooling that is competitive with North American tooling, and since the lead time is long whether sourced domestically or not, the disadvantage of the longer supply chain is less critical.
Disruptions to established supply chains: Implementing a reshoring strategy requires a significant realignment of supply chain networks, which can be disruptive in the short term. The process may involve finding new local suppliers, renegotiating contracts, and adjusting distribution channels. These transitional challenges could also create business relationship turbulence with the previous international vendors and need to be considered and tackled carefully.
In short, reshoring is complicated and takes careful planning and execution. Little things like securing the return of hard tooling that may have been built for you overseas can be more time-consuming and costly than you might expect. This means ensuring appropriate inventory banks are built in preparation for reshoring.
The impact on financial reporting
Whether evaluating your current offshoring initiatives to consider the best options for your sourcing strategy or already planning your reshoring initiative, it is crucial to also understand the intricate connection between sourcing strategies and financial reporting. Here are a few areas to consider in your strategic planning.
If reshoring, you should expect an increase in the cost of sales. This will impact the gross profit margin, and hence, impact the overall financial analysis and performance evaluation.
Higher inventory costs have a direct impact on interest costs, which can add up over time. Offshoring will almost always drive higher inventories, and this in turn will drive consumption of working capital and available credit facilities. Many overseas purchases are effectively prepaid causing this working capital consumption to occur well before the receipt of the inventory asset.
When paying in a foreign currency, such as the U.S. dollar, but selling locally, the business won't be benefitting from the natural hedge of selling in the U.S. dollar but incurring all the risks associated with paying it back to the vendor, which can impact the overall costs.
Shipping costs have been on the rise in recent years, doubling or tripling in some cases, which can further increase expenses for businesses engaged in offshoring.
Higher inventory costs do not just impact interest charges, they can directly result in higher obsolescence risks which may result in a balance sheet quality issue, and thus, an obligation to disclose, especially if approaching a known product end of life.
Helping you make informed decisions
The impact of reshoring on a business’s financial reporting depends on various factors, including the nature of the business, the scale of operations, and the specific circumstances surrounding the reshoring decision.
Regardless of your preferred strategy, it is recommended that you plan in advance and consult with BDO’s professional advisors for more tailored guidance and analysis based on your unique situation. Our Accounting Advisory teams can help your business in all matters financial–from managing change to business advisory, transactions, capital markets support, and financial reporting services.
To learn more about how BDO can help your business succeed, please contact:
Anne-Marie Henson, Eastern Canada & SMB Leader, Markets & Industry
Charlie Reid, Director of Operational Improvement, BDO Canada
Mary Mathews, Partner, Accounting Standards & Advisory