It's an old story: Jobs move to where labor costs are lower. But it's also a common experience that other factors affect total costs, and a decision based on labor costs alone doesn't always spell success.
Case in point: Despite the removal of customs and regulatory constraints, the 10 nations that joined the European Union (EU) nearly a year ago have been quite slow to deliver results for logistics.
Many labor-intensive jobs have moved into Eastern Europe, admits Erik von Engelen, product director with Exel Technology, in charge of global freight management for Europe, the Middle East and Africa. But, he quickly adds, these decisions are slowly being reconsidered. Many of the products produced by these plants have to flow back into Western Europe because that's where the consumer markets are. The center of gravity is shifting from the Benelux countries (Belgium, The Netherlands and Luxembourg) to Germany because that's where the end consumers are located.
In Europe, von Engelen points out, 60% of logistics costs are for transport and 40% comes from warehousing and related costs. And transport, he notes, is about to become more expensive.
Developing highway toll systems are making transport more expensive in Europe because the systems that affect both cars and trucks levy a higher toll on trucks. Older trucks with higher emissions often pay even more in tolls.
Tolls are designed to address two problems: congestion and pollution. About five years ago, the EU adopted emissions standards for trucks, referred to as Euronorm. The standard for new trucks now is Euronorm 3, von Engelen says, and Euronorm 4 is starting to go into effect. These standards are designed to meet the goals of the Kyoto Agreement, which went into effect last month. The U.S. did not sign that agreement, but that won't help companies that operate globally. The German tolls are an example.
The cost of the German LKW Maut toll system is estimated at Euro 2.4 billion ($3.1 billion) annually. German authorities estimate the road toll will raise transport costs 7% to 9% and this will translate into a 0.15% rise in consumer costs.
"Across-the-board rises in transport costs will equally impact all German manufacturers and retailers," says John Manners-Bell, lead analyst for Transport Intelligence. "However, its effects on companies involved in international trade will not be so equable. This particularly applies to companies which move their goods through Germany to and from the Nordic Region or to Central and Eastern Europe." Though consumer demand is still developing, production in the Eastern European countries is often flowing West through Germany.
Frank Sportolari, general manager of UPS Italy, adds fuel to the discussion, noting that Germany is the world's largest exporter when all trans-border trade is considered. At Euro 731 billion in 2004 ($953 billion), this was an increase of 10%, he points out. Almost two-thirds of those exports are to countries in the European Union, Sportolari notes. That amounts to a lot of surface transportation.
Multi-modal transportation may be one of the goals of the toll systems, but it is not yet a solution.
Short sea shipping and inland barges are fairly common options in Europe. You'll see barge operations in Rotterdam that push freight down the Rhine River, van Engelen points out. There is also a rail line being developed from Rotterdam into Germany. "They call it the Iron Rhine," says van Engelen, but the flexibility of multimodal options is limited. Unless you're looking at a long-haul move, he says, you'll pay more and add time to get containers on and off the barges.
Multi-modal may still be a bulk option, suggests van Engelen. For smaller shipments, shorter distances or lower volumes the only choice is truck.
The Netherlands and Belgium are still gateways to Europe, and van Engelen expects them to remain that way for some time. Labor rates may be attractive for labor-intensive industries, but the tradeoff is between transportation cost and labor cost — at least until a stronger consumer market leads to less of a westerly flow for goods made in the eastern countries.
Attracting logistics talent from the West will also be a challenge for the former Eastern Bloc nations. Wages are as much as 10 times lower, so some companies establishing Eastern European logistics operations are sending in western talent to develop and train a local workforce.
The labor cost advantage will gradually disappear as living standards improve in the East, but it should remain an advantage for about the next 10 years.
The U.S.-Europe market is best described as flat, says David Yokeum, president of World Cargo Alliance, a network of independent air and ocean forwarders. This is true in spite of the weak U.S. dollar.
"What's surprising is that U.S. exports have not picked up," Yokeum comments. "[The flow of goods from] Asia to Europe has a lot to do with it because the growth of China is changing the growth of the world."
Current trends definitely have the scale to combine labor with transportation and logistics in the cost to the end user, Yokeum continues, and labor comes into play, but there is so much shifting around the world that it's going to affect a lot of the emerging markets like Eastern Europe, Africa and Central America.
Time also comes into play, says Yokeum. "That's why it's not all going to happen in one region of the world. It just can't." Added to the time zones and distance is the congestion factor that can add delays such as those experienced recently at U.S. West Coast ports.
Fuel costs have not curbed growth, says Yokeum, whose business takes him around the world 10 times a year. Fuel costs are affecting everyone, not just one or two regions. To counter some of those effects, long-haul transportation is becoming more efficient — including larger container ships — and that's keeping regions like Asia competitive as manufacturing centers.
The growing complexity of global networks is affecting companies of all sizes. "At one time, when you would talk about being a global manufacturer or distributor of some product, you were a pretty good sized organization," says Jim Preuninger, CEO of Management Dynamics, a provider of supply chain solutions. "Today, you can find mid-sized and even small companies operating around the globe." To do that, those companies need a logistics network that can support the effort and information systems for control.
Initially, much of the logistics network may come from third parties as global players develop their markets. And, as in the case of Eastern Europe, third parties will fill gaps while logistics networks evolve.
"There are a lot of logistics companies that are strong, regional niche players," Preuninger observes. "They know everything there is to know, they're experts, and they have some infrastructure — warehousing or consolidation or intermodal services."
Preuninger's company is following manufacturers and third parties into new regions as they develop new markets and sourcing. The questions are becoming global: What's the optimal routing? Do I want to move cargo from Asia into Europe? How do price, lead times and transit times play?
From the execution side, global companies want to see their inventory, get control over it and "manage into the supply chain," says Preuninger. That means seeing-inventory when it's two, three or five days out from the distribution center and allocating it to sales orders. That requires reliable infrastructure as well as information, and from all accounts, the Eastern European nations aren't quite there yet, despite elimination of many of the border controls.
It isn't all bad news. Frank Sportolari at UPS notes that exports from Poland and Hungary were very good in 2004, up 35% for UPS in Poland and 20% in Hungary. That contributed to overall European export growth of 12% for the carrier. Without the newly acceded nations, Sportolari estimates European exports handled by UPS would have grown less than 10%.
John Manners-Bell at Transport Intelligence agrees that the infrastructure isn't in place to serve all of the Eastern European markets from central distribution in The Netherlands or Belgium, where most European distribution centers are based, but he is starting to see regional distribution taking over from national stock points in the more developed countries like Poland and Hungary.
The watchword for Eastern Europe is: Remain skeptical and check out infrastructure and logistics capabilities before committing to a network change.
Overcoming the invisible border
Despite the fact that the European Union expanded by removing internal border restrictions among 10 Eastern European countries, many companies operating in Europe still acknowledge the invisible boundaries. Country operations are often treated as independent profit and loss centers, observes Carl Fransman, managing director of Europe, Middle East and Africa for MCA Solutions (www. mcasolutions.com), a provider of supply chain solutions.
Despite the fact the borders have fallen away, many corporations still manage operations like conglomerates of smaller entities. "The reality is not what we thought it would have been once the borders opened and after the expansion," Fransman says.
The reason to be in Eastern Europe for the short term is to profit from a price reduction, he continues. The long-term reason to be there is the hope there will eventually be a local customer base. The customer base isn't there yet because the Eastern Europeans generally do not have the purchasing power.
Fransman has seen some companies begin to centralize distribution operations in Europe and then pull back from that strategy. "They want to sit closer to the customer. Too many companies sell the same product or a similar one, so you differentiate on service." If you can guarantee faster response time, especially in a business-to-business market, that will get you the contract, he continues.
A decentralized network is harder to manage, says Fransman, but it can be cheaper and provide better performance with the right systems to manage. Even some third-party logistics (3PL) operations will decentralize when they take over a company's operations, he adds. "When a company like DHL takes over your warehousing, they have such a vast network of warehouses they can store wherever they deem most appropriate."
In Europe, he adds, products are differentiated by market — not so much on product characteristics but on the packaging and documentation that goes with them. That's because of the many languages represented across the European market.
When you add up minimum order quantities and safety stocks for goods stored in multiple country-stocking locations, total inventories can be huge, according to Fransman. While the country approach may be important to maintain service levels, there's a need for companies to eliminate barriers within their networks so they can manage assets more effectively.
What are your global sourcing plans for 2005?
|Continuing expansion into Asia||39%|
|Increasing domestic (U.S.) sourcing||22%|
|Increasing North American sourcing (within NAFTA)||10%|
|Considering Eastern European sourcing||10%|
|Increasing Central/South American sourcing||8%|
|Reducing Western European sourcing||5%|
|Reducing Asian sourcing||3%|
|Considering African sourcing||3%|
World Cargo Alliance