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Cost Modeling

Low-Cost Energy Tips Scales in Favor of US Manufacturing

25 July 2013

Everyone talks about the rising costs of doing business in China as a reason why manufacturers are bringing factories back to the United States. But it’s certainly not the only one. Indeed, low energy costs in the U.S. arguably have as much influence on decisions to repatriate business back to American soil.

The increased availability of oil and shale gas — one of three commonly recognized forms of unconventional natural gas along with tight gas and coal-bed methane — and the relative cost advantage of energy prices in the U.S. compared to other countries are factors providing America with a competitive edge in manufacturing, operations and logistics strategies.

“Countries like Canada and the United States possess affordable, accessible reserves of natural gas and oil — among the largest in the world. Some experts even expect natural gas prices in America to be 50 to 70 percent cheaper than prices in Europe for the foreseeable future,” said Helmuth Ludwig, chief executive officer of Siemens Industry Sector, North America. (See the Sidebar at the end of this article for the complete transcript of the interview with Ludwig.)

“The natural gas boom is helping reindustrialize America by working to lower the cost of doing business here. Even with low energy prices, Siemens is helping further reduce the operating costs of our customers through efficiency measures. Using both hardware and software to modernize our Norwood, Ohio, plant, we were able to expand capacity by 50 percent, increase productivity by 42 percent and cut energy consumption by 40 percent — a return on investment in two years. We believe that in the near and long term, these types of efforts, combined with low energy costs, will help make U.S. manufacturers even more competitive globally.”

From offshoring to reshoring

Several factors, not just energy pricing, have boosted recent reshoring activity, which some are calling a “manufacturing renaissance,” particularly within the U.S automotive and industrial sectors.

Labor and total-landed cost on both sides of the Pacific Ocean have shifted, and are typically the most-often cited reasons that companies give in rethinking their factory location plans.

For instance, China is targeting to raise the minimum wage by at least 13 percent a year as part of its five-year development plan, a move that has paved the way for Indonesia, Malaysia, Thailand and other Southeast Asian manufacturing countries to take similar steps, said Dennis Young, executive vice president of business development at Sanmina Corp. in a speech.

“We have seen labor rates in China go up anywhere between 15 to 25 percent a year during the last three years,” he said. “In 2005, China enjoyed a 51 percent labor rate benefit and 31 percent landed cost benefit. Five years later, because of the increase in labor rates that we have had to pay [in China], those benefits shrank to 38 percent, and the landed cost benefit fell to 22 percent.”

Conversely, labor unions representing U.S. factory workers have given wage concessions to top-tier original equipment manufacturers (OEM), such as General Electric, which is investing $1 billion in its Louisville, Ky., plant while hiring 3,000 workers there in the last few years.

“GE took water heaters manufactured in China, which were very complex but not too expensive, and brought them back to the U.S. and did a product redesign,” said Young, adding that Sanmina works with GE. “GE was able to manufacture the heaters in Appliance Park in Louisville at a very cost-competitive rate compared to China — not just because of the rising cost of labor in China, but also because of the redesign that GE did on the product and the concessions it got from the union to hire new employees at a lower labor rate.”

The Atlantic reported that Appliance Park’s union “was so fractious in the ’70s and ’80s that the place was known as ‘Strike City.’” But the union, according to the magazine, agreed to a two-tier wage scale in 2005. Today, 70 percent of the jobs at the site are on the lower tier, which starts at about $13.50 an hour — nearly $8 less than what the starting wage was previously.

Other factors, such as tax benefits and being close to the R&D team and the end customer, are also helping to tip the scales in favor of the U.S. And Siemens’ Ludwig points out that engaging with innovation centers are also critical.

“Manufacturing is no longer about brawn over brains,” said Ludwig. “Manufacturing has become knowledge work with the introduction of innovative technology that is software based. This innovation engine must be linked to our manufacturing sites. We need to keep that innovation pipeline full and focus our manufacturing on the early stage where value is created. There is no better place for driving high-end technological innovations to commercial success than the U.S.,” he said.

Energy costs also affect business

Energy prices are likewise becoming a high-priority issue, purely from a bottom-line perspective. Two main manufacturing and operations costs are directly affected by energy prices: the cost of powering the plant; and the cost of moving parts through the supply chain.

Inside the plant, cost differences are increasingly evident. Comparing the cost of running factories in Mexico, China and the U.S., Sanmina’s Young said, “Energy costs for us in Mexico are four times what they are in the U.S. China is about three times [the U.S.].”

And even though natural gas prices have started to rise after plummeting to near lows, it’s often high oil prices that pinch the supply chain. This is something not likely to change any time soon, given the U.S. Energy Information Administration’s projected short-term outlook calling for average crude oil spot prices to stay at or above $100 per barrel for the rest of 2013 and 2014.

“The impact in the rise of energy costs is causing companies to rethink where they manufacture,” said Thomas Dinges, senior principal analyst for electronics and media at IHS. “Companies are getting hit with increases in freight costs and fuel surcharges. This is a big cost for everyone now, and it factors into a company’s total energy costs.”

“The solution used to be ‘put it on a plane in Shanghai, fly it to Memphis and FedEx will put it on the customer’s door the next day.’ But, that’s a heck of a lot of jet fuel that’s costing significantly more than it used to a few years ago,” he added.

“The final transportation and logistics costs have become prohibitively expensive in certain areas. Suddenly people are getting their UPS, FedEx or DHL shipping bills from China and having one of those ‘My God…What are we paying for this?’ moments. They start pulling out spreadsheets from the last five or seven years to compare prices, and they see that the prices keep going up. So, now people are looking at their ‘all-in” costs. That’s part of why people are exploring the idea of returning to the U.S.”

The U.S. energy scene

Companies considering the leap back will want to keep an eye on the energy-pricing scenario, especially as it relates to the U.S. shale gas boom and the impact it’s expected to have on gross domestic product and manufacturing growth.

By the numbers, shale gas accounted for 27 percent of U.S. natural gas production in 2010. That could climb to 44 percent by 2015 and reach 60 percent by 2035, according to a 2012 report from IHS called “The Economic and Employment Contributions of Unconventional Gas Development in State Economies.”

The shale gas contribution to GDP was approximately $77 billion in 2010; that will increase to $118 billion by 2015, and will nearly triple to $231 billion in 2035, according to the IHS report. The increased shale gas production has helped keep natural gas prices down, and IHS expects that this will result in an average reduction of 10 percent in electricity costs nationwide over the forecast period.

In the long run, improved competitiveness among U.S. domestic manufacturers, due to lower natural gas and electricity costs, will result in an initial 2.9 percent increase in industrial production by 2017, and 4.7 percent higher production by 2035 compared to the projected activity level that would occur under a higher-price scenario without unconventional gas, the firm said.

For a company like Siemens, which already operates approximately 130 manufacturing plants in the U.S. alone, the stakes are pretty clear.

“Energy pricing is one of just a number of opportunities unique to the U.S. market right now and which make it an interesting place to invest. We expect our Siemens Industry Sector market in the U.S. to grow by 4 percent annually between now and 2018. Additionally, the balance sheet shows approximately $1.6 trillion in cash reserves currently being held by U.S. manufacturers,” Ludwig noted.

“As confidence builds, we expect to see investments that will modernize manufacturers similar to what we have already seen in the U.S. aerospace and automotive industries.”

Today, Siemens exports about $2 billion of products a year from the U.S., and Ludwig believes increased competitiveness of manufacturing will lead to export growth.

“When we opened our turbine plant in Charlotte, N.C., the extraordinary thing wasn't just what these turbines could do—it was who decided to buy them. The first 12 turbines off the line in Charlotte went to Mexico and Saudi Arabia. Amazingly, only 1 percent of American companies export today. There is, surely, more that can be done, and plenty of room is available for expansion,” he said.

Sidebar

Siemens’ Bullish on Manufacturing in North America

An interview with Helmuth Ludwig, chief executive officer of Siemens Industry Sector, North America.

Electroncis360: Siemens has been growing and strengthening its manufacturing base in the US. What are the advantages for locating—or relocating, if that's the case—facilities there?

Helmuth Ludwig: We see the U.S. as a good place to invest for a number of reasons. First, we like to operate close to our customers, and here we have proximity to our largest market.

Next, countries like Canada and the U. S. possess affordable, accessible reserves of natural gas and oil, which are among the largest in the world. Some experts even expect natural gas prices in America to be 50 to 70 percent cheaper than prices in Europe in the foreseeable future.

Finally, manufacturing is no longer about brawn over brains. Manufacturing has become knowledge work with the introduction of innovative technology that is software-based. This innovation engine must be linked to our manufacturing sites. We need to keep that innovation pipeline full and focus our manufacturing on the early stage where value is created. There is no better place for driving high-end technological innovations into commercial success than the U.S.

Electronics360: How do you see the "American manufacturing renaissance" evolving? What are the challenges and benefits for the manufacturing and high-tech sectors?

Helmuth Ludwig: While low energy costs and a highly motivated and trained workforce are key elements of continued growth in the industrial sector, the manufacturing resurgence in America is being driven by a software revolution, and our ability to now integrate real and virtual worlds.

Software is allowing the real manufacturing world to converge with the digital manufacturing world which enables organizations to digitally plan and project the entire lifecycle of manufactured products. Siemens' Product Lifecycle Management (PLM) software was used to digitally design, test and assemble NASA's Mars Rover Curiosity. Chrysler uses this software to make cars. Dyson uses it to make vacuum cleaners, and Calloway uses it to make golf clubs. This bridging of the real and virtual worlds continues to drive innovation and stimulate the resurgence of manufacturing in America.

While we are bullish about growth of the U.S. market, challenges still exist, particularly with uncertainty about global economic conditions. Also, companies like Siemens must find ways to encourage the brightest minds to pursue careers in engineering, and make manufacturing attractive again. This starts at the middle- and high-school age, where students must be exposed to science, technology, engineering and mathematics.

Electronics360: Specifically, what role has energy pricing played in influencing the company's manufacturing, operations and supply-chain strategies? How does energy pricing fit into the company's near and long-term strategies?

Helmuth Ludwig: The natural gas boom is helping re-industrialize America by helping to lower the cost of doing business here. Even with low energy prices, Siemens is helping further reduce operating costs of our customers through efficiency measures. Using both hardware and software to modernize our Norwood, Ohio plant, we were able to expand our capacity by 50 percent, increase productivity by 42 percent, cut energy consumption by 40 percent – a return on investment in two years. We believe that in the near and long term, these types of efforts, combined with low energy costs, will help make U.S. manufacturers even more competitive globally.

Electronics360: How is energy pricing impacting how Siemens' customers and suppliers respond to these changes?

Helmuth Ludwig: Energy pricing is one of just a number of opportunities that are unique to the U.S. market right now and that make it an interesting place to invest. We expect our Siemens Industry Sector market in the U.S. to grow by 4 percent annually between now and 2018. Additionally, the balance sheet shows approximately $1.6 trillion in cash reserves currently being held by U.S. manufacturers.

As confidence builds, we expect to see investments that will modernize manufacturers similar to what we have already seen in the U.S. aerospace and automotive industries. This increased competitiveness will lead to increased exports. Siemens now exports products worth $2 billion from the U.S. to global markets.

When we opened our turbine plant in Charlotte, the extraordinary thing wasn't just what these turbines could do – it was who decided to buy them. The first 12 turbines off the line in Charlotte went to Mexico and Saudi Arabia. Amazingly, only 1 percent of American companies export today. There is surely more that can be done and plenty of room for expansion.

Electronics360: What cost benefits have resulted from having manufacturing and supply chain operations in the U.S.? What are the projected savings for the next few years?

Helmuth Ludwig: Low energy costs, access to highly-motivated workers and being close to our customers are the key factors to operating manufacturing sites in the U.S.

For example, Siemens has made Charlotte, North Carolina one of our three global export hubs. At 450,000 square feet, our $350 million state-of-the-art plant in Charlotte produces advanced gas turbines – adding more than 1,000 direct jobs to the local economy while creating more than 2,000 indirect jobs outside the plant.

Siemens operates approximately 130 manufacturing plants in the U.S. alone, so we understand the challenges facing our customers, including increasing energy efficiency.

The industrial sector is the leading user of energy in the U.S. each year, consuming 33 percent of the country's energy, according to the U.S. Energy Information Administration. Of that energy consumption, an estimated 37 percent, or $60 billion, is lost each year. We see opportunities for growth in this area.

Electronics360: How does the cost-value trade-off of working/producing in the U.S. today compare to Europe and Asia — specifically China? How has this mindset shifted in the last couple years and what considerations will Siemens and other manufacturers factor in when deciding where to open a new plant or relocate operations?

Helmuth Ludwig: For too long, we've operated under the assumption that because labor is cheaper elsewhere, manufacturing here would more or less be doomed. But that assumption has turned out to be wrong, as U.S. productivity has increased and the cost of labor in other countries has risen.

As the manufacturing industry in America experiences a resurgence, it is clear that there will be an emphasis on advanced manufacturing, not low-tech or commodity manufacturing. Research and development is crucial to sustaining this trend, and it is why Siemens invests approximately $1 billion annually in R&D efforts in the U.S. alone.



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