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The concept of nearshoring has gained considerable popularity in logistics and supply chain circles over the past few years. 

The trend, which began as a tentative foray towards shifting production closer home, initially in response to geo-political tensions and trade wars, later gained traction during the Covid-related supply chain disruptions.

Nearshoring, in a way, marks a reversal from the decades of offshoring that saw a large chunk of manufacturing activity move out of developed countries and the expansion of production centres in China and other Asian countries.  

In this article, we will examine what nearshoring means, the background thereof, how it was conceptualised, stages in its evolution (pre-Covid and post-Covid), advantages and disadvantages, impact on trade patterns, realignment of traditional commercial ties, changes in cargo and investment flows, as well as the future outlook.

Background:

Beginning in the 1980s, Western corporations looking to streamline their cost base started evaluating various options for reducing costs. 

The most successful of these initiatives was moving production to foreign countries to avail of the benefits of the low cost of labour and establishment expenses – referred to as outsourcing or offshoring.

China was the biggest beneficiary, as Western conglomerates found in China a vast and cheap labour pool and ample resources. China also had the added advantage of being the most populous country, due to which it theoretically also constituted a vast untapped market. 

The shift in production was enabled by fast-improving transport connectivity, which reduced the cost of transport calculated as a proportion of the product’s value, thus making international transport cost-effective and financially viable. With transport costs slashed drastically, it was cheaper to outsource even the production of low-value items of daily use and then ship them to the US or Europe rather than produce them locally. 

The Chinese government, too, proactively projected itself as a global manufacturing base and was soon dubbed “factory to the world”. 

Over the decades, China has solidified its position and is now the world’s largest exporter. It has also moved up the value chain from producing low-quality and cheap products to now increasingly manufacturing high-value electronic and high-tech products.

Presently, almost all major manufacturing companies, across all verticals, have a significant presence in China and rely extensively on Chinese-made components, thus ensuring that China is deeply intertwined in the global supply chains of all products.

The rise of China had a positive impact on neighbouring countries, which, too, saw an increase in foreign investment as large corporations set up production facilities in other countries, resulting in Asia, as a whole, dominating global production in most sectors.

Concept

China’s dominance in exports led to sizeable distortions in the balance of trade for most countries. At the same time, its attempts to leverage economic heft in foreign affairs and at international forums caused considerable unease.

Besides, stretched supply chains and overreliance on China as a procurement location left companies and retailers exposed to substantial risks arising from potential disruptions to manufacturing and exporting activities in Asia and to the overall supply chain.

These factors caused companies to scour for production centres closer to their consuming markets or home base, resulting in a shift in manufacturing capacity to countries which were located in geographical proximity – giving rise to the term “nearshoring”, as plants were literally located nearer and supply chains were shortened. 

Evolution – pre-Covid and Post-Covid

With geo-political tensions spiking sharply over the past decade and the commencement of trade wars between the US and China, companies found the total cost of ownership of Chinese imports increasing. Also, rising income levels in China meant a steady erosion in the labour cost advantages that China had enjoyed for the better part of 3 decades.

Overall, as local political exigencies caused most major economies to prioritise protectionist tendencies over commercial considerations, countries undertook policy measures to safeguard local businesses and disincentivise imports. 

Parallelly, as the benefits of free trade and economic cooperation became apparent over the years, countries started forming regional blocs (such as the NAFTA/ USMCA in North America and the EU in Europe), whereunder lesser developed countries in these blocs gained certain advantages in terms of preferential tariffs and priority access to markets in developed countries. 

Corporates looking to diversify sourcing locations, therefore, started setting up capacity in alternate locations, which had benefitted from FTA’s/ Regional economic groupings. 

This combination of factors caused manufacturing to move nearer and was the initial stage of the nearshoring trend.

The strategy gained widespread acceptance in the post-Covid years, where the unprecedented magnitude of transport disruptions led to supply chain reliability deteriorating markedly, causing higher costs, longer transit times, extreme variability in the delivery of products and components, and missed sales opportunities. 

Recognising the fact that the longer the supply chain (in terms of distance), the greater the probability of contingencies affecting the supply and distribution network, companies were compelled to look at locations nearby, the logic being that the shorter the distance, the lesser the time taken for delivery, the lower the probability of transport disruptions and greater the supply chain reliability. 

Therefore, post-Covid, companies moved rapidly to develop manufacturing capacity in locations nearer to their primary markets.

Advantages and Disadvantages

The concept of nearshoring has certain associated advantages and disadvantages, which are explained below:

Advantages:

1. Supply Chain Reliability

Increasing supply chain reliability was perhaps the most important objective of nearshoring, to ensure that supply chains continue functioning smoothly in the face of trade wars, sanctions and counter-sanctions, and contingencies, which have the potential to disrupt the transport of goods and cause impediments in the supply chain.

With shorter distances for the cargo to be transported, as also by avoiding the fallout of eco-political pressures, companies are able to infuse additional resilience in their supply chains, thus leaving them much better poised to weather market volatility and macro-level uncertainty. 

This will minimise the probability of stockouts, facilitate continuing business operations with optimal levels of inventory (to avoid excess cash tied up in inventory), and avoid the risks of lost sales and revenue opportunities. 

This will also help companies adjust their supply to unexpected and unanticipated changes in demand (within reasonable limits and inside the scope of normal variations).

2. Shorter transit times 

Shorter distances invariably translate into shorter transit times, thus helping reduce the time needed to deliver the final product to consumer markets or components and raw materials to manufacturing locations. This improves the order-to-cash cycle and the turnover period, which has a positive impact on cash flows and revenue. 

This also decreases the risks associated with damage, theft, obsolescence etc., of cargo, as it is in transit for a shorter period.

The shorter transport time also creates a buffer for companies to cover for delays encountered in the normal course of commerce and operations.

3. Faster access to markets

With shorter distances to cover and shorter transit times, companies can access their markets a lot faster. Companies can ensure that their goods reach the consumer faster than was possible with longer supply chains, which in times of cut-throat competition and commoditisation of most products, can translate into a significant competitive advantage.

This also shortens the sales cycle and increases the turnover ratio, potentially helping increase sales and revenue (as the company is in a position to deliver goods faster to the consumer, something that has become an expectation in these days of e-commerce and same-day delivery).

4. Greater control over the supply chain and components thereof 

Since supply chains are located closer home, companies can exert relatively greater control over the supply chain, various components thereof, and the stakeholders involved in the process. In case of contingencies, companies have recourse to a wider range of remedial measures and alternatives to ensure that their supply chains operate with minimal disruptions and that the commercial and operational impact is within acceptable limits.

5. Quicker response times in case of contingencies

When production is located closer to home, companies can respond faster in case of unexpected events hampering production or operations. Generally, the more stretched the supply chain, the more difficult it is to prepare and implement contingency plans.  

For example, if a company’s manufacturing is primarily concentrated in China (or elsewhere in South East Asia) while the major market is in the US, sea transport is the only option available (the air mode is theoretically an alternative, but given the cost difference, it will be unsuitable for most commodities, except high-value ones or critical and time-sensitive shipments).

 In this situation, should the supply chain experience impediments arising from factors such as labour trouble at Chinese ports or Covid-induced lockdowns restricting transport movement and reducing port labour availability or congestion at maritime ports causing prolonged delays, there is little the importer can do as his options are limited. 

Now, if the company were to adopt the nearshoring strategy and move all or part of its production to a location closer home, such as Mexico, the company not only has an alternative to China – which will ensure at least a partial supply of finished goods or components thereof, it also has more options in case of disruptions arising from common causes. 

If maritime ports are congested, the importer can truck goods across the border from Mexico to the US. In locations where rail connections are available, the company can arrange rail transport to US inland rail depots, from where goods can be distributed further inland. If the container carrier cancels a few sailings or if there are inordinate delays in transit times, the importer can once again utilise the rail or road modes to ensure that cargo flows keep moving.

6. More multi-modal transport options

With nearshoring, the shorter distance and contiguity between the manufacturing location and final markets will mean that more transport options are available to importers and cargo owners in the form of alternate routings, alternate modes of transport and an innovative mix of multi-modal solutions.

Apart from the example of nearshoring to Mexico explained above, European companies are exploring relocating manufacturing facilities to other countries within the European continent itself, in which case, given the robust rail and road connections connecting European countries, these companies can opt for trucking or trains. 

By avoiding risks arising from reliance on one primary mode of transport (sea, in most cases), importers can strengthen their supply chains and make them more resilient and capable of functioning smoothly even in the face of contingencies and disruptive events.

7. Mitigated impact of supply chain disruptions

As a result of factors such as a wider range of transport options, availability of multiple modes, shorter distances and greater control, importers are better poised to lessen the potentially debilitating impact of supply chain disruptions than would be possible in the case of dispersed/ stretched supply chains. 

This will greatly help in maintaining the continuity of cargo flows and the stability of the overall business.

8. Lower transport costs 

Since distances are shorter, the cost of transport is generally cheaper. This is subject to the caveat of bigger vessels offering economies of scale, thereby lowering the per-unit cost of transportation, which might not be possible in the case of shorter routes where smaller vessels are deployed. Generally, however, companies do benefit from a reduction in transport costs, albeit not entirely proportionate to the reduction in distances involved.

This translates into lower TCO, which enables importers to improve their margins or pass on the benefits to end customers in the form of lower retail prices or discounts.

9. Lower inventory requirements and reduction in associated costs

With shorter transit times and more reliable supply chains, companies can afford to maintain lower inventory levels and also decrease their reorder levels.

This directly reduces inventory holding costs, with lesser working capital tied up in inventory, besides lower warehousing and storage space requirements. 

The company also reduces risks associated with obsolescence, theft and security of cargo. 

10. Avoiding the fallout of trade wars and sanctions

Nearshoring to locations that are not engaged in trade wars or are subject to tariffs and sanctions enables importers to avoid the fallout of trade barriers, higher tariffs, import quotas, and the consequent impact on business.

11. Benefits from preferential tariffs and priority access accorded to the country where production has been shifted

Countries that are prime locations for nearshoring are usually also part of regional trading blocs, and their products are accorded benefits in the form of concessional tariffs and preferential access to developed or target markets. Companies which relocate manufacturing capacity to such countries can also avail of these benefits.

Oftentimes, countries that have lost due to nearshoring themselves attempt to take advantage of these benefits. This is aptly illustrated by Chinese companies, who, after seeing Western corporations move production elsewhere and facing declines in exports to the US (due to sanctions and tariffs), are now investing in Mexico, so their products can be labelled “Made in Mexico” and exported to the US under more beneficial terms than was hitherto possible.

Disadvantages:

1. Cost of labour will be more than in traditional manufacturing locations

The biggest raison d’etre for companies to move production abroad was to benefit from cheap labour. Since the cost of labour was considerably lower than in developed countries, corporations were able to reduce manufacturing costs significantly, which enabled them to sell at lower prices, which in turn made the products affordable to a larger section of society and enticed more customers, leading to higher sales, revenues and profits.

In contrast to most Asian countries, the cost of labour is higher in countries in the American or European continent, which are preferred destinations for nearshoring. While labour costs are still cheaper than in developed countries, these countries are not as cost-competitive as the traditional outsourcing locations.

Therefore, companies looking to nearshore will find themselves facing higher labour costs, which causes an increase in the overall cost of production.

2. Availability of adequate manpower

Apart from the cost of labour, companies could also face constraints related to the adequacy and quality of manpower. 

Most countries do not enjoy the demographic advantages that Asian countries possess, leaving them at a disadvantage in terms of available workforce. 

The smaller talent pool also causes a demand-supply mismatch, exerting upward pressure on wages.

3. Lack of technical expertise

Given that the offshoring trend has been in vogue for close to 4 decades now, Asian countries have gained considerable expertise in the manufacturing sector. There is a vast pool of trained and skilled workers who possess both the expertise and the experience to handle such tasks. 

Therefore, when shifting production to countries closer to home, even from within the workforce available, it might be difficult to find adequately trained manpower with the requisite technical and other skills needed to perform such jobs satisfactorily.

4. Lack of manufacturing infrastructure and ancillary trade enabling ecosystems

Countries such as China have built their manufacturing prowess not just on the basis of cheap labour but by creating the entire supporting infrastructure that any industry would require to commence large-scale production. This would inter alia include the construction of manufacturing hubs with dedicated facilities and infrastructural adjuncts such as highways, connections to main markets, raw material suppliers in the vicinity, reliable power supply etc. 

Having built this trade-facilitating ecosystem steadily over the decades has enabled China to offer unparalleled world-class facilities to companies looking to invest in the country. 

Other countries competing for business moving from China will find it difficult to offer a combination of favourable demographics and high-quality infrastructure, thereby hampering their chances of competing with existing outsourcing centres.

5. Overall higher TCO

While factors such as shorter distances and shorter transit times would help reduce costs, the constraints in the form of a lack of adequate and trained workers, sub-optimal infrastructure, and limited trade connectivity could result in higher costs for companies.

In certain situations, this could translate into a higher TCO, thereby eliminating the cost advantages that companies hope to obtain through outsourcing.

Here, it is pertinent to note that reducing costs is not the sole criterion of nearshoring. Rather, the primary consideration is creating a more robust and reliable supply chain by diversifying sourcing origins, for which the company would be willing to incur higher costs (as long as they do not exceed the perceived overall benefits).

In this scenario, the ultimate decision would depend on the benefits from a smoother and more resilient supply chain evaluated vis a vis the additional costs, if any.

6. Domestic market is likely to be smaller (unlike in the case of China, where the large population constitutes a distinct lucrative market)

Apart from the cost advantage, companies outsourcing manufacturing to China also benefit from being located in and around the vicinity of large population centres. The large population constitutes a vast and lucrative domestic market that the company can simultaneously serve, apart from its export-oriented production.

The domestic market and consumer base in most countries would be far smaller than in China. The only comparable country would be India, which is encumbered by far lower levels of GDP and per capita income, which means that while it might have a population base similar to China’s, its consumers do not have comparable purchasing power or disposable incomes.

This implies that nearshoring to countries would, by default, mean shifting to smaller countries, where the local markets would not be as huge as China.

7. Lack of transport connectivity – especially maritime, and time required to reconfigure shipping networks, build transport routes and scale up capacity therein

Ever since Asian countries have dominated global manufacturing and exports, shipping companies have recognised the vast potential and business opportunities and introduced numerous services connecting Asia to the consuming regions in North America and Europe, among other regions.

As a result, Asian countries are amongst the most well-connected in the world, with frequent and reliable connections all across the globe.

Besides the number of connections, the sheer volume of commodities exported means that shipping lines allocate vast amounts of capacity (in the form of vessel capacity and equipment such as containers).

Both these factors facilitate the export of massive quantities of goods, which have made China the world’s largest exporter.

This is manifested in the fact that the largest container vessels (with a nominal carrying capacity of roughly 24,000 TEUs) are deployed on the Asia-Europe and Asia-US West Coast trade.

Other countries will not be able to provide the same level of transport connectivity in terms of geographical coverage or frequency of connections, or capacity available, thus stymying to some extent the chances of other countries offering an ideal replacement for China.

While scaling up production capacity in other countries might be an individual company’s prerogative, exporting the higher quantity produced will also require corresponding investments in port capacity and the addition of new shipping services and capacity by shipping lines. Constructing or expanding port capacity is a multi-year project involving heavy capex and could conceivably take a considerable length of time. 

Shipping lines will be able to introduce new services and/ or inject additional capacity to serve the country’s exports provided there is supporting infrastructure and capacity; however, this once again is a complex exercise, as it involves redesigning their complete network and reallocating tonnage and equipment to serve the new souring origins, without compromising on the quality of service provided to current markets.

8. Lack of port capacity

Regardless of how high or efficient manufacturing levels are in any country, its volume of exports primarily requires adequate port capacity to cater to international trade. When we talk of port capacity, we refer not only to the total cargo handling capacity but also to the port infrastructure in terms of the draught offered, what size of vessels it can handle, cranes, storage area etc.

 China and other Asian countries have long stolen a march over their competitors due to their steady focus on export-oriented production and ongoing investments to increase port capacity and improve operational efficiency at ports. Their headstart has ensured that the list of the world’s top ports is dominated by Asian ports.

Companies looking to move production elsewhere will, in all likelihood, face challenges related to port capacity – a factor that needs to be given appropriate weightage when taking such a decision.

9. Difficulties and Costs of redesigning established supply chains

Current supply chains have evolved and stabilised over decades, during which time trade-enabling infrastructure has also been developed along the traditional trade routes. This would inter alia include the construction of warehouses and CFSs in the vicinity of bigger ports, container depots near production hubs, and rail connections to the hinterland.

Importers and Retailers, too, have configured their transport planning and processes around these established supply chains.

Creating an alternate supply chain involving a new sourcing origin will not only be a capital-intensive exercise but will also mean extensively redesigning the entire supply chain. 

The costs and difficulties involved in doing so present a unique set of challenges to companies exploring the nearshoring option.

10. Costs and complexities associated with maintaining two parallel supply chains

Even if a company were to nearshore production, it is unlikely to move its entire supply chain to a new country. The most probable outcome would involve moving part of its production to a third (closer) country while also maintaining manufacturing plants in the original locations. 

This is to hedge their bets and ensure diversification of sourcing origins, whereby the company can enjoy the benefits of established facilities and cheap labour while also evading tariffs and sanctions by serving the American market through another facility (which is not subject to these sanctions).

The result would be the creation of two parallel supply chains geared to serve two different markets.

This would obviously increase costs (establishment costs of the new manufacturing facilities as well as the loss of economies of scale at the original location) and would also increase the scope, scale and complexities of supply chain planning.

Beneficiaries – countries like Mexico and Eastern Europe

As things stand right now, the primary beneficiaries of nearshoring include Mexico, which is a practicable alternative to US importers, while European companies can consider locations in Eastern Europe.

Given the strained ties between US and China, the biggest and immediate focus of nearshoring initiatives has been the shifting of US-oriented manufacturing to alternate countries. By virtue of its proximity to the US, the signing of agreements such as USMCA, and robust transport connections, Mexico has emerged as the location of choice for companies looking to pivot away from China.

A number of companies, such as Unilever, Denso, and Continental AG, are focusing on setting up export-oriented production facilities in Mexico. At the same time, Mattel has allocated CAPEX of $50 million to expand its plant in Mexico, overtaking its other hubs in China, Vietnam and Malaysia.

At an aggregate level, US companies plan to invest USD 40 billion in Mexico by 2024.

Likewise, for companies primarily serving European markets, the preferred nearshoring locations are countries in Eastern and Central Europe. While quite a few countries are marketing themselves to companies looking to nearshore, the most popular options are Poland, Hungary and Romania. Each of these countries is well connected to Western and Continental Europe by road, rail and barge, making the transport process shorter, faster and more reliable. 

Other advantages these countries offer include cheap labour (relative to Western European countries, even though it is more expensive than the common Asian hubs), cultural affinity, ease of travel within Europe and close political ties. 

Impact of nearshoring:

As more companies nearshore and increasing amounts of capacity are shifted to other countries, we will see some impact on international trade and in the geopolitical situation, which are explained below:

1. Shorter distances to traverse, lower TEU/miles, and lower freight rates

Since the concept of nearshoring involves moving production closer home, the distance that the cargo has to transit is shorter, which translates into a corresponding decrease in TEU/ miles. 

TEU/ miles are calculated by multiplying the overall number of containers transported with the distance that each container has travelled. 

TEU/ miles is a measure of the demand for shipping services and is used in conjunction with the more traditional measures of volumes and revenue. 

The shorter distance could also imply lower freight rates (depending though on a range of factors, such as the size and energy efficiency of the vessel, competitive pressures, vessel utilisation levels etc.).

2. Volumes shifting from deep-sea trades to short-sea/ intra-regional trades

The current manufacturing hubs based in Asia are located far away from the major consumption markets of North America and Europe, traversing which involves sailing across oceans and major seas, wherefore these trades are dubbed deep sea trades.

Trade between countries which are located closer to each other is generally through smaller water bodies and involves shorter distances, and hence these routes are referred to as short-sea trade. In cases where both the origin and destination countries are located in the same geographical region, the routes are called intra-regional trades (prime examples being Intra-Asia or Intra-Europe).

Since nearshoring aims to reduce the distance between the origin and destination countries by shifting production to the same region as primary markets, there will be a shift in volumes from deep-sea routes to short-sea/ feeder routes. This will increase the relative importance of short sea/feeder trades and cause an increase in demand therefor.

3. Commensurate investments in and redeployment of vessels, capacity and equipment to serve the emerging procurement hubs

As we witness growth in export-oriented production in nearshoring locations, various stakeholders in the transport process will have to increase their capacity at these new manufacturing hubs.

This includes shipping companies introducing new services to cover these locations, which also includes investments in vessels of adequate capacity and adding equipment suitable to the cargo profile of the trade (such as reefer containers to serve countries in which pharmaceuticals production has increased or 40’HC containers for trades where garment manufacturing has been shifted to).

Port operators will have to invest in augmenting port capacity and infrastructure, dredging (to deepen draught to cater to bigger vessels carrying heavier cargoes), procuring container handling equipment (cranes and ITVs), acquiring additional space for storage purposes etc. 

Amongst other trade-enabling infrastructures that will get a boost are CFSs, ICDs, railway lines and road connectivity.

As new sourcing origins witness an upsurge in CAPEX meant for infrastructure, investments in existing hubs will slow down (as volumes will not increase at the same exponential speed which they experienced for the past 2 decades).

4. Changes in vessel fleet composition and higher demand for smaller vessels exerting a moderating influence on the trend of upsizing vessels

The upsizing of vessels was made feasible because of the concentration of production in a few select locations, which meant high volumes from a limited number of ports/ countries.

With production now dispersed across locations, cargo volumes will be spread more equitably across ports/countries/ regions. Therefore, the need to deploy mega vessels to carry big container lots will dissipate, and shipping companies will instead have to look for a greater number of smaller vessels to cover the increased number of sourcing origins. 

Also, the new manufacturing hubs might not offer draught deep enough to accommodate mega vessels; wherefore, shipping companies will need to deploy vessels that are smaller in size.

These factors will mean reduced demand for mega vessels, which will moderate the tendency to upsize vessels while also increasing the demand for smaller and mid-sized vessels, which offer more operational flexibility and can call at a greater number of ports. 

This factor will play out in the long run and is contingent on the pace at which nearshoring gathers momentum, and will cause changes in fleet composition, with the balance tilting in favour of relatively smaller vessels.

5. Changes in cargo and investment flows

Cargo outflows have mostly been dominated by Asia over the past 2 decades, an inevitable consequence of the offshoring/ outsourcing trend. This has often been referred to as the shifting of power Eastwards. With nearshoring, the balance of power will steadily shift towards other / developing countries in the Western hemisphere, leading to changes in cargo flows.

Since investment follows cargo flows, there will be changes in investment flows as well, corresponding to the alteration in cargo flows.

6. Geo-political realignments and the emergence of new trade blocs

Nearshoring will result in reduced reliance on limited sourcing origins and strengthen trade and political ties with new countries, which will lead to the formation of new trade alliances. Geo-political realignments will occur as economic relations become deep-rooted and as countries prioritise investments in geographically closer and politically aligned trade partners. 

Future Outlook

Regardless of the advantages enjoyed by existing manufacturing centres, as well as the obstacles in the path of shifting production geographically closer, nearshoring has been steadily gaining in popularity, with the supply chain disruptions over the last 3 years providing further impetus to the process, as these disruptions exposed vulnerabilities in the existing global supply chains and demonstrated the risks of over-reliance on a handful of manufacturing locations.

As companies further grapple with the complexities arising from trade wars and geo-political tensions, it is slowly becoming evident that supply chain reliability can be better served by redesigning supply chains to bring them closer home.

Companies will likely look at having two parallel supply chains, one a China/ Asia-centric one to cater to Asian markets and another one to serve their core American/ European markets.

Companies are slowly investing the resources required to build scale and develop infrastructure in newer manufacturing locations, which in the long run, will bring the efficiency and competitiveness of these new locations on par with that of existing manufacturing locations.

While the extent of capacity moved will depend on considerations such as the costs and accruing benefits, political expediency and growth rates, it is inevitable that an increasing amount of capacity will eventually shift to nations that are located in proximity to developed nations.

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Disclaimer: The authors’ views expressed in this article do not necessarily reflect the views of Marine Insight. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Marine Insight do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendations on any course of action to be followed by the reader.

The article or images cannot be reproduced, copied, shared, or used in any form without the permission of the author and Marine Insight.

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