Rethinking comparative advantage in electronics industry

There was an article in firstpost today, which caught my attention. It talks about how Google chose to manufacture it's new streaming gadget, Nexus Q, in silicon valley of US and not in China or other East Asian countries. It was opposite to the thinking of other organizations, such as Apple, who primarily source from Asian countries. 

The belief for many years, regarding the manufacturing of electronic goods, has been that East Asian countries have a comparative advantage in terms of labor cost. Initially, the trickle that started with Japan, Korea and Taiwan making some electronic devices, developed itself into an Electronics International Production Network deluge that enveloped China, Thailand and other East Asian countries. The Asian electronic network virtually rules the production chain of electronic components, save a very niche category, which for some security and technology reasons, is still with western nations. The network of production chains lead to specialization and scale economics, that tilted the balance even more towards Asia. It became difficult for others to compete. (Take India for example, which missed the hardware industry revolution and is struggling to catch up, despite cheap labor cost. See here for more.)

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A paragraph on theories of trade is needed to put things in perspective. The traditional, and inadequate, Heckschler-Ohlin theory of trade would predict East Asian domination based on the comparative advantage. However, HO model also had interesting corollaries in factor equalization and Stolper-Samuelson theorems which would predict that the advantage might decrease over time. The intra-industry trade theories which studied demand effect and specialization effects in greater detail, over traditional theories, cannot explain East Asian dominance, as the electronic products today are catering to global demand, and the taste doesn't change based on geography here (take iPhone for example). The theory of Krugman on increasing returns due to specialization (and not just starting factor endowments), which determines trade, is something that comes closest to explain East Asian dominance. The scale and specialization worked for Asians, to help them reach where they are today in electronics trade. 
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This move by Google doesn't fit the pattern. Why would someone start procurement (or production) at a place where the costs are almost double. The reasons given by Google is that they will have shorter lead times in development, shorter shipping time of products, less freight cost, better cooperation as the design team can work with the suppliers easily, fewer defects due to better automation and so on. 

Coming to what Google says, I don't agree with 'lesser freight cost' or 'lesser defects' theory. Freight cost of products will average out when you take the whole global demand for products, given that the demand from other continents is significant, irrespective of where the production is located. Lesser defects is again a function of design and production process, and it can always be checked, irrespective of location. So the only advantage lies in faster product launches and faster iterations of products. And this advantage might be a game changer.

Google is looking at the total cost, rather than just manufacturing/production cost. A very valid reason is that the total cost is not just production cost. It's the total design and development cost, plus the recurring regular 'cost of time delay' of shipping if you think that developed markets drive major demand. I would add to it the fact that it is easier to work with suppliers closer home. When I used to develop products, (in my previous life in hydraulics industry), I always found that, as a designer, it was important to work with suppliers to get the product right. Whenever the supplier was in other city/abroad, the feedback cycle for improvement got stretched, affecting the product development cycle adversely. This is a very valid reason to have your suppliers near home for product development. And Google knows that its products are highly prone to obsolescence, and the product development cycles would be frequent. 

That's true of the entire electronic hardware industry today. For the products that are coming out for the past few years. e.g. the phones, pads or laptops, have typical life-cycles of a year or two. The industry, 20 or 15 years ago (think 2-in-1s, CRT TVs, old desktop machines etc), had longer life cycle periods, of 4 to 5 years. So the game is changing in this industry when we account for the need to invent frequently. 

It looks to me, that it is dawning upon organizations that for the new genre of electronics products, it makes sense to have their suppliers closer home. The best battle to watch out would be between Google products (if they continue with the same strategy for other products they are coming up with) and Apple, over a period of time. Apple is still going with the older model, Google seems to be challenging it. I think, we would need a new theory then. To put our minds at rest by explaining away the world!

Update on 07 Dec 2012:
Apple is planning to now return some Mac production to US from China. Looks like there is some rethinking going on in Apple too about their China strategy.