The Soap Opera of Reshoring
Reshoring. The corporate version of moving back home after a wild adventure overseas. But is it as simple as packing your bags and saying, "See you soon, mom and dad"? Well, it's more like trying to assemble a 10,000-piece jigsaw puzzle blindfolded.
And with all the talks recently on the breakup between the US and China, it’s important to realize how many things need to go right to make reshoring work.
Let’s start.
The Story of Bath & Body Works
The Wall Street Journal had a great article a week ago about Bath & Body Works, a skincare firm that has worked hard to reshore its production (hat tip to Anurag Mathur, Wharton Exec MBA student, who has shared this article). The article tells the story of the company's Ohio-based "beauty park," which is a manufacturing marvel:
“The result was a production initiative with little parallel in corporate America. Now every step of production occurs at plants just feet from each other on the company’s dedicated “beauty park” on the outskirts of Columbus. One factory makes the foaming pump and mechanism. Another makes the bottle itself, a third makes the label, a fourth makes the soap, fills the bottle, attaches the label and screws on the top. A fifth packages it. Getting a bottle to distribution is down to 21 days and a few miles. A majority of Bath & Body Works products, which are sold in its own stores, are made on site.”
If you think this is a trend that started with the Trump tariffs, the results of COVID, or the recent spat with China. Well, wrong you are:
“The effort, which started in 2008, required a lot of negotiation with sometimes skeptical suppliers. The campus includes 10 manufacturers and millions of square feet of production and warehouse spaces, with 5,000 employees working there during peak production. Bath & Body Works had sales of $7.56 billion last year, increasing annual revenue by more than $2 billion since 2019.”
Why does it take so long? Why is it so complex? What are the drivers behind such a decision? Let’s delve deeper.
Economies of Scale vs. Economies of Scope
The article mentions that Bath & Body Works wanted to be able to produce and bring products to the market quicker. But this is only part of the story. The more interesting aspect is that the firm launches around 7000 new scented products a year.
I tend to discuss the notion of Economies of Scale a lot in this newsletter.
A lot.
A lot (you get the point).
But it’s time to discuss the notion of Economies of Scope.
For that, let me make sure we understand the difference.
Economies of Scale
As I discussed just last week, Economies of Scale refer to the cost advantages that a business experiences when it increases its level of production. The idea is that as the production quantity increases, the average product's cost per unit decreases. This reduction in cost is achieved through factors like purchasing raw materials in bulk at discounted prices, streamlining manufacturing processes, and spreading fixed costs such as machinery and overhead over a greater number of units. The larger the scale of production, the more these cost savings can be realized, making products more cost-effective and potentially leading to lower prices for consumers.
Think of a car manufacturing plant. The more cars of the same model they produce, the cheaper each car becomes. They can buy parts in bulk, streamline production, and spread fixed costs (like the cost of building the plant) over more units.
Economies of Scope: The Artisan's Approach
Economies of Scope refer to the cost advantages that a company can achieve by producing multiple related products or services together rather than separately. Unlike Economies of Scale, which focus on increasing the quantity of a single product, Economies of Scope capitalize on the efficiencies gained from variety and diversification. By sharing resources such as equipment, raw materials, or marketing across different products, a company can reduce costs. For example, a factory that produces both cookies and crackers might use the same ovens, packaging equipment, or distribution channels for both products, leading to savings in production costs. Essentially, Economies of Scope make producing a range of related items together more cost-efficient than producing them individually.
Let's switch scenes from the car manufacturer above and stroll into a firm like Bath & Body Works. The air is filled with a blend of aromas, colors, and textures. Each stall offers a myriad of different products, from handcrafted soaps to exotic spices. Why settle for plain vanilla when you can indulge in a symphony of scents?
Economies of Scope are about diversity and creativity. It's not just about making more; it's about making more varieties. It's the art of crafting different products that share resources or characteristics.
But each of these “Economies” is more than just a concept. It requires crafting the right supply chain.
Connecting to Responsive vs. Efficient Supply Chain
The notions of Economies of Scope and Economies of Scale are tightly linked to two concepts we discussed before: efficient vs. responsive supply chains. At the time, we linked them to the notion of demand uncertainty. But they are also linked to scale vs scope economies.
The principle behind Economies of Scale – the idea that more quantity leads to a lower cost per unit – aligns with an efficient supply chain. To develop such scale economies, supply chains usually focus on:
Bulk Production: Producing in large quantities reduces per-unit costs, mirroring the emphasis on efficiency in the supply chain.
Standardization: Just as producing a single type of product can drive down costs, an efficient supply chain strives for standardized, predictable processes. It aims to eliminate waste and achieve the best cost performance.
For example, a global electronics company producing millions of identical smartphones might focus on an efficient supply chain that minimizes costs by using large shipments, standard components, and streamlined logistics.
On the other hand, Economies of Scope, where diversity and variety are valued, link more naturally with a responsive supply chain. To develop such capability, supply chains usually focus on steps and measures such as building flexibility. Just as a business leveraging Economies of Scope must be adaptable to produce various products, a responsive supply chain must be capable of responding to fluctuating demand or unexpected changes.
Our example of Bath & Body Works, with its 7,000 new scented products a year, needs a responsive supply chain that can quickly pivot between different scents, ingredients, and packaging to meet ever-changing consumer preferences.
In a world that values both the bulk buyer's paradise (Economies of Scale) and the artisan's approach (Economies of Scope), understanding the connection between Economies of Scale and Economies of Scope with the efficient and responsive supply chain respectively becomes crucial. Choosing between these models depends on the specific business strategy, market demand, and product nature.
Supply Chain Surplus
Ok. So you decided to build a responsive supply chain to gain Economies of Scope. Not so simple.
“To make it happen, BBW had to persuade its best suppliers to move. The plus for suppliers was continuing to do business with a fast-growing skin-care seller—with volume guarantees from BBW for a set number of years. The minus: spending millions to relocate production and buy new equipment. From a supplier perspective, there was a lot of resistance,” said Craig Miller, who worked for Rieke at the time and now works in supply chain and manufacturing for a pharmaceutical company. “You want us to buy more equipment. Our lease rate is going to be double what it’s going to be in rural Indiana. Come on, that doesn’t sound any fun.”
For example,
“Rieke Packaging, which makes dispensing pumps for soap bottles, didn’t know if it was going to be worth the investment. At the time, Rieke made the pump at factories in China. Rieke had an existing factory a few hours away in Indiana that could potentially supply the park, but Bath & Body Works said it wanted factories on-site.
So how can you make the business case for this?
Their reshoring strategy emphasizes the importance of "supply chain surplus," a critical concept that extends beyond mere efficiency or profit maximization. It involves looking at the supply chain as a whole rather than individual components and finding ways to create optimal value across the entire chain.
The complexity lies in the conflict between individual incentives and collective optimization:
Individual Incentives: Each supplier, manufacturer, or distributor in the chain has its own incentives and goals. They seek to maximize their profits, reduce their costs, and meet their specific objectives. However, if each player solely focuses on their individual gain, the entire supply chain may suffer from suboptimal performance. It's like each musician in an orchestra playing their favorite tune without regard to the overall symphony.
Collective Optimization: Supply chain surplus maximization requires an overarching view. It might mean that individual players have to make decisions that seem suboptimal from their narrow perspective. However, when coordinated and aligned, these decisions lead to optimal outcomes for the entire chain. It's a complex negotiation where individual interests must be balanced with the collective goal of maximizing overall value.
The Role of the Central Firm
The central firm orchestrating the reshoring must act as a coordinator, aligning the individual interests with the collective goals. It's about getting all the players to work in harmony, even if it means making individual compromises. This alignment is not just about cost savings or efficiency but about creating a more responsive and robust supply chain that delivers greater value.
The important part here is that it's not a zero-sum game where one player's gain is another's loss. Instead, it's about finding the right balance and alignment, where individual decisions might seem suboptimal but collectively lead to an optimal and more valuable supply chain. For example, in the case of Bath and Body Works, if indeed consumers value variety and speed, and the firms can sell more products at a higher price, the entire pie grows, which means that potentially every player can be better off.
Agility and Lead Time
Why was it so important to co-locate the suppliers?
To understand, we need to resort to math and specifically to my third most favorite operations equation (after Littlet’s Law and The Newsvendor formula, but of course, before the Pollaczek–Khinchine formula, in case you are asking).
I already discussed the formula before: The Economic Order Quantity (EOQ) is a widely used formula in inventory management that helps companies determine the optimal order quantity to minimize total inventory costs (shipping and holding). The EOQ formula is expressed as
In order to become more nimble, firms need to be able to have smaller batches, both in manufacturing and shipping. In order to do that, companies often aim to reduce the shipping (or ordering) cost in the formula. The ordering cost encompasses various expenses related to placing an order, including shipping. Strategies to reduce shipping costs may include negotiating with Suppliers, consolidating orders, and shipping in bulk can lead to discounts. And …reshoring or sourcing materials from nearby suppliers, which significantly reduces transportation expenses.
This is also an opportunity to talk about the Impact of increasing interest rates. As we discussed before, increasing interest rates could exert pressure on firms to reduce shipping costs further. Higher interest rates mean that the capital tied up in inventory incurs a higher opportunity cost. This is reflected in the holding cost in the EOQ formula. As holding costs increase, the importance of reducing ordering costs (including shipping) becomes more pronounced to keep the overall inventory costs low.
To summarize: The only way to develop Economies of Scope is to have small batches. The only way to economically have small batches is to have very low shipping costs. Pretty much the only way to do it is to co-locate your suppliers. And the only way all of this makes sense is if variety and speed are your competitive strategy and the customer is willing to pay for the cost of production in places that are, generally speaking, higher in favor of variety, speed, and maybe quality.
Manufacturing Campuses
The notion of manufacturing campuses and hubs is not all that new. A manufacturing hub or campus typically consists of a central manufacturing facility surrounded by or located near suppliers and related businesses. This kind of setup aims to reduce costs, increase efficiency, and improve collaboration by co-locating suppliers and manufacturers.
Some examples of companies and industries that have applied this strategy include:
Toyota: Toyota's production system includes close collaboration with suppliers, and the company has been known to encourage its suppliers to set up operations close to its manufacturing facilities. This reduces transportation costs and lead times.
Volkswagen: In Chattanooga, Tennessee, Volkswagen has constructed an automotive manufacturing campus where several of its key suppliers are located on or near the site. This helps ensure more streamlined production and just-in-time delivery of parts.
Aerospace Industry: In the aerospace sector, companies like Boeing have had supplier parks close to their assembly lines, encouraging co-location and coordination with suppliers to meet the complex and precise demands of aerospace manufacturing.
Intel: Intel has a history of working closely with suppliers and has co-located some of its suppliers near its manufacturing facilities to increase efficiency in the highly competitive semiconductor industry.
Foxconn: The electronics manufacturing giant has built extensive manufacturing campuses in various locations, such as China, where suppliers and other related companies are also located nearby. This close proximity to suppliers enables quicker response times and more efficient production.
Steel Mills and Automotive Industry in Detroit: Historically, steel mills and automotive companies in the Detroit area created industrial complexes where suppliers were located nearby, aiding in the rapid growth of the American automotive industry.
Special Economic Zones (SEZs) in various countries: Many countries have created SEZs to attract manufacturers and their suppliers to a specific region. These zones are designed to foster collaboration and efficiency by having suppliers, manufacturers, and sometimes even research and development all in one place.
In other words, the idea is not new. Co-location of suppliers and manufacturers is a strategy that can be found in various industries and has proven to be effective in improving efficiency and speed while enhancing collaboration in the supply chain.
But it’s not easy. Note that in most of the examples above, you either have a massive player “coordinating” (some may say forcing) the supply chain or a government that provides incentives. These things do not just “happen.”
The Encore
Bath & Body Works made it work.
The story of reshoring is no soap opera, but it's an exciting drama of its own. It shows that proximity and clustering are making a comeback, but like a challenging piece of music, it requires finesse and harmony to get it just right.
Even if your heart is set on reshoring, ensure you have what it takes. The competitive strategy has to be right. The customer has to care about the value added generated from it. The suppliers have to be aligned. The local government has to be willing to work with you. Marketing, supply chain, and corporate development have all to be aligned. And you need to be able to find employees. So basically, you need to align the stars!
So next time you pump that $7.95 bottle of foaming hand soap, remember the orchestration behind the bubbles.