Recently, newspapers’ headlines present China as loosing its lead because of manufacturing cost increases. Is this just a fad or a fact? And does this situation require companies to rethink their sourcing and industrial strategies?
CHANGE OF MIND ABOUT CHINA SOURCING?
There is a clear shift in the general public perception about China sourcing. Newspapers are full of headlines like the ones below:
- “After decades of outsourcing, manufacturing jobs coming home to US”
- “The UK manufacturing taking on China”
- “China offshores manufacturing to the US”
Beyond headlines, the public’s interest started shifting at the time of the financial crisis in 2008.
A comparison between the number of google searches on the topic “China sourcing” and those on the topic “made in USA” shows both magnitude and timing of that shift.
Actually, a new concept is emerging as well: reshoring. When companies “reshore”, they bring back home production that they had delocalized earlier. This concept only appears in 2010.
Reshoring, if wide spread, would mean that China no longer can compete with Western manufacturing.
In 2011, the Boston Consulting Group (BCG) issued a report stating: “Made in the USA, Again: Manufacturing is expected to return to America as China’s rising labor costs erase most savings from offshoring”. The report points out that although there is still a cost advantage to China, it tends to be counterbalanced by other costs such as logistic costs.
Are increasing costs in China killing sourcing and manufacturing in China? The question does seem legitimate.
FACTS AND REALITIES ABOUT CHINA
CHINA MANUFACTURING COST INCREASES
There is no doubt that costs are rising in China. Wages and salaries have increased yearly by 15 to 17% over the last few years. Employees may be disappointed by a 30% raise.
As a matter of fact, the 12th five-year plan (FYP) aims at an increase of 13% per year for all minimum wages.
China single focus on export as engine of growth is slowly fading. The 12th FYP’s objectives include strengthening domestic consumption.
Measures taken years ago already, such as changes in Export VAT rebate policies, show a clear strategy by China’s government toward supporting export of higher value added products and not export of low skill labor and resource intensive products.
Nevertheless, exports continue to grow, year after year, except at the deepest of the financial and economic crisis in 2009. While its costs are clearly increasing, the growth of China exports does not seem to be affected.
CHINESE MANUFACTURERS START PRODUCING ABROAD
Some Chinese manufacturers are now producing abroad. Beyond known companies such as Huawei or Haier, less known ones also open plants in location like the Southern States of the USA or in Eastern Europe.
END OF CHINA AS WORLD MANUFACTURING BASE?
Combining all this, it would be easy to conclude that China will soon loose its status of manufacturing base of the world. But this would be a mistake: the reality is both more subtle and more complex.
What is clearly taking place in China is a transition from low skilled labor intensive industry into a higher value added industries. Simplistically, China is in transition from the “cheap” shirt, shoes and toys producer of the world into “good value” machines, electronics and solar panels producer.
The 12th FYP lists seven strategic industries, far from the products we see as “Made in China”:
- Advanced equipment manufacturing
- New materials
- Next generation information technology
- Energy saving and environmental protection
- New energy
- New energy vehicles
This is not new, in 2003, BCG was writing: “… one finding is clear: a company can now source almost anything from China. The opportunity to source in China has expanded to include extremely high-tech products, as well as components that are part of a more complex logistics pattern, such as automobile parts. ”
Is it really the end of an age for China manufacturing?
Yes for certain industries with low margin products and low added value. In a first phase those will be (are) moving to China’s Western provinces or to other countries. Then, after a some years, they will suffer steady upward price pressure. Only those manufacturers who are able to increase efficiency and show some business innovation will be able to fight head to head with other countries champions.
But it is another story for sectors that require infrastructure, a good supply chain and a network of integrated suppliers, both relatively cheap workers AND relatively cheap professionals (engineers, logistics …).
Until recently, Chinese business model was based simply on low costs as the competitive advantage. Nowadays, China’s good companies use their low cost to build new competitive advantages.
The Economist writes: “contrary to conventional wisdom, it will not mean that companies close their Chinese factories [ … ]. China is still a terrific place to make things. Labour may be cheaper elsewhere, but it is only one cost among several. Unlike its lower paying rivals, China has reasonable infrastructure, sophisticated supply chains and the advantage of scale.”
The Financial Times comes to a similar conclusion in an article titled: “Reshoring, five reasons why China will remain the world’s factory”.
In some sectors, like electronic products, very few places in the world can compete with the combination of production capacity, available skills and tight fabric of experienced suppliers.
WHAT IS THE FUTURE OF CHINA SOURCING?
What does this means for organizations sourcing parts and products from China?
The short answer is: the successful ones will be those who will source more, not less.
However, more does not mean bigger volume but a wider scope: the higher the added value in China, the more opportunities of getting a competitive price and other advantages.
For instance, pre-assembled sub-systems will generate more savings then a few simple parts.
Products arranged in kits will bring more savings then simple products shipped in bulk. When products require basic technical work (configuration, customization and redesign) as opposed to a pure OEM according to drawings from abroad, the savings will be higher.
Moreover, China is becoming a serious contender for many assembled equipment, and exports more and more machinery and production equipment across the world.
China’s industry is continuing its transformation and successful industries of the past decades are not the ones that will grow tomorrow. What has not changed is the tremendous momentum of the country. It is developing capabilities and competitive advantages that go far beyond pure low costs. Today’s labor cost increases are not going to fundamentally alter this position.
For Western companies looking at China as a sourcing market, it is important to integrate these changes. As it is important to understand that the future is in more complex and more added value commodities and products.
Doing this requires more subtle analysis while making “make or buy” decisions. It also makes selecting and managing suppliers tougher. The China choice is no longer a no-brainer. But for those who devise the right sourcing strategy and implement it efficiently, the advantages will be strong and sustainable.