Site Selection 2014: The Importance of Cost Model Analysis

By Doug Donahue, as published in Site Selection.
Any manufacturer contemplating production in a cost-competitive location should initiate their search with a cost model analysis. This may seem like common sense, especially when the new site is in a foreign country. After all, no company would make any investment without a full picture of costs they would incur.

Unfortunately, however, because many manufacturers are unfamiliar with the gamut of expenses that can arise in an unfamiliar location, they are unable to execute a fully comprehensive and accurate cost analysis. Others lack the in-house skills required to make accurate projections. This can lead to hidden costs that will only be identified later when it is too late.

How can a proper cost model analysis set manufacturers on the path to success when it comes to site selection in a cost-competitive destination? The fact is, there are many complicated aspects to establishing initial operations in an unfamiliar location. The following are just a few elements to keep in mind when considering this important step.

What should be included in a manufacturing cost model?
All costs associated with doing business in a particular place should be included with the exception of raw materials. Be aware that a cost model is not a startup model. While startup models are vital in the early stages, they are not all encompassing like a cost model. To be accurate, a cost model should include all the operational costs a company will incur. From there, it should take account of particular local costs. These can vary depending on the region. Examples of these expenses include rent, taxes, utilities, maintenance, waste, security and shipping costs (among others).

What is the benefit of performing a cost model analysis?
An accurate cost model allows for the comparison between your current manufacturing operations and an alternative facility in a new location. It can also enable you to compare expenses at two different locations in the same region. Finally, it can also give some idea of the costs experienced by the competition.

How much can manufacturers save in cost-competitive locations?
No matter the country, prices vary depending on the region. Mexico is Entrada Group’s country of expertise and specialization, so we can illustrate the range of cost savings throughout regions of Mexico. For example, total operating costs in the centrally located state of Zacatecas can be as much as 40% less than at a similar site near the U.S. border. Within a single region, prices can vary depending on the manufacturing processes and types of production. In Zacatecas, companies with labor-intensive operations may pay as little as $5 an hour. Companies with more sophisticated processes can pay as much as $15 an hour. So while costs fluctuate across Mexico (just like anywhere else) companies can expect to save between 25% and 50% by relocating, or expanding, their operations to Mexico.

A 2014 study by the Boston Consulting Group found that Mexico has lower average manufacturing costs than China. This is due in part to stable wage growth, productivity gains and steady exchange rates. The lower cost of labor in Mexico allows companies to save money on things such as wages and healthcare costs.

How can a single cost model be accurate, when every company has different operations and processes?
In short — cost models must be highly tailored for individual companies. When we first engage with a manufacturer considering Mexico, for example, we let them know that we will need extensive input from senior management in order to accurately forecast costs. A typical first step involves understanding costs for a manufacturer’s current operations and then creating a model, based on the same production processes within a Mexican environment. The next step would be to compare costs with a similar company already operating in the targeted region. This is done by analyzing monthly statements of operating expenses, paying particular attention to average months as opposed to atypical months. The final step is to analyze and modify data based on differences between the two companies to create an accurate benchmark.

While there are many benefits to expanding manufacturing to a cost-competitive destination, manufacturers need to be aware of the full picture as they explore true costs of production. Once this is done, efforts can shift to productivity and quality assurance — core aspects that will enhance prospects for success at the new location.

This article is an extract from Entrada Group’s latest whitepaper about cost modeling analyses for overseas manufacturing, available for download at

Source: Site Selection

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