In business parks and along industrial corridors, mid-size U.S. contract manufacturers are successfully wooing new business by promising lower costs than the competition. The only thing surprising about their success is that the competition they're beating is China.

Matthew Davidson, CEO of Xten Industries in Kenosha, Wisconsin, ranked 3,134 on this year's Inc. 5000 and one of the manufacturers enjoying a flow of contracts coming back from China, says he knew it all along. "We were convinced to do this by management gurus and consultants," he says. "This has been the great boondoggle, that we must outsource to be competitive. Twenty percent of goods sent to China don't make sense."

Really? Manufacturing wages average 67 cents an hour in China, compared to $17.23 in the United States. One hundred Chinese cities have populations of more than one million people, compared to nine in the U.S. China's only labor union is controlled by the state and is largely considered useless. "China's labor force wants to work. They're happy working," says CEO Charles Colman, whose food service container company, San Jamar, sends 60 percent of its production overseas -- forty percent to China. A good slice of the 40 percent that stays in the U.S. goes to Xten. With China's sea of inexpensive non-union labor, why not outsource it all?

"That's hooey," says Davidson. Xten is an ISO 9000:2001 certified contract manufacturer of toilet paper dispensers, napkin dispensers, medical waste and other containers -- bulky, low value containers that, as it happens, are not ideal for offshore manufacturing. Some of Xten's customers learned this only after outsourcing their production, closing their U.S. plants, and watching their manufacturing cost rise instead of fall. "This whole move to China was driven by [large corporations]," Davidson says. "They can set up plants in China, have full control of their workforce, and take full advantage of labor and material cost."

Small and mid-size companies, however, cannot always justify the expense of shipping to China. The price for sending a 40-foot shipping container from Shanghai to the West Coast is $6,000. Only 2,000 toilet paper dispensers fit on a container. "Our products are mostly air," Davidson says. "They don't stack well." With China's export tax (up to 20 percent of the value of the goods) plus land transport in China and the U.S., the total shipping price tag runs closer to $8,000 -- four dollars each on a toilet paper dispenser that retails for less than fifteen dollars.

"If you're a Tyco and you know your annual usage of fire alarms, you can make a deal with the shipping company with a very attractive annual rate. They know your product is there every month, filling 50 percent of their ship." Smaller orders are the first to get bumped on an overbooked ship. To offset the unpredictability of shipping schedules, Xten is forced to buffer with extra inventory in both the U.S. and in China. "Tyco can keep a 10-day inventory instead of a 30-day inventory. The rest of us have to look at our costs very carefully."

Bill Strauss, Chief Economist at the Federal Reserve Bank of Chicago, agrees. "If you're going to be selling in a country, there are a lot of benefits in producing in that country."

Xten also has an unusual business approach. "We never say no," says Davidson. Today's companies, for example, require finished parts boxed and shipped direct to retail stores. "If a customer wants us to ship to three different outlets, we'll do it," Davidson says. "Factories are now distribution houses."

China's manufacturing strength lies in what Ted Fishman, author of China, Inc., calls "a cookie-cutter approach," leaving U.S. manufacturers like Austin-based Formaspace with a lucrative niche in customized products. Formaspace -- 1,314 on the Inc. 5000 -- builds custom heavy-duty furniture for laboratories, clean rooms, and industrial settings. Formaspace's products must meet critical application specifications for cleanliness and chemical and electrical resistance. "Mass customization is a source of strength for American manufacturing," says CEO Jeff Turk. Not only does Formaspace not outsource production to China, it exports its furniture to China. "Quality is a difficult thing to come by," Turk says. "Local companies often claim to meet standard engineering specifications they don't actually meet. It's easy to hide a quality flaw in furniture."

Formaspace did try to outsource parts of its IT work to China and Tawain, without success. Part of the problem, Turk found, was a cultural divide. "It's not in their culture to say no or to say something will be delayed, so they just say yes. When you have critical needs, you can't have that."

The weak dollar has helped both Xten and Formaspace. "With the weak dollar, the U.S. is actually a more attractive place to do business," says Strauss. Turk agrees: "America has a big For Sale sign on it, which is great for manufacturers in the U.S." In the end however, Xten's and Formaspace's core capabilities remain customer service and customization. "I've never believed in a permanent competitive advantage," says Turk. "You always have to provide the best product and the best cost."