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Offshore Doubters Return Work to Germany

The trend toward outsourcing production to other countries is slowly being reversed as Germany becomes attractive to foreign investors

When the metal sheets came back from Romania "as if they had been gnawed at by rats," Rutger Dautel knew that his company's adventure in offshoring production had come to an end. He slammed on the brakes.

Dautel is a classic German medium-sized company based in the southern state of Baden-Württemberg that manufactures tail-lifts and tipper structures for trucks. Workers at the company's plant in Leingarten separate the metal used with highly modern gas cutting machines. Workers in Romania used straightforward metal shears for the same work.

"We couldn't present that to any customer," says one Dautel welder. "There were major qualitative flaws in the processing. We had to constantly touch things up in Germany. The Romania deal was a total fiasco." Of course, when company management embarked on the endeavor three years ago, they had a different outcome in mind.

Back then, things weren't going well for the business, which employs about 250 people, and layoffs ensued. Cost pressure was high and the company's profitability was at risk. Then, in 2004, one part of the assembly process was relocated to Romania.

It didn't take long for the disenchantment to creep in. For work to even begin in the city of Sibiu, Dautel first had to ship the materials there. Its Romanian business partner seldom met deadlines, and quality was often extremely poor. Even just shipping the product back to Leingarten often proved difficult -- shipments often got stuck at customs for days at a time, and that led to delays back home.

Like many other managers, company head Dautel had dreamed of massive savings. At the end of the day, though, it turned out to be a zero-sum game -- one that cost him a lot of nerves.

Dautel's decision to backtrack now puts him in good company. Many thousands of German companies joined the march to Eastern Europe and China during the past 15 years, hoping to reduce production costs there. But recently many have been returning, disillusioned. Smaller companies in particular are finding they overestimated the apparent advantages of low labor costs or more advantageous tax laws.

So far, it has not been the largest and most well known companies that have begun reconsidering Germany as a production location. And the return home usually involves considerably less ballyhoo than the earlier offshoring of production. Nevertheless, the trend is significant because medium-sized companies are both the heart and the driving force behind the German economy.

It is companies like Siteco, which produces lighting technology, Optotec, the producer of technical devices for opticians, or Gröditzer Kurbelwelle, one of the world's leading producers of crank shafts, who are now coming back -- along with the jobs they provide. They all hoped to make their fortune in the east -- whether in Maribor, Slovenia, Panagyurishte in Bulgaria or Katowice in Poland. But now they are coming back home to Germany's cities and states -- to Traunreut in Bavaria, Rathenow in Brandenburg and Gröditz in Saxony.

Coming Home

Jungheinrich, a company that produces fork lift trucks, even shut down its plants in Spain, Britain and France, redistributing production to its three German locations in Norderstedt, Lüneburg and Moosburg. Offshoring production is largely yesterday's news for all of these companies. Instead, production capacities are being massively relocated to Germany, researchers at the Fraunhofer Institute for Systems and Innovation Research (ISI), who regularly study the phenomenon, have found.

According to their findings, more than 6,500 companies in the metal, electronics, chemistry and plastics industries relocated their production process abroad, either in whole or in part, during a period of two years. Two years later, about 1,200 of them are giving up production abroad again.

A total of more than 3,500 companies from the metal and chemical industries -- two major sectors of the economy -- have returned home since 2000. Service or consumer goods companies, which have also been eager to relocate production, are not even included in these statistics.

"The relocations to Germany are not isolated cases," says ISI's Steffen Kinkel. His conclusion: "We are dealing here with a quantifiable and genuinely relevant phenomenon." The Federation of German Industry (BDI) itself also admits that "fewer investments are being made abroad and more are being made in Germany."

The Joseph Vögele corporation, for example, wants to set up an entirely new company headquarters and is looking for suitable real estate in Mannheim. The company's present headquarters are too small now that the decision has been made to integrate assembly currently being done in Slovenia into the German production location.

The Mannheim-based company is the world's market leader in the production of road-paving equipment, and its executives believed the high-volume business would be best pursued abroad, where costs are lower. "That was an illusion though," Bernhard Düser, a member of Vögele's board of directors, says today.

"The more production that takes place here at the Mannheim production location, the cheaper it gets," the manager says. Thanks to stricter cost controls, the management of Vögele even succeeded in making its workers in the German state of Baden-Württemberg produce at the same costs as their counterparts in Slovenia.

One decisive argument for making that decision was surely the southern European country's admission into the European Union (EU). Since then, wages have been rising rapidly in Slovenia -- just as they have in other countries that joined the EU, such as the Czech Republic, Hungary and Poland. In Poland alone, average incomes rose by 40 percent during the past four years. But when it comes to productivity, almost all of the new EU member countries are lagging far behind.

Part 2: 'There Is No Longer a Trend Towards Offshoring'

In Germany, on the other hand, unit labor costs have sunk 10 percent since 2000 in the auto supply industry alone -- owing largely to moderate wage increases and growing productivity. Unit labor costs in the economy as a whole sank by 3.6 percent last year. "Many companies that offshored production failed to take the dynamization of factor costs in foreign countries -- such as wages, energy or materials -- into account," says ISI expert Kinkel.

The turnaround is especially evident in machine construction. "There is no longer a trend towards offshoring," says Dieter Brucklacher, the president of the German Association of Machine and Plant Construction (VDMA). The mood of the companies has reversed, he claims, to such a degree that they now have more faith in Germany. "Businessmen are quite capable of reacting emotionally," the lobbyist says.

The German manufacturing industry is once more channelling plenty of money into its domestic production locations. The outlays for machines, plants and buildings will add up to almost €52 billion ($73.5 billion) this year. Compared to the low point in 2005, that is a plus of 19 percent. The increase will even amount to 26 percent in eastern Germany.

Things looked quite different just a few years ago: Between 1990 and 2004, for example, German companies' investments in the 10 new EU member countries in Central and Eastern Europe increased from €348 million ($492 million) to €41.4 billion ($58.5 billion). The number of people employed by subsidiaries of German companies in Eastern Europe rose from 31,000 to 757,000 during the same period of time. Meanwhile, about 120,000 German jobs had fallen victim to the rush to relocate production by 2004.

The reasons were always the same: Either companies wanted to benefit from the extremely low wages in other countries or they wanted to open up the markets where they were investing to their products. But most companies never thought carefully about whether it actually made sense for them to relocate production abroad.

The German Center for Productivity and Innovation (RKW) is giving many companies poor grades. RKW's Thomas Pries speaks of an "insufficient analysis of all relevant production location factors prior to engagement abroad." The researchers at the Fraunhofer Institute came to a depressing conclusion based on the actual figures from an auto components supplier.

First, the institute compared the costs at the German production location to the supposed costs in a neighboring Eastern European country. They included all labor, material, energy, administrative, distribution and transport costs and found that a medium-sized company stood to make a meagre 6 percent profit in Germany before taxes. On this basis, producing in the neighboring country would have yielded almost 20 percent, since labor costs there make up only 4 percent of total costs, as opposed to 18 percent in Germany. The calculation was tempting -- but it had nothing to do with reality.

Nothing To Do With Reality

When ISI researchers factored in all the potential for savings at home as well as additional costs for the offshore location, the return for the German production location rose to 13.2 percent, while that for the location abroad sank to 15.8 percent. "One should not think seriously about relocating production for the sake of a benefit of about 2.5 percent," says ISI researcher Kinkel. He warns against overly hasty plans for turning one's back on Germany.

For example, an offshore production location's start-up time is almost always underestimated: It is often twice as long as planned. The costs of continuous supervision are also often misjudged. The personnel required during the start-up period are almost always paid for by the German headquarters, which thereby artificially increases its costliness, while the offshore location does not need to finance the supportive services.

The search for external suppliers is also far more complicated than many businesses relocating to offshore locations want to admit at first. Many materials need to be cumbersomely shipped from Germany. Moreover, such banal factors as lack of loyalty to the company or a high number of workers staying home sick have a lasting negative effect. Hamburg-based Neuenfeld Machine Factory (NMF) was one of the companies that learned this lesson the hard way.

In 2004, NMF decided to set up its own production facility in Yangzhong, China. NMF is one of the world's largest producers of ship cranes. Most of its customers are in China, which is aiming to become the world's No. 1 one shipbuilding nation. What could have been more obvious than producing in China?

But the initial euphoria quickly petered out. "The Chinese often left us in the lurch, and in the end they harmed us more than they helped us," company director Karl-Heinz Heck notes soberly with hindsight. The lack of suitable skilled labor -- workers capable of assembling the highly complex crane facilities -- turned out to be the greatest problem.

In addition, there were sometimes electricity blackouts that lasted for days. At times the weather was so hot that no work could be done. And sometimes entire brigades of workers left for Shanghai, where they could earn more money. "We used to think you couldn't sell cranes from Europe to China and cover your costs," Heck says. "But what use are the greatest cost benefits to me when I cannot supply customers?"

At the beginning of this year, NMF relocated essential parts of its production process back to Hamburg, where 45 new jobs are expected to be created within the next 12 months.

But many companies are reluctant to talk about such developments, and they shy away from discussing their previous offshore flops. "They bear the stigma of not having succeeded abroad," says Ralf Löckener of Sustain Consult, a consulting company that examines, among other things, the long-term effects of moving production offshore.

Instead of drawing attention to the fact that they are creating jobs in Germany and reaping the public relations benefits, companies "prefer to suffer the persistent negative headlines about their former offshoring of production," Löckener says. "They are especially concerned about their rivals gloating."

Meanwhile, German companies aren't the only ones who have discovered that production can still be a profitable endeavor in the euro zone's biggest economy. Germany has in fact become a magnet for foreign companies that are relocating abroad.

Germany's Research Advantage

Rolls-Royce moved its production facilities for the V2500 turbofan series from Derby in Britain to Dahlewitz in the eastern German state of Brandenburg back in summer 2005. The decision was only logical given Rolls-Royce's previous involvement with Brandenburg, where the British company has had a research and development center since 2004. The turbofan company has set up a research center in cooperation with Cottbus University -- its first such facility in Germany.

The US software company Red Hat -- whose product pallet includes Linux operating systems -- moved its European headquarters from England. The company relocated its sales and marketing departments and a training center to the greater Munich area, a region not exactly noted for its low costs. General Electric has also invested €52 million ($73 million) in a research facility there. The company justified its decision by pointing out that the region represents a "technology cluster," comprised of scientists and technicians that is second to none in Europe.

The major Asian companies Hyundai, Honda and Panasonic have also set up research and development centers in Germany. Hyundai subsidiary Kia alone plans to invest more than €1 billion ($1.4 billion) in the greater Frankfurt area by 2010.

"Labor cost advantages can quickly be lost due to the development of a national economy," says Marco Neuhaus, the author of a study on Germany as an offshore location produced for Deutsche Bank. "But in the longterm, qualitative factors such as the competence of the employees and the standard of research and development are more important," the banker says.

"Unfortunately," he adds, "the Germans are still not fully aware of these strengths."

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