Ever wonder why, in an age when companies are sending thousands of high-wage manufacturing jobs offshore, Toyota Motor still makes Corollas in Silicon Valley—one of the most expensive places on Earth to produce goods? The answer lies in a business principle that Toyota remembers but many others have apparently forgotten: sending goods 500 feet in 24 hours is better than shipping them 5,000 miles across logistical and political boundaries in 25 days. But to act on this principle, a company must be efficient enough to produce its goods close to the places where they are in demand, even when labor costs are high.

For manufacturers in Europe and the United States, offshoring can make good sense. They should look carefully at their economics, however, before they send production overseas. Our experience shows that too many of them overestimate the savings to be had from going abroad and fail to recognize the problems, such as dealing with inventory, obsolescence, and currency exchange rates (exhibit). Unlike companies in service industries, where no physical goods change hands and wages typically represent a higher share of operating costs, many manufacturers may be...