To regionalize or not? Optimizing North American supply chains

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Despite a growing global economy overall, today’s trade environment is turbulent, not least in North America. Worldwide, supply chain headwinds are fueled by increasing cost and risk—geopolitical, economic, and environmental—compounded by shocks such as spiking inflation, Russia’s invasion of Ukraine, and the lingering repercussions of the COVID-19 pandemic.

To stay ahead in this unpredictable economy, companies are building speed and agility into their operations, and supply chain configuration is a priority.1Strategic courage in an age of volatility,” McKinsey Quarterly, August 29, 2022. Leaders are considering manufacturing and sourcing in-region—not only to gain a cost advantage, but also to increase resilience.

Approximately 40 percent of companies are reviewing their supplier bases to be closer to their main markets, which in many cases lie in North America.

There is, of course, no one-size-fits-all solution. Instead, the case for regionalization depends on specific industry and location circumstances. This article therefore analyzes the factors that affect North American regionalization decisions and focuses on ten industries where potential shifts could occur.

Offshoring remains important—but pressures build

North America is the world’s second-largest market—yet despite strong regional trade relation­ships and interdependencies, it is increasingly reliant on imports from the rest of the world.2 The value of total imports, excluding natural resources, grew from 26 to 35 percent of the region’s gross output over the past decade, and this growth is accelerating compared with local manufacturing capacity (Exhibit 1).

Over the past decade, North America has increasingly relied on imports.

China continues to be the largest provider of goods to North America, although its share of the market remains flat overall. In contrast, Southeast Asia has seen a rapid increase in market share and now accounts for about 16 percent of North America’s imports.3

Malaysia, Thailand, and Vietnam have led this surge via three industries: integrated circuits, phones, and computers. Over a ten-year period, the value of these countries’ exports to North America in these three industries alone has risen by $55 billion. Contributing factors include competitive costs, skilled workforces, relatively easy raw-materials sourcing, free-trade agreements, and government programs backing industries such as electronics.

Yet pressure is rising on the offshoring model, as issues including higher labor costs and logistical complexity underscore the need for value-chain agility and resilience. Tariffs and duties are becoming more unpredictable, quality standards more exacting, and end customers more demanding.

At the same time, governments are expanding incentive programs encouraging local manufacturing for several priority industries in North America, for reasons including national security, competitiveness, and self-sufficiency. In the United States, commu­nication technologies and space technologies and systems are now considered relevant for national security, while Canada supports aerospace, medical technology, and next-generation technology. Meanwhile, Mexico has sectoral promotion programs that allow for preferential tariffs on inputs for manufacturing. Self-sufficiency has likewise increased in importance, with Canada expanding support for domestic production of pharmaceuticals and medical devices.

Disruption risk has also intensified. Shocks that disrupt supply chains for a month or more—including conflict, trade disputes, natural disasters, cyber­attacks, and pandemics—now occur every 3.7 years on average.4Risk, resilience, and rebalancing in global value chains,” McKinsey Global Institute, August 6, 2020. Manufacturing and sourcing outside a region, with supply chains extending over a large area, can amplify this vulnerability.

Shocks that disrupt supply chains for a month or more—including natural disasters, cyberattacks, and pandemics—now occur every 3.7 years on average.

In addition, companies now face stricter environ­mental, social, and governance (ESG) expectations. Transportation and energy account for 75 percent of greenhouse-gas emissions related to international trade, and long-distance imports can generate ten times the emissions of products manufactured in North America.

Building resilience with regionalization

Regionalizing supply chains is one way to mitigate this supply chain shock.5Future-proofing the supply chain,” June 14, 2022. How companies decide on regionalization depends on their individual situations. Some industries are better placed than others. Production shifts are not always possible, especially where value chains are highly integrated or country-specific competitive advantage is strong.6Risk, resilience, and rebalancing,” August 2020.

Many factors influence the success of a regional­ization strategy. For example, higher material and labor costs must be weighed against potentially lower logistics costs, working-capital requirements, and tariffs and duties. Labor availability is important, with skills shortages just in advanced industries amounting to tens of thousands of vacant roles in Arizona and Texas alone. Infrastructure, productivity, and supplier availability are all relevant as well. The availability of installed capacity and a relatively mature supplier base can be enough to tip the balance in favor of regionalization in certain industries.

Industries that are capital- or knowledge-intensive, or whose products are especially complex, may find moving more complicated. It may be easier to make the shift where top exporters have already done so, or in trade-intensive industries where demand from the region is already growing rapidly. Noneconomic factors and policy interventions can further accelerate regionalization for priority industries—identified by country-specific factors such as national security, competitiveness, and sustainability.

The argument for regionalization in North America

Moving some or all supply to North America may boost profitability directly, while also increasing the flexibility and responsiveness of the supply chain. Considering the full cost cycle is vital in deciding whether targeted benefits can be achieved.

For example, for certain products in industries such as automotive components, consumer electronics, medical devices, or industrial products, manufacturing abroad may no longer be the lowest-cost option to serve the North American market. Relatively high material costs in North America (20 to 25 percent higher than traditional manufacturing hubs) may be outweighed by the impact of non­material costs such as labor, transport, and tariffs. By relocating to Mexico, certain production lines in these industries may save 15 to 25 percent of total landed cost; and a facility in the United States may have a similar cost profile to an overseas hub, with closer proximity to end users. Given the total landed cost, there could be a strong case for regionalization.

This might not be the right move for other industries, subsectors, or products. For example, a company producing active pharmaceutical ingredients close to end users might not be able to offset the higher operating costs of small plants in multiple locations, despite savings in transport, tariffs, customs duties, lead times, carbon emissions, and working capital.7Strategic courage,” August 2022. For this company, it might be more profitable to consolidate production at a single hub. However, if it has a portfolio of products especially sensitive to disruption risk, it may be prudent to have multiple production centers.

The existing supplier base plays a key role in such decisions. For example, as of mid-2022, analyzing 20 components with high material costs (including metal parts, such as heat exchangers or aluminum pipes, and plastic components such as polymer pellets) revealed that only about one-quarter were in fact more affordable to source from Asia than from Mexico—and only one category, polymer pellets, showed a cost advantage of more than 10 percent. However, finding, qualifying, and developing the right suppliers for certain categories in North America for operations at scale remains a significant challenge, making it difficult for many buyers of components to realize the promised cost savings.

Country-level factors for decision making

Within North America, each country offers unique conditions. Those relocating to the region or increasing their existing footprint can choose from diverse environments and market considerations.

Regional boosters may be helpful. For example, the United States-Mexico-Canada Agreement has broadened trade stimuli; stricter rules of origin, for example, mean that intraregional automotive manufacturing is flourishing. The agreement also strengthens protection for patents and intellectual property, which boosts industries such as pharmaceuticals and aerospace manufacturing.

Factors such as self-sufficiency, national security, and technology development play a role in industry location. The US Congress has passed the Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act to promote manufacturing in semiconductors.8 Canada is investing about 1 billion Canadian dollars ($750 million) in the Global Innovation Clusters program (formerly known as the Innovation Superclusters Initiative), which seeks to accelerate the country’s technology development.9

Several free-trade agreements and multiple transport links further support North American regional integration. The United States, Mexico, and Canada are all strong trading partners, usually ranking in the top three countries for imported goods for each respective market. Mexico and Canada provide over 20 percent of US imports globally, ranking just after China. This connectivity mitigates distribution risk, offering alternative ways to transport goods within reasonable timelines and costs.

Mexico and Canada provide over 20 percent of US imports globally. This connectivity mitigates distribution risk, offering alternative ways to transport goods within reasonable timelines and costs.

These three markets offer varying conditions with respect to cost and capital, labor, infrastructure, service and quality, and environmental and social requirements. While sector needs may differ, overall the region offers favorable conditions for multiple industries.

Mexico’s high manufacturing base (accounting for around 25 percent of jobs) renders it attractive to labor-intensive industries. Similarly, its lower inland logistic costs are key for industries where transportation costs are inherently large due to the volume of products.

The United States’ accessible energy costs make it more suitable for energy-intensive industries. A well-educated workforce with manufacturing experience and incentives for several industries make the United States attractive for moderately labor-intensive industries requiring high-skilled talent. The United States is incentivizing energy efficiency through the Inflation Reduction Act, particularly for locally made clean-energy equipment.10

Canada offers the lowest energy costs in the region, providing a key advantage for energy-intensive industries. Companies might face stricter regulatory restrictions, but those with strong sustainability commitments could benefit.

Ten North American industries where regionalization could occur

Regionalization’s impact is specific to each industry and sector. However, some industries are particularly affected by global trade shifts and have a strong case for regionalizing part of their manufacturing and supply chain footprint.

Our research has identified ten industries with strong regionalization feasibility. These include medical devices, semiconductors and electrical components, computers and electronics, and pharmaceuticals. These industries are likely to see demand rise across North America. They are boosted by noneconomic factors, such as government support, as well as economic drivers, and may well see larger shifts in their production facilities and supply chains due to regionalization (Exhibit 2). Other industries in this group include automotive, electrical equipment, machinery and equipment, chemical, mobile, aerospace, furniture, food and beverages, and apparel.

Economic and noneconomic factors suggest that ten industries are more open to regionalization in North America.

Three major industry archetypes for regionalization

As companies weigh a move to North America, the implications and challenges will depend on supply chain integration across the region. Based on both anticipated North American demand over the next five years and self-sufficiency levels, industries for regionalization can be classified into three major archetypes:

Well established with stable growth. Companies that are part of well-established industries in the region, such as aerospace and automotive, with stable growth and high self-sufficiency, can find the right country fit to sustain their growth and productivity.

Mid-tier industries. Companies and industries in this group can focus on continuous improvement in productivity and cost to avoid losing production to other regions and strengthen existing infrastructure to increase self-sufficiency.

Accelerating with room for improvement. Industries with low self-sufficiency, such as semiconductors, mobile phones, and communication equipment, will require significant investment to develop the required infrastructure—but this can be justified by high expected growth (Exhibit 3). To attract these industries, North American countries can invest in the required infrastructure, facilitate incentives, and align on development priorities. Talent sources for underdeveloped local industries could be found or grown.

Regionalizing industries may face challenges depending on supply chain integration in North America.

As trade dynamics shift and market demand continues to grow, the pressure for regional strategies is likely to persist. By evaluating their position, companies can decide how best to adapt their operations. For some companies, regionalization offers agility and flexibility in an unpredictable global trading landscape.

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