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The Evolving Cost of Labor

Should we still consider the cost of labor as one of the main decision points in outsourcing or moving manufacturing to a low-cost region? The answer is, of course, yes. However, with a shift in the global landscape, we should look closely at where that decision may take us. Historically, most roads have led to Asia, and more specifically China. Assuming that our decisions to either move or outsource operations to countries other than our home base are for all the right reasons, let's focus on the trends of just the labor rates.

Somewhere around the end of 2008 and the beginning of 2009, there was an inflection in a grouping of low-cost country labor rates that we track: India, China, Thailand, and Mexico. Labor rates at all of these countries dropped, except for China, which continued to climb. There has been a bit of jostling over the past few years, but the forecasted outcome is that China will continue to increase at an average rate of about 13 percent per year over the next five years. This leaves them at the highest labor rate in this group of countries. Mexico and Thailand have very similar hourly rates, which are lower than China, and a very similar average annual growth rate of about 5 percent per year over the next five years.

When we look towards Europe, we track Ukraine, Romania, the Czech Republic, Hungary, and Poland. While all of these countries have higher rates than our Asia grouping, Ukraine and Romania are very competitive with more modest growth rates over the next five years in the range of 10 percent per year.

Pulling back to a higher level, we see that in real terms, labor rates for Ukraine, China, Mexico, Thailand, India, and Romania are projected to be between $3 and $6 per hour at the end of 2016. The fundamental question is how much does this affect us? Of course, this impacts each company differently, as the percentage of labor content and technology varies by product.

When making decisions to move operations, there are other indicators and metrics we suggest besides the capabilities of outsource partners, transportation costs, infrastructure, and the like. Looking at foreign direct investment, GDP for industry per worker, and regional risk assessment will help build a more comprehensive picture.

16 comments on “The Evolving Cost of Labor

  1. Cryptoman
    July 24, 2012

    Besides the cost of labour, I also think what you get for your money is important. The common belief is that China is very good at imitating but not too much in innovating. Once a client who was getting his fire detectors made in China told me a story that is a perfect example of the imitation capabilities of China. A few years back, my client provided a sample to the manufacturer as a reference for the batch of products that was going to be manufactured there. Apparently, that particular sample had a random scratch mark on the chassis. When my client received the first batch of products, he was quite surprised to see the same scratch mark repeated on every single item! Another common belief is that although software work is cheap to outsource in India, the end results often need redoing due to the poor coding practices. In addition, to this extra effort, retesting of the modified software also adds to the total cost. Therefore, if one wants to achieve a high standard of quality in products, cheap labour has to be approached with great care and caution.

  2. Houngbo_Hospice
    July 24, 2012

    @Cryptoman,

      Therefore, if one wants to achieve a high standard of quality in products, cheap labour has to be approached with great care and caution.

    You have a point here. But the only factor that will make companies reconsider their outsourcing strategy is the increasing cost labor in the then cheap-labor countries. In a recent past, manufacturers have perfectily been able to balance good quality products and cheap labor. Things may not be the same today, but it did work fine in the past. 

  3. Houngbo_Hospice
    July 24, 2012

    “Labor rates at all of these countries dropped, except for China, which continued to climb.”

    Is there any reason why labor rates in China keep increasing than in other countries? Is that due to China's desire for hegemony? How will the country's economy be affected when manufacturing companies withdraw from China?

  4. elctrnx_lyf
    July 25, 2012

    Labor cost is very important parameter in any equation to select the right country to outsource engineering or manufacturing operations. Same way it is very important to consider the risk of natural calamities based on geographical location and previous history of operations.

  5. bolaji ojo
    July 25, 2012

    Labor costs can be easily determined. Many other costs are just in the estimator's head. How do you calculate the potential cost of a natural disaster before it happened and even afterward; how do you prepare for the unknown and value the cost to the enterprise of putting in redundancies for an event that has yet to occur?

    We can blame executives for putting so much emphasis on labor but oftentime it is the only “known” factor of their total production cost that they are able to somewhat estimate as accurately as possible. The rest are just numbers on an Excel file.

  6. Himanshugupta
    July 25, 2012

    the infliction point coincide with the recession, so there might be an inference. I highly doubt that companies will pull out of China as they (both companies and government) have invested so much in the infrastructure projects. Even if the labor rates keep on climbing, the domestic market is big enough to support the industry and increased price of products.  

  7. Wade McDaniel
    July 25, 2012

    I think there are other distinct advantages to manufacturing in China, although labor rates may not be one of them. Over the years manufacturing clusters have become prolific, starting along the coast and moving inland. We've published a white paper ( Clusters Meld the Benefits of Modern Offshoring and Traditional Vertical Integration)  on manufacturing clusters, its posted on the EBN Avnet Velocity site. http://www.ebnonline.com/velocity/

  8. Eldredge
    July 29, 2012

    @Cryptoman – A friend of mine works in softweare testing, and related the same kinds of issues with outsourcing software development. I supppose offshore sources may eventually develop enough expertise to address some of the quality problems. but Iwonder if, by that time, labor rate rise enough to wipe out the benefit anyway.

  9. Barbara Jorgensen
    July 30, 2012

    The question you posed upfront–should we continue to consider the cost of labor–made me stop and think about that for a second. What a wonderful world it would be if all costs were equal and we didn't have all this squabbling and infighting about jobs and outsourcing. Of course, there's no way I can see eliminating job costs from the equation, and your points are well-made.

  10. Ashu001
    July 30, 2012

    Barbara,

    How do you plan to achieve that?

    Wages everywhere are a function of Two things only.

    One is Demand for Labour and the other is Supply of the Labour.

    Everything else,Like Mandating Minimum Wage standards,etc is just secondary to this fundamental fact at hand.

    I don't know of a good way to do that,but you never know some smart people might be able to do it in the future.

    Regards

    Ashish.

  11. Ashu001
    July 30, 2012

    Houngbo,

    China's wages are increasing because of three major reasons-One is that the Governments of most States are mandating/pushing for massive increases in Minimum Wages there.

    Obviously,one you mandate Minimum Wages,prices rise for everything and especially Labour.

    The second is that People are less willing to work for dirt-poor wages which they were willing to work for previously(expectations of a much better life).

    And Finally,its because the supply of Labor coming in from Rural/interiors of China is drying up thanks to their One-Child policy.

    The country's economy will hopefully be able to move up the Value chain(into Services) as manufacturers withdraw from the country.

    Otherwise,things could get ugly very,very quickly.

    Regards

    Ashish.

     

     

  12. Ashu001
    July 30, 2012

    Crypto,

    Good examples!

    I am assuming that you feel that we are not going to see any concrete cases of Innovation from either China or India today-Correct?

    Thanks for sharing!

    Ahsish.

  13. Ashu001
    July 30, 2012

    Wade,

    I agree.

    A lot of countries(other than China) are copying this mercantilist model.

    Its quite an effective way to offer customers with everything all at one go.

    I like it and I am sure it will continue to be a massive way in which manufacturers tend to coalesce and pool their resources together.

    Regards

    Ashish.

  14. Cryptoman
    July 31, 2012

    Hi tech4people,

    I think making a conclusive statement such as “we are not going to see any concrete cases of Innovation from either China or India today ” is difficult. It depends on the incentives available for people to make innovations. I am pretty sure there are very creative thinkers in India and China and such people are the drivers of innovation at the end of the day. Yes, the current manufacturing trends in those countries are based on western designs. However, that will not be a stopper for innovation in India and China. As a matter of fact, having access to every step of manufacturing high-tech products can be very inspiring for young people working there. Thanks to this exposure they have the opportunity to “borrow” ideas from existing designs to create better and more advanced products.

    I also think that innovation does need to be supported by a solid infrastructure of mentors, designers, private and government support. The education system has to plant the seeds of curiosity into young minds rather than giving merit to memorising what is already available in textbooks. That is how creativity is nurtured, i.e. by providing the necessary space for the human brain to develop in the right direction. All of these essentials of innovation cannot be created overnight though. A country has to commit to a long journey in order to join the club of solid innovators.

    At the end of the day, there is no mental difference between the people on this planet. Anyone can create anything. The difference is in how people are taught, directed and motivated throughout their lives as well as the living and the sociopolitical conditions in their home geography.

     

  15. Ashu001
    July 31, 2012

    Crypto,

    Absolutely right!!!

    How do you see the increasing trend of Chinese,Korean and Indian Students attending Higher Education in American Colleges play out into this theme?

    Will it ensure that these countries get the right Engineering skills and manpower back in their home countries?

    Increasingly,I see a lot of restrictions on these Skilled people in the West[US,UK,Europe];basically you can study here but we don't want you working here.How will that impact things?

    Regards

    Ashish.

  16. Cryptoman
    July 31, 2012

    Hi Ashish,

    I think foreign students at Western universities are a good competent labour resource for the Western high-tech industries. Only the selected few foreign students, i.e. “creme de la creme”, are allowed to work in the West after completing their studies. The West will carry on employing the relevant foreign workers for years to come as this is one of the key drivers of innovation in the West.

    Following is an excerpt from Apple's webpage:

    At Apple, interns are an important part of the team. Whether you sign on for a summer internship or a co-op during the academic year, you'll be working on critical projects. Better yet, you'll be that much closer to landing a full-time job at Apple after graduation .

    That is a good example of how the big companies create the “natural selection” environment I mentioned above. Have you noticed how big and successful companies boast with having an international working environment with people from so-and-so number of countries in the world? Those Western companies have discovered long ago that by employing international talent, they make every spent dollar stretch as far as it possibly can. I have seen many examples of how employing foreign workers is so beneficial for a company but I will not get into the details of this in order not to get off-topic.

    As for the returning students to their home countries, surely the aggregate intellectual level of the nation goes up, however, unless there is a suitable infrastructure to allocate the returning talents into suitable jobs, such talents are simply wasted. I have witnessed many examples of such waste in a third world country where extremely talented and well-educated technical people end up doing irrelevant work purely to earn their bread. This third world country was (and still is) simply not equipped to make use of such people. This situation can only be described as a tragedy in my book.

    I conclude by saying “An education abroad ensures nothing at home unless that home is built well enough to accommodate”.

     

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