People fall into two schools of thought these days.  There are those that think China outsourcing has run its course.  They subscribe to the notion that the appreciation of China’s currency (RMB), labor shortages and cost increases and increased fuel prices mean cost savings opportunities have substantially diminished.  In contrast, the other side of the coin spells out what others have believed for years—startup costs and tooling are less in China, products with high labor content have to be outsourced and China will always be “Factory to the World.”  For several reasons, they are both correct.

Rising wages

In a December 15, 2011 Wall Street Journal article it was reported that China's Ministry of Human Resources and Social Security, announced 21 provinces and municipalities had, on average, instituted annual minimum wage increases of 22% by October of last year. Officials in Shenzhen, in China's southern manufacturing heartland, said in November that they would raise the city's minimum wage by 15% in January, to attract more workers.  While wage hikes are nothing new, they have reached a point where factories are no longer able to absorb the increases meaning higher costs are passed on to consumers.  However, with last year’s economy taking a turn for the worse, demand dampened driving commodity costs down.  The result was China’s digging in its heels on allowing currency to rise against the dollar.

Since the mid-90s companies sought out the labor machine that China represents with its nearly 800 million strong workforce to remain competitive in Western markets.  China’s family planning practices in place since the 1970s translate into a tightening demographic of available workers.  This has also meant that China has moved more inland to expand its available workforce.  Even so, the average hourly wage earner still makes only around $70 per week on the low end and up to $80 at the high end.   While this is nearly double what it was around 2001, compared to the 2011 U.S. Federal minimum wage of $7.25 per hour/$290 per week the 275% premium speaks for itself.  Add to that mandatory unemployment taxes, healthcare benefits and other layers of overhead U.S. companies have to absorb and the costs begin to add up.

U.S. Manufacturing on the rise

According to a February 1, 2012 Bloomberg report in which she sums up the U.S. manufacturing landscape, Caroline Baum states that “manufacturing employment peaked at 19.5 million in 1979, when it represented almost 22 percent of the workforce. Last year, the 11.7 million manufacturing workers accounted for less than 9 percent of total employment, according to preliminary data from the Bureau of Labor Statistics. During that time, the value of U.S. manufacturing output kept increasing, thanks to strong productivity growth.”  So in other words, Advantage U.S. 

And she goes on. “Manufacturing employment has increased 334,000 since the low in December 2009. Southern, non-union states offer an increasingly hospitable environment for factories. NCR Corp. opened a new plant in Georgia to produce automated teller machines. Caterpillar Inc. plans to build a new construction- equipment factory in the U.S. Ford Motor Co. is bringing 2,000 jobs back from China and Mexico after reaching an agreement with the United Auto Workers union. Even a family-owned North Carolina furniture manufacturer decided to reopen a factory that has been shuttered for more than a decade.”

Advantage-U.S.

China’s Innovation

What comparative advantages China may be giving away in labor and productivity however is being bolstered by innovation which takes China to an entirely new level on the global playing field.  China has doubled the number of international patents created since 2005 and is launching products at a fraction of the time as its Western counterparts.  Mckinsey Quarterly's February report cites their government’s emphasis on indigenous innovation, underlined in the latest five-year plan. Chinese authorities view innovation as critical both to the domestic economy’s long-term health and to the global competiveness of Chinese companies. China has already created the seeds of 22 Silicon Valley–like innovation hubs within the life sciences and biotech industries. In semiconductors, the government has been consolidating innovation clusters to create centers of manufacturing excellence.  And the report goes on to say that because of its large market, much of China’s innovation is staying there.

Advantage-China

Striking the balance-bringing it together

Because of the cross pollination of U.S. industry standards, quality processes and knowledge transfer, more and more firms are combining China’s vast low cost labor machine, ingenuity and speed to market to become multi-national in scope.  Solar power companies, the auto industry and a new medical initiative sponsored by the Chinese and U.S. governments are creating opportunities for both our countries to leverage their strengths.  Read the joint statement here.

China wins because they gain access to medical innovation and improved standards of healthcare.  The U.S. gains access to an untapped market for highly profitable products and services.  This bi-lateral agreement fosters long-term cooperation with China in the areas of research, training, regulation and the adoption of an environment that will increase accessibility to healthcare services in China. Participating U.S. companies initially include 3M, Abbott, Chindex, Cisco, General Electric, IBM, Intel, Johnson & Johnson, Medtronic, Microsoft, Motorola, and Pfizer. Supporting organizations include AdvaMed, the Alliance for Healthcare Competitiveness, the American Chamber of Commerce in China, and the American Chamber of Commerce in Shanghai, PhRMA and the U.S.-China Business Council.

As we continue to increase trust, enhance communication, and cooperate in developing life improving technologies and innovations, a new frontier of collaboration is emerging that will change the world as we know it.

David Alexander is the founder of Baysource Global and Executive Vice President of Direct Source China, a strategic sourcing and strategy firm with offices in Miami, Tampa and Shanghai.

With the middle-class consumer demographic growing rapidly in China, companies who are not including China in their target audience could find themselves falling behind in the years to come. Here's more...
 

 Are you ready to talk to them?

Things can and do go wrong and having the peace of mind that you have a contact in the U.S. is invaluable.  This goes a long way, particularly in the start-up phase of a project as you require hands on involvement with your project.  It is important that you have a day to day contact in your time zone for trouble shooting, planning and preparation.   Too often small but critical details can be lost in translation as operators try to work through cultural barriers, time zones and misunderstandings.  Even those dealing with a satellite factory right in the U.S. have to deal with production issues, timing and other miscues.  If you’ve ever played the secret game as a kid, where one person begins a story, then passes it around a ring of people until the last one hears it, then you have seen how details are lost and the story is altered from its original concept.  The same is true when passing along instructions to your offshore manufacturing partners.  Unless you have a consistent source, who speaks your language and understands the objectives, you can end up with a mess.

1.  Freight costs—Freight and logistics should not exceed 10-12% of your total cost of goods.  In other words, if you ship a 40 foot container to the U.S. this will cost on average $5,000 including import fees, duties, tax and drayage (overland transportation to/from a shipping port).  So if you can’t move approximately $50,000 of product, that should already be 20-30% below existing manufactured cost, you need to re-evaluate whether it makes sense.

2. Carrying cost of capital—Cash is king in any business.  It is critical to produce inventory that will move once it gets to the U.S. otherwise each month that inventory is tying up capital and not producing top line sales revenue, you are eating into your cashflow.

3. Warehouse space—every square foot of a warehouse used to store products has a fixed cost.  Unless you have excess space available, you need to be certain you are allotting this valuable real-estate to products that are generating revenue.  Otherwise the savings will be offset by the additional cost of warehouse space.

4. For items #2 and #3 it is imperative that analysis be given to not only finished goods but also raw material and components.  Often overlooked is the advantage of using China to absorb the financial burden of not only managing but paying for commodity purchases, raw material, components and works in progress.  Every month of financial responsibility taken on by your China producer is a month of cashflow freed up for your business.

5. Start-up costs—your China factory will absorb many intangibles associated with start-up costs including learning curve, purchasing coordination, and in many cases tooling not to mention infrastructure such as plant, property and equipment.

Quality, consistency and timing should only be the “cost of admission” and no sacrifices should be made in these areas.

Interested in learning more? You can right here.

In a town ironically named Americus, Georgia two hours south of Atlanta, that is precisely what Jae Lee has set out to do, producing 2 million Chopsticks each day destined for Japan, Korea and yes, even China.  In May of this year, the Americus-Sumter County Payroll Development Authority (PDA) made a formal announcement that Georgia Chopsticks, LLC would open a production facility in Americus that employs 150 people.  According to Lee, China with its 1.3 billion population lacks ample natural resources to support demand for chopsticks and on Tuesday, May 31 a formal ribbon cutting ceremony was held to mark the opening of their plant.

According to the Atlanta Journal Constitution Lee who started his chopsticks business in Cochran last November, sent a couple of samples overseas, and within a few months needed to expand.  Said Lee, "I knew there was a need and I thought I could make a profit."  Imagine that.

"We tend to think that the Asians take care of that pretty well," said David Garriga of the Americus-Sumter Payroll Development Authority, the economic agency that owns the plant that Lee rents in the city's old industrial park. “For Americus, the chopsticks factory represents a flashback to its days as a manufacturing center,” Garriga said. But as many companies shifted work overseas, many shops shut down.

So why aren’t more companies strategizing to include China in their plans?  In an October 6, 2010 Bloomberg Press report it was estimated that China market was valued at $150 billion in potential goods and services or a top ten global opportunity for U.S. companies. “U.S. companies have experienced tremendous commercial success in China's market and the prospects for future growth are significant,” says Erin Ennis, vice president of the U.S.-China Business Council.

China has become the U.S. third largest customer for things like Greentech, machinery, luxury items and even wine.  China's expanding consumer market clearly has an appetite for Western brands.  Thanks to the gateway of information available through the internet, television and other media there is almost built-in demand for products from the West.  As long as companies are focused on things like quality and safety the market is stronger now than in the history of our trade relationship.

“The Chinese appetite for fashion has become voracious,” says Farooq Kathwari , chairman, chief executive officer, and president of Ethan Allen Interiors.   “The observation that ‘we first dress ourselves, then we dress our homes” applies equally in China. For years, French, British, Japanese, and American clothing designers have taken China by storm. It was a natural evolution that consumers so immersed in couture and inspired by the biggest names in fashion would turn next to fashion for the home. The demand is there and growing.”

Kathwari should know.  He’s been in China since the 1970’s when he began buying arts and crafts there.  Today they are marketing Ethan Allen —a quintessentially American brand—in 53 locations in major cities across China. They ship 60 percent of what they sell there from their well-established U.S. manufacturing base and in turn buy Chinese products to be marketed in Ethan Allen Design Centers in North America.

The U.S. exports about $100 billion annually to China in goods and services, supporting about half a million American jobs.  According to the White House new deals in the works with China will support up to 235,000 new jobs in the U.S.  In addition to major players such as General Electric, Honeywell and Navistar, there are opportunities for companies of all sizes to exploit increased demand by the growing Chinese middle class.

For now, the man who would sell chopsticks to the Chinese quietly goes about his business of working toward a goal of producing 10 million chopsticks per day.  As of June he’d received 450 job applications.  For many of those Americans out of work in the little Georgia town, the Chinese market for their products could soon mean the good fortunes in their cookies may very well come true.

Diving into unknown waters

Many have asked me what it's like doing business in China.  I've always said that if you are doing it by yourself it can be as dangerous as swimming with croccodiles.  I finally came across a photo that captured the essence of this concept.

What is something you can think of that can’t successfully be outsourced in China?  Think long and hard about this. Resist the temptation to veer toward intangibles or time sensitive services with obvious geographical barriers such as a haircut or plumbing repair.  What product theoretically cannot be manufactured in China?  How about a portrait?  I have an acquaintance that has connected with amazingly talented artists who will take a family photo and reproduce a framed, hand painted, oil on canvas likeness taken from a photograph.  It will have the same level of detail and quality as those done by artists in the U.S. costing a minimum of $1200-$2500 just for the painting itself.  This does not include the frame which can be another $350-$500.  The exact quality portrait from China can be delivered to your doorsteps for $450 or about a quarter or less that which someone would expect to pay here.  Why is this?

 If you said labor cost you are only partly correct.  There are many more factors that play into “the China price” for which Westerners have had an insatiable appetite since the Wal Mart effect took hold in the early nineties.  Yet now writers, politicians and economists say the tide is turning.  Many assert that currency fluctuation, labor shortages near China’s coastlines, and a rising middle class, are quickly narrowing the cost gap between China and the West.  They might be forgetting one thing though according to Mike Bellamy, author of The Essential Guide to China Sourcing , “there is no Next China.”

Rising labor costs in China

In a Roya Wolverson interview published in Time, May 16, 2011, Pin Li, President of the Wanxiang America Corporation stated that “rising labor costs in China will only cause inflation and not necessarily jobs returning to the U.S.”  He further explained that what this means is “instead of paying $1 for latex gloves the price may rise to $2 and will still represent the lowest cost available in the world.” 

In other words, assuming material costs are consistent globally, even doubling or tripling the average monthly wage of Chinese factory employees still does not bring total cost of goods in line with U.S. workers.

In a recent conversation, Bellamy, Chairman of the Advisory Board for China Sourcing Information Center  begins to make the “No Next China” case with the notion that China’s economy is still vastly lopsided in its dependence on exporting.  The Chinese and its neveaux riche’ have created the world’s second largest economy that many predict will be bigger than the U.S. within the next decade.  The only fuel to keep this burning is the demand for cheap(er) exports.  A growing middle class also means bolstered domestic consumption, particularly as brands become more prevalent with Chinese consumers.  But to sustain economic growth, exports have to remain a big chunk of the equation.

A shift by coastal manufacturing regions

The question may not be so much about “Made in China” as it is “What will be Made in China?”  Sure there is great capacity and infrastructure in coastal regions but there may be a shift developing with the evolution of improved skill sets and wage increases.  Dr. Eric Thun , lecturer in Chinese Business Studies at the University of Oxford China Center, says "pushing manufacturing into high value-added activity is very much what the government wants.  This kind of cost pressure stimulates upgrading."

Bellamy adds, “because China’s economy is still heavily export dependent at present, over the past years there have been concerns about the China government promoting the interior too fast at the expense of the coast.  This could have major side effects on the much needed revenue stream gained by supplying product to overseas buyers. But, as April data demonstrates to policy makers, the development of the interior is not having a major impact on exports. “ 

The role of appreciation in Chinese currency to U.S. job creation

 Since June, 2010 when currency truly began floating, the RMB has appreciated 6% against the US dollar.  Depending on whom you talk to however, the RMB is still undervalued by as much as 25%.  Add to this CPI inflation and productivity growth rates (Chinese worker productivity is growing faster than U.S.) and the RMB will continue to be undervalued for five years or more.

Pin Li argues that “currency can help but it also can hurt. Structural issues are more fundamental for the U.S. and China. This is more of a political question than any economist can even measure. Politically we have to pretend it's an issue. But the reality is that jobs from China won't come to the U.S. They'll go to Mexico, Korea, and Indonesia. And that means the imports that came from China will now cost more which also doesn’t solve the deficit issue.”   

Bellamy claims “we can expect that the US government will probably use the April export record to put pressure on China to allow their currency to appreciate.  The China government has a plan in place for a slow but steady increase as opposed to a dramatic adjustment as desired by the US. Don’t expect China to change their plan just because of this April data and any related pressure from the USA.”

China as a market 

Li’s passive reference to the deficit is interesting and should not go unnoticed.  While many grip about jobs, only a small percentage of Western companies have invested in growing market share in China.

In an October 6, 2010 Bloomberg Press report it was estimated that China market was valued at $150 billion in potential goods and services or a top ten global opportunity for U.S. companies.  “U.S. companies have experienced tremendous commercial success in China’s market and the prospects for future growth are significant,” said Erin Ennis, vice president of the U.S.-China Business Council. 

Beijing has a $145 billion trade surplus with the U.S., more than its deficit with the next seven- largest partners combined.  But is this solely due to undervalued currency and cheap labor?  Could it be more the apathetic or myopic strategies of only selling into North American and European markets and not breaking from traditional business models? 

Pin Li makes a bold statement when he asserts, “Firms’ access to Chinese should be their more of a concern than an unbalanced currency.”  

The next five years 

China remains a factory to the world.  Government subsidized infrastructure has ensured overcapacity of manufacturing availability.  One needs to simply travel from town to town; cranes as far as the eye can see.  Staggering development continues in all sectors such as transportation, industrial, housing, recreation, hospitals, shopping centers, and resorts.  Innovation and branding are now woven into the next generation’s mindset with Beijing’s full support.  There is no next China.  Whether as adversary, trading partner, or ally the future will depend on setting priorities and building mutual trust.

David Alexander is President of BaySource Global www.baysourceglobal.com

Via Tech Crunch

“The idea that China could succumb to the kind of unrest rocking authoritarian governments across the Middle East was absurd,” a senior Chinese official said. According to a Reuters report, “Long-term disruption to the site would exclude the company from the world's biggest Internet market by number of users -- about 450 million and growing. That could hurt its planned initial public offering in New York and anger the United States, which has criticized Chinese Internet censorship.”

According to a report in the February 24 edition of Wall Street Journal Asia many Internet users are becoming increasingly aware of the extent of the censorship system, as well as how it works, and are either seeking new ways to get around it, or becoming increasingly frustrated at their failure to do so.
One of the most damning critiques of China's censorship system came Tuesday from Murong Xuecun, a popular Chinese Internet author.
"Our mother tongue has been cut into two parts: one safe, and the other risky," he told an audience at the Foreign Correspondents' Club in Hong Kong.
"Some words are revolutionary, and others are reactionary; some words we may use, and others belong to our enemies."

via Tech Crunch

Head West and turn...

Let’s be clear on one thing.  This piece is a completely self-promoting call to action.  If you were in charge of business development for your organization; and here is the one qualifying caveat—for a product or service you absolutely knew would help other businesses reach their targets while delivering a heady ROI, would you not pound the war drums?

In a January 31 API wire the #1 manufacturing country was reported.  Many would assume China leads the way by a commanding margin yet it trails the $1.7 trillion output of the United States by a whopping 40% meaning we produce more with less labor.  It also indicates that low value added jobs with less profit margin have gone overseas.  So what does that mean for us?  It means that China is still the factory to the world and if operations decision makers haven’t developed a competent model to outsource redundant, high labor and low value add processes, they are tempting fate.  Is it finally time for your organization to embrace a synergistic offshore-onshore manufacturing & distribution strategy?

Consider Sure Power of Portland who increased their employment by 53% after embarking on a manufacturing outsourcing strategy to free up valuable plant space.  They increased sales 188% by re-dedicating valuable assets to R&D and higher margin products.  This translated into a 204% increase in tax contributions to the state of Oregon in one year.  Getting to China however can be a daunting and expensive undertaking for the inexperienced and timelines are usually doubled when going it alone.  Does your company have any KPIs for lost opportunity cost?

Assume for a moment that you are the SVP of Operations for a U.S. firm in Des Moines that manufactures some sort of metal and plastic assembly.  Sales have been flat and finally in that Monday morning meeting the inevitable question arises.  “What are we doing about China?” your boss asks.  You have a solid team of purchasing professionals, none of which can point to Hong Kong on a map.  However, through the internet one of your go-getters, Bill, has begun to put a spreadsheet together of die cast and injection molding companies in the Guangdong Province, which he’s researched as being a hotbed for these industries.  Since Guangzhou is a FTZ (Free Trade Zone) Bill with his Operations Management degree, has identified this as the logical place to start.  He’s shared a couple of months of emails with “agents” posing as direct factory managers and is ready to take his associates to China.  Just say the word.

Assuming that Bill and the others now have passports and visas in hand, they begin booking flights, hotels, trains, and ferries to venture out into the Middle Kingdom.  In all they’ll be gone for just under three weeks.  Since this is the company’s first sojourn to Asia, you’ll undoubtedly accompany them on this exciting new foray into the land of the dragon along with your Ops VP.  Now you and your four valuable employees will be out of pocket the majority of a month leaving yours and their day to day responsibilities to others or to simply take a break from existing projects.  How much time and capital do you think this will require?  You may be surprised.

The following lists conservatively typical expenses by line item for a 2 ½ week trip to China.¹  Remember, you’ll require a full 24 hour day of travel to and from and a day of recovery once you’ve arrived.

Cost for single trip, five personnel, to China

T

The good news is there are competent firms in place to assist in your project management initiatives.  In a recent poll on Linked In, 150 Supply Chain professionals weighed in with their response to the question, What is the best way to manufacture outsourcing in China? (See diagram below). 57% of respondents chose “Establish a trusted partner in China.”  Perhaps a good portion of the voters had already been through the trial and error process.  Or it could be that those who have succeeded in tandem with a firm watching out for their best interests can easily quantify the decision to engage a reputable partner for monitoring manufacturing, quality control, packaging, labeling and logistics.

Linked in Poll-150 respondents

In his article 10 tips to better sourcing William Atkinson of Purchasing Magazine explains that regardless of their China story, those who have enjoyed a successful relationship with China have done so through proper guidance and preparation.  In this critical juncture of global commerce, fluctuating currencies, and competitive pressure, it is imperative to select a reliable partner whom you can trust, knows the local governments and regulations, has engineers on staff who understand your products and who can help you gain a foothold in this valuable region of the world.

¹Airfares, four star accommodations and RMB exchange rates as of February, 2011 for travel in March, 2011

Baysource Global President, David Alexander can be reached at david.alexander@baysourceglobal.net

www.baysourceglobal.com

Unflappable, Dan, walks into an Office Depot to prepare his counter strategy which we later learn is simply to put up a sign that reads, “We Fix $6 Haircuts.”  Brilliant.  

In 2005 when we began to offer our clients our sourcing and project management services in China, we assumed our only competition would be others who jumped on this bandwagon.  Were we wrong.  Our greatest barrier to acquiring new clients became the honorable but misguided efforts of those managers who had been led to believe that a web search and a few returned emails from China meant they were well on their way to implementing their companies’ low cost sourcing initiatives. $6 haircut indeed. 

In the past decade technology has enabled much more efficient  information transfer between continents.  FTP sites and inexpensive phone rates via Skype, Vonage and other VOiP carriers have improved the cost and speed of sharing data.  Social Media, blogs and email have given us the perception that barriers to communication have fallen.   Airfares to and from China are reasonably priced and with over 1 billion people in a country the size of the U.S. there are plenty of agents ready and willing to take on your manufacturing project.  All of these new advantages,  highly valuable as they are, present no assurrance that your new found business associate in Asia has the know-how, experience and resources to deliver you a quality product and service. 

Now, even some of the top private equity firms in the U.S. have followed the models of Fortune 1000 companies opening offices in China to centralize sourcing and purchasing.  I write about the “Five Things You Should Know Before Launching in China” http://bit.ly/c5eeBg which lists key considerations prior to investing in this front-loaded, fixed cost model.  

Faced with the downturn in our economy, manufacturers and distributors are re-thinking which initiatives make the most sense for offshore manufacturing outsourcing.  This is a good practice and new criteria have been distilled into this decision making process.  What is clear now however, is that many are finding the “$6 haircut” actually costs triple that or more when you leave this vital decision in the hands of those without the know how or qualified personnel in place.   What are the true costs of poor quality, defects, and missed product launch deadlines?  How many personnel on your  payroll have to get involved to solve the various challenges that result in poor execution?  Need to airfreight and rush that order in?  You just doubled, tripled or worse your shipping cost of goods. 

When taking a project to China, it is imperative that you confirm you are working with engineers who understand Western quality standards, tolerances and material specifications.   Be sure you have a dedicated team of advisors who have an interest in your success, respond to your project timelines, and share your same sense of urgency.   Are your China contacts truly invested in your business and do they have only your best interests in mind? 

Many of our new clients are now those who assumed the $6 quotation they received would net them a $12 profit.  There are multitudes of willing entrepreneurs in China willing to take your $6 time after time.  Buyer beware the $6 haircut.  There is great peace of mind knowing you can walk out with both ears, without a mowhak and ready to face the day with confidence.

David Alexander is President of BaySource Global www.baysourceglobal.com a leading sourcing and project management firm with offices in Shenzhen and Shanghai.