Radically reshaping manufacturing: A conversation with Katy George

In this interview, the McKinsey director explains next-shoring and why dramatic changes in demand and technology, as well as in energy and labor costs, are forcing manufacturers to rethink production and distribution strategies

It is both an exciting and confusing time for manufacturers. Radical changes in demand in emerging and developed markets coupled with advances in technology and a growing appetite for variety and flexibility are not only allowing but compelling companies to rethink where they manufacture. It’s not simply a matter of bringing back manufacturing from low-cost locations: companies must instead take a next-shoring approach—deciding which products should be manufactured close to demand and which should be produced near an innovative supply base. In this video interview, McKinsey director Katy George explains how next-shoring can push effectiveness and efficiency, and why companies must view their manufacturing process as an ecosystem that needs to be optimized from the supply base to the consumer. An edited transcript of her remarks follows.

Many questions, many answers

This is a very exciting time for manufacturers—but also potentially a confusing time for manufacturers because a lot of the economics and the technologies in manufacturing are changing more dramatically today than ever before. Economics are changing in that, as we all have seen and heard, energy costs are changing around the world, declining in the United States, which is great for US manufacturing in some segments. Labor costs are changing and the labor-cost gap between developed and developing nations is shrinking.

But even more fundamentally, we see other changes that will radically reshape manufacturing strategies around the world. These changes include radical changes in demand patterns: rapidly growing demand in emerging markets—which will overtake consumption even in developed markets, and which requires very different manufacturing footprints—but also changing demand patterns in developed markets and an explosion in the demand for product variety and flexibility, which means that there’s a real premium on shortening supply chains like never before. And finally, we see dramatic changes in manufacturing technology. Advanced robotics, 3-D printing, digitized manufacturing—all of these create new challenges but also great new opportunities for manufacturers.

And this is where there’s been a lot of confusion. A lot of the discussion is, “Should we bring back manufacturing? Should we reshore from a developing country like China to a developed country like the United States?” But in fact, only a very small part of manufacturing value added is driven by labor cost. And energy costs also are driving some segments very specifically and very fundamentally but not other segments.

What we’re finding is that manufacturers need to think about what’s next. And so we urge them to think about what we’re calling next-shoring, which is about how do you think about understanding which segments need to be manufactured near demand and which segments need to be manufactured near innovative supply bases. We see these two things (proximity to demand and proximity to innovation) as the primary drivers for manufacturing-location decisions across most manufacturing sectors.

Getting closer to demand

Companies will have to think about their manufacturing strategy generally around how they work with their supply chains and how they adopt new technologies. But that really comes to a crux in thinking about where they’re going to manufacture. So where should they be manufacturing in order to take advantage of the opportunity to create very flexible supply chains with retailers or OEMs or whoever their customers are? But also, how should they think about location in the context of new technologies?

It will be critical for manufacturers—for some manufacturers—to be very near innovative supply chains and to have supply bases that can support their adoption of new technologies and their continued innovation around those technologies, particularly as many of them are nascent technologies.

It will be important for companies not only to think about where they locate their plants, but also how they invest in their ecosystems: developing their supply base, helping their supply base think about the right locations, helping to invest in new-technology adoption, as well as thinking about worker training. And that could be in collaboration with suppliers, but also with community colleges, local universities, state governments, et cetera. This notion of pulling together the whole ecosystem around viable advanced manufacturing will become very important for manufacturers in all sectors.

I think companies really need to understand how important proximity to demand is and realize that more and more companies are successfully finding hybrid models of manufacturing, both in developed economies near developed-market demand and in developing economies near the exploding demand in those emerging economies.

A revolution in manufacturing technology

The advances in manufacturing technologies that we are seeing are more exciting and potentially more disruptive than anything we’ve seen in a long time. These include advanced robotics, which create much more flexibility in the way automation can work in a factory than in the past. This also includes digitized manufacturing, where plant managers can monitor machines on their iPhones and make real-time decisions about how to optimize production in a factory, as well as to do much more predictive maintenance work around their assets—and going beyond managing a factory that way, to manage a whole global network of factories and suppliers with this kind of real-time information.

One of the companies that we looked at actually had been doing manufacturing in Mexico and decided to move that manufacturing to the United States, because they realized they needed to be nearer to 3-D printing capability. That was going to be an important new technology for them going forward, and they had to be close to a supply base that they could nurture and develop and be a part of in order to take full advantage of this new technological advance. The opportunity from 3-D printing trumped the labor-cost advantage of being in Mexico.

Thinking more broadly

Companies will have to evolve their own management capability in manufacturing strategy and implementation in order to take advantage of these trends and opportunities. One will be to actually think in a much more integrative way around how to create manufacturing flexibility in their supply chains and then fully take advantage of that through the value chain to the market.

So we do believe that being proximate to demand is going to be increasingly important in more and more segments. But that does mean that your manufacturing strategy has to connect very closely to the value you’re creating through the supply chain. And, therefore, the collaboration with your customers will be critical to getting that right.

The second thing that companies will need to do is to really think through technology strategy. Many companies have incrementally improved technologies but many actually in some segments have focused more on product development and product innovation than on process innovation.

Now, however, there’s real opportunity from process innovation as well. It will require clients and companies to really develop the capability of scanning the world for new technology advances and understanding where those can be applicable to their supply chains, to their manufacturing—and how to access those technologies, either through developing capabilities internally or, more often, with partnering.

Another capability that companies will need to have in order to successfully take advantage of these trends and opportunities in manufacturing is the ability to cultivate their supply base and to really develop it beyond probably what they have done before. But also really thinking about how they are the centers of a whole ecosystem that has the right kind of skill sets, the right kind of technology innovation and investment, and the right kind of joint development of new technologies for manufacturing in order to truly take advantage of the opportunities at hand.