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Dissecting Global Competition: Insights from the NAPIS
   by Jeff Mengel, Plante Moran
   Outlook   Spring  2012
  
In today’s plastics industry, it is crucial for companies to have solid financial and competitive benchmarking data to support their strategies as well as to proactively manage relationships with customers, suppliers, lenders and investors. Enter Plante Moran’s North American Plastics Industry Study (NAPIS), which examines best practices and characteristics that shape the success of North American processors.

How can plastics processors remain competitive amidst pressure from Mexico and China? Plante Moran dissected the factors related to global competition – press rates, quality, launch capability and productivity.

Comparing apples to apples
It is important when conducting this kind of analysis to compare apples to apples. Therefore, for purposes of comparison, let’s assume each fictitious company in each country has

  • 50,000 square feet of manufacturing space
  • 20,000 square feet of logistics space
  • 15,000 square feet of office space
  • a 25-machine operation and
  • floor space allocated relative to a broad array of machine sizes.
  • In addition, we are assuming direct manufacturing hours are based on 85 percent uptime for days in operation (three shifts 250 days/year in Western economies and 300 days/year in Asia). This is equivalent to 58 percent theoretical utilization (compared to an average of 40 percent for the plastics industry based on NAPIS data).

    Direct costs
    Direct staffing levels tend to be around 10 percent of the cost of sales. Here’s how direct and indirect labor breaks down:

    Location Direct Labor Indirect Labor
    China Inland $1.93 $5.20
    Mexico Interior $2.88 $13.93
    Indiana $16.27 $20.48

    When it comes to labor, it doesn’t get much cheaper than China. Interestingly, however, indirect labor in Mexico is relatively pricey. The lesson here is simple: if a company employs considerable direct laborers, it is beneficial to have a presence in Mexico. However, a highly automated plant with a lot of indirect labor – engineers, mold-setters, toolmakers, quality, logistics and maintenance personnel, etc. – makes it no longer as beneficial to be in Mexico.

    Outside of labor, manufacturing floor space and electricity are direct cost considerations for companies. Here’s a quick comparison:

    Location Floor Space
    ($/square foot)
    Electricity
    ($/kilowatt/hour)
    China Inland 4.86 0.1161
    Mexico Interior 7.28 0.1151
    Indiana 6.75 0.0614

    Although there isn’t a significant difference in the cost of floor space among China, Mexico and the United States, electricity is a different story. Mexico and China are comparable but are much more expensive than Indiana. Please note, however, that electricity costs are highly dependent upon where you reside in the United States, ranging from $.05/kwh to $.20/kwh.

    Other cost drivers
    There are a variety of other cost drivers, some of which make the United States more attractive than its so-called low-cost counterparts and some of which are problematic. For example, there are much more stringent regulatory requirements in the United States, including taxes, work rules and safety and environmental regulations, that don’t need to be addressed in other countries. In addition, operating in the United States requires partnering with a variety of professionals – legal, insurance, etc. – resulting in substantial fees.

    On the other hand, the United States provides companies with access to a highly talented workforce. This is huge and the number-one reason why indirect labor costs jump up to $13.93/hour in Mexico (versus direct labor costs of $2.88/hour). The United States also affords greater access to customers. The greater intimacy and responsiveness a company can provide, the better position it is in. Finally, teamwork is much better in the United States, where there are better staff retention levels and communication protocols.

    Comparing press rates
    If we calculate the press rate for Mexico, China and Indiana using the set of assumptions dictated previously, we arrive at this:

    Tonnage Size China Inland Mexico Interior Indiana
    40 11.15 19.75 24.10
    300 29.89 43.74 46.59
    1000 69.60 89.37 84.16

    When working with a 40-ton press, Mexico and China are less expensive than the United States. However, as size increases, it becomes more competitive; for a high tonnage press, Mexico is actually more expensive than the United States.

    Beyond the press rate
    Plastics tend to put more emphasis on the press rate, but it’s only one piece of the puzzle. There are four equally important aspects to consider: launch capability, productivity (cycle time), yield (quality) and flexibility (complexity management).

    Launch capability is focused on anticipating customer requirements. How fast can you go to market? How quickly can you meet customer needs? How efficient is your production part approval process? And if production must be handed off from the launch team to the manufacturing team, how efficient is this process?

    Next, how are cycle times managed? Factors include actively managing process windows (narrow is better), machine repeatability and uniqueness of materials processed. Less variation in a process means better repeatability. Likewise, better machines and processes equate to better parts. The United States tends to be highly automated, while China and Mexico are much more craft-oriented. Although commodity materials are common across all three regions, the United States produces more parts using engineered materials than Mexico or China.

    Third is yield. Quality costs drive manufacturing complexity, with higher indirect costs and system noise. Quality is better in the United States than in Mexico and China. The expected scrap rate as a percent of sales in the United States is 1.5 percent; in China and Mexico, it is 3 percent.

    Finally, it’s much easier to be flexible and manage complexity in the United States than in other regions. It’s very common for companies to accumulate molds, tools and resins to the point that they become inflexible, which affects profitability. Dealing with complexity is key to retaining profitability as you grow.

    The bottom line is that determining how competitive you are versus Mexico or China requires consideration of a number of factors, not just rate. Oftentimes, you can obtain a cheap rate in China and still not be the cheapest producer due to the other issues.

    The proof is in the pudding: a cost of sales comparison
    A typical US molder achieves an 81 percent cost of sales (or 19 percent gross margins) and an operating income of 7 percent. This is due to the following cost breakdown: materials, 46 percent (resins = 36 percent); overhead, 25 percent; and direct labor, 10 percent. The key for US plastics molders is to manage these items. If this is done effectively, companies can manage their income statement.

    In Mexico, the average cost of sales is 80 percent. That means, by and large, molders achieve a one percent benefit in Mexico versus the United States.

    China, as expected, paints a different picture. The average cost of sales in China is 67 percent, yielding 33 percent gross margins. (There, materials equal 48.7 percent of costs, direct labor is 2.3 percent and overhead is 16 percent.) This is why people go to China. It is cheaper – that much is clear – at least until you look at the big picture and take all factors into consideration.

    What if…?
    So how can US plastics molders be competitive? By reducing headcount and improving quality and utilization.

    What if, by reducing complexity and increasing automation, a company reduced headcount by five percent? This alone would result in an operating income of 8.5 percent – an increase of 21.4 percent from the average of 7 percent. By improving quality by 25 percent (by decreasing defective parts per million from 15,000 to 11,250, for example), operating income would increase to 7.3 percent. By improving utilization by 10 percent, the operating income would increase to 8.6 percent. And by combining all of the above, companies would increase their operating income to 10.2 percent – a 45.7 percent increase! (These metrics, by the way, are accomplished by the top 25 percent of the industry and distinguish top performers from average molders.)

    In conclusion
    US molders can complete with Mexico, especially those with heavy automation, complexity and commitment to quality. Two areas where Mexico excels, however, are in heavy manual assembly and logistics (but only if you are shipping within Mexico). If you’re shipping to Mexico or require significant manual assembly, it may behoove you to do it in Mexico.

    It’s difficult to compete with China if you’re doing so within their competency (commodity molding or lower technical molding), the product is consumed in China or the product is easily transported (smaller, nested and not subject to just-in-time inventory procedures). The best way to compete with China is through significant headcount reduction (it would take a 40 percent reduction in US headcount through automation to have equivalent labor content) and heavy automation for labor cost savings and quality improvement. Competing with China requires meticulous attention to detail in the product you make, which are often larger products, requiring just-in-time delivery and with a level of technical complexity that needs to be actively managed.

    Jeff Mengel is a partner at Plante Moran and leads the firm’s Plastics Industry Team. Mengel is a CPA with over 30 years of experience and has been studying the industry through benchmarking studies for over 15 years. He can be reached at jeff.mengel@plantemoran.com.

    Processors can participate in the 2012 North American Plastics Industry Study at http://plastics.plantemoran.com. Participants are assured confidentiality and will receive a free 70 page report within two weeks, comparing their company versus quartile data within North America.