Monthly Archives: October 2013

Offshores Coming Home (Part II)

I periodically revisit the trend of “reshoring” – the process of bringing activities that were off-shored back to the home country. According to a recent article in the Financial Times, the shift from off shore manufacturing to domestic manufacturing has become increasingly pronounced (see US manufacturers ‘reshoring’ from China):

…[A] Boston Consulting Group survey found that 21 per cent of a sample of 200 executives of large manufacturers were either already relocating production to the US, or planning to do so within the next two years. A further 33 per cent said they were considering it, or would consider it in the near future.

Those figures are sharply increased from a similar BCG survey early last year, which found 10 per cent of respondents moving production to the US, and a further 27 per cent considering or close to considering it.

The article attributes the driving factor to wage inflation in traditionally low cost manufacturing countries. However, as I’ve mentioned previously, there are various other factors affecting those decisions as well, including increased automation in manufacturing, changes in long term strategies, and quality differentials (see Offshores Coming Home).

In fact, there is a long standing debate about the perceived benefits of offshoring versus its actual costs. And as I’ve noted (see Small Business in US Reevaluate China Outsourcing Strategy):

I have found that managers typically overestimate the benefits…i.e., the ability to access cheap labor…and underestimate its costs (e.g., those born out of cultural, political, economic, and regulatory differences across countries)…

Although I agree that there are compelling business reasons to consider offshor[ing], it is also important for managers to recognize that the practice is not without strategic consequences.

All things considered, it seems there is something to the reshoring trend. The phenomenon has garnered more and more interest over the years (as depicted in the Google Trend Report below). And given recent technological advances, coupled with  political and economic developments in emerging markets, I fully expect the reshoring trend to continue.

Screen Shot 2013-10-14 at 11.35.52 AM

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The Coase Legacy in Strategy

The world recently lost a truly beautiful economic mind. I, along with many others, have been reflecting on Ronald Coase’s passing over the past several weeks, and I was truly saddened to read the news. His 1937 classic “Nature of the Firm” had a profound impact on my intellectual development and growth.

Coase is perhaps best known for “Coase’s Theorem,” which addresses economic efficiencies in the face of externalities. Coase argued that in a world without transaction costs, markets can efficiently allocate costs associated with externalities. Indeed, the system of “Cap and Trade” can be viewed as an attempt at Coasian bargaining by creating a market for externalities.

Though Coase’s Theorem has been influential in the realm of both economics and public policy, his contributions extend well beyond those domains. His work has been central to Business Strategy, and in particular, Corporate Strategy. What many often forget is that Coase was the intellectual founder of the field of Transaction Cost Economics. And as I explained in a blog post lauding Oliver Williamson as the Nobel recipient in Economics (see Oliver Williamson, Nobel Honoree):

Transaction Cost Economics is a central theory in the field of Strategy. It addresses questions about why firms exist in the first place (i.e., to minimize transaction costs), how firms define their boundaries, and how they ought to govern operations.

In Transaction Cost Economics, the starting point is the individual transaction (the synapse between the buyer and the seller). The question then becomes: Why are some transactions performed within firms rather than in the market, as the neoclassical view prescribes. The answer, not surprisingly, is because markets break down.

Coase recognized that there were costs to using the market mechanism (transactions costs) that resulted in market failure.

For these reasons [because of transactions costs] it is often more advantageous to structure transactions within firms. And this is why firms are not just ubiquitous in our society, but also worthy of study in their own right. This contrasts with the typical view of firms in neoclassical economic theory as, at worst, a market aberration that ought not exist, and at best, a black box production function.

Today, transaction costs economics is often used to explain corporate scope, and is widely applied to the study of growth and diversification – whether via organic growth, alliance, or acquisition.

All things considered, as a Strategy scholar, I feel truly fortunate to be able to stand on the shoulders of intellectual giants such as Coase.

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