Head of Market Research for QAD
Catherine is a Market Research Analyst for the life sciences, consumer products and food & beverage industries at QAD. She supports the vertical team with updates on latest trends and industry news. She has an MA in Economics from UC Santa Barbara. Outside of work, she enjoys writing humorous short stories and pilates.
Poor capacity utilization is a common challenge for contract manufacturing organizations (CMOs). If you have 10 manufacturing sites and are only using half on a weekly, monthly or annual basis, then your utilization rates are low. Industry best practice points to 70 percent utilization rates or higher, yet, it’s common for CMOs to report utilization rates in the 30-40 percent range. McKinsey research found that solid dose manufacturers were, on average, using only 25 percent of their total capacity. Underutilization is so prevalent that, according to McKinsey, the pharma industry “could shut down three out of four plants today and still meet demand.” But why?
Poor capacity utilization can result from equipment shutdowns, untrained operators or incorrect materials. Some production runs might need specialized staff who are unavailable at the point of production. In fact, shortage of skilled labor in manufacturing is predicted to be a persistent and growing problem for the foreseeable future. According to Deloitte & The Manufacturing Institute, over the next decade nearly three and a half million manufacturing jobs likely need to be filled and the skills gap is expected to result in 2 million of this jobs going unfilled.
Inefficiencies associated with capacity underutilization can have a significant impact on profitability. When agility is low and turnaround times are at risk, financial metrics are also in jeopardy. Consider the impact on return on invested capital when more than half your equipment sits idle (such as some of the recent items being tariffed by the administration!)
The good news is that technological advances combined with smarter supply chain practices might solve these problems. Some companies, are addressing the issue by adjusting their product mix and divesting several sites. Another solution is the ability to schedule operations on a more granular level. For many companies that might not be an option because of broken processes that keep them from scheduling to the degree necessary to utilize capacity.
Whatever corrective actions a company may choose, they need the data to determine what those actions are. IoT (Internet of Things) and other technologies all collecting and communicating data, will help improve capacity utilization. Historically, acquiring visibility down the production line has been a challenge. Legacy systems weren’t designed to talk to one another, but companies need them to because they’re basically Franken-companies, made up of smaller companies put together into one through M&A activity and divestitures.
Because of the current problem of underutilization, combined with the administrations trade and tariff restrictions and regulations, contract manufacturers would be wise to work together to utilize the excess space, manufacturing lines and technology that has already been invested in.
US manufacturers won’t pull out of China since China constitutes a large market for many multinational corporations. Rather, they’ll have to setup, reestablish or reopen manufacturing facilities in the US to offset the tariffs. So the upshot is that manufacturing will return to the US, albeit in the form of smaller operations as the US operations will only manufacture for North America and South America.
Eventually, I see two spheres of economic influences in the world, one controlled by China and the other by the US. The US sphere will consist of the EU, North America, a few Asian countries and most of South America. China’s sphere will contain Asia, Eastern Europe, Russia, Africa and some South American countries.
To take part in either sphere, companies will have to manufacture in that region. So companies will need to have two major manufacturing facilities;s including the aviation, automotive, medical, information technology, manufacturing and environmental engineering industries.
This is already playing itself out as China expands its One Belt One Road initiative encompassing infrastructure investments in over 70 countries in Eastern Europe, the Middle East, and Asia. China already “owns” Africa.
Author of "Selling to China: A Guide for Small for Medium-Sized Businesses," and Managing Director of All In Consulting
Chao holds a BSEE degree from Columbia University, an MSEE from the University of Pennsylvania, and an MBA from the UCLA Anderson School of Business. Chao’s clients include: Intel, Emerson Electric, SPX, Kingston Technology, Baxter Healthcare, and dozens of small and medium-sized companies. Chao and his team have conducted over 200 projects in China covering more than 12 different vertical markets. His professional career includes stints at Philips Lighting in California, and China; Kingston Technology in California and Japan; SoftBank in Japan; and Merrill Lynch in New York and Japan. He speaks fluent English, Mandarin, and Japanese and currently resides in Los Angeles.
President, Stratagerm Consulting
Michelle Klieger is president of Stratagerm Consulting, LLC. She is a tariff expert and an economist that specializes in international trade and helping clients manage the current tariff and trade environment. As a former research analyst, Michelle can look at and evaluate an issue from 360 degrees, and has experience in international supply chains and navigating international policy. Michelle holds an MBA from Indiana University’s Kelley School of Business and a Masters in Agriculture Economics from Purdue University.
The pending trade war with China will not bring back a significant amount of manufacturing business back to the United States. It is structurally impossible in the near term and improbable in the long term. When manufacturing left the United States, those factories closed. Many of them have been repurposed. Therefore, even if companies wanted to bring their manufacturing back, they would need to invest in new buildings and equipment before anything could be produced here. This process would take several years and is more expensive because of tariffs on steel and aluminum needed to build new factories.
Since fewer than 25% of companies have made tariff related changes to their businesses, most companies have not started to consider other manufacturing locations yet. Companies are still hopeful that there will be a quick resolution to the trade war and a reversal in protectionist practices from both governments. Therefore, 75% of companies have not considered investing in new domestic infrastructure to offset a reduced capacity in China. Many industries have reported, in their comments to the U.S. Trade Representative, that no other country in the world could absorb the additional production required to compensate for a significant production in Chinese production.
Some manufacturing will move back to the United States. These products will be exclusively for the domestic U.S. market. The products will be produced domestically to avoid import tariffs. However, other countries have not put similar tariffs on Chinese goods. So, products produced in the United States will not be sold to these other locations. China still maintains established supply chain, low costs, and free trade agreements with other key trading partners. Therefore, these partners will still purchase directly from Chinese factories and not from American factories, limiting the efficiencies of scale that can be created. American companies will manufacture some goods domestically and some goods in China.
Some products will not be cost effective to produce domestically. Therefore instead of bringing manufactured back to the United States, they will not be manufactured at all because the customer will not pay a higher price. In these cases, manufacturing will decline in both China and the United States.
In the short-term contract manufacturing firms will benefit from President Trump’s trade initiatives. Stratagerm advises clients to find immediate solutions to alleviate rising costs associated with the tariffs, especially tariffs on Chinese goods. Contract manufacturing is a solution to overseas manufacturing that can be used, while a long-term plan is devised and implemented.
Manufacturing has and will suffer due to trade tensions with China. Much of the affected offshore production has been established through long term relationships and is now hurt by protectionist barriers. I have personally witnessed supply chain conversations deteriorate over the simple existence of US tariffs, even when those tariffs did not directly affect the industries in question.
Founder and Managing Principal of Weilian Poder Global Consulting
Weilian Poder Global Consulting is an international business consulting firm based in the New York area. He is an expert in emerging markets and risk management with significant experience living, working, and studying in China.