China Ain’t So Cheap Anymore
By Tom Ryan
Sourcing from China has become a lot more expensive, and seems to have caught some U.S. importers off guard. For some U.S. companies, the changes are squeezing margins, forcing price hikes, and leading many to scramble to find new ways to cut costs or locate new sourcing regions.
“Companies say that, all of a sudden it’s not as competitive to make their product in China,” and are looking at other locations, Patricia Mears, director of international commercial affairs for the National Association of Manufacturers, told the Minneapolis Star Tribune.
The higher costs are largely due to rising wages across China, as well as increased enforcement of existing labor laws within China. Some economists estimate that Chinese wages are rising about 15 percent per year.
Rising energy and raw material costs (e.g., steel, petroleum-based products) are impacting all sourcing regions. But rising oil prices have clearly hiked transportation costs for those shipping out of China. Also, U.S. companies have been hurt by a move by China to reduce exporter tax breaks, as well as the jump in the value of the yuan by 16 percent in 18 months.
Rampant inflation in China is also not helping. China’s consumer price index jumped 8.7 percent year-on-year in February, rising at the highest pace since May 1996.
“Clearly, inflation has accelerated,” said Manufacturers Alliance economist Cliff Waldman. “Much of the problem is food. Food price inflation in China is running about 18 percent year-over-year.”
That’s partly because of a massive diet shift toward grain-fed livestock and recent swine disease that have driven up grain and meat prices in China.
Chris McNally, China specialist for the East/West Center in Honolulu, said a few U.S. manufacturers such as Intel have moved factories into inner China to take advantage of cheaper land and local laborers who don’t have to be fed and housed in corporate dormitories.
In some sectors, wages for high-skill professionals are doubling.
“I know companies that are paying $200,000 or more a year for a comptroller to oversee their business in China,” Phil Mason, president of Asia Pacific and Latin American operations for Ecolab, a maker of cleaning products, told the Star Tribune. “The market has become extremely competitive…There is not a lot of difference today for us to be hiring somebody in China vs. putting in someone from the United States. That’s for a high-level, skilled, experienced person going into a leadership position.”
“For most of the businesses that we have been in touch with, wages are the big deal,” Mr. Mason said.
Discussion Question: Are we witnessing the end of China as the world’s dominant manufacturer? How should suppliers (as well as retailers pursuing private label programs) address the rising costs coming out from China? What’s the optimal sourcing strategy for today’s economic environment?
The reason why China and other lower cost countries took the dominant role in supplying the rest of the world with consumer goods was they had access to abundant skilled labor that was at an income disparity to the rest of the developed world. Chinese manufacturers specialized in products that were not necessarily high-end, but offered good value for money.
As wages and employment increase fostered by an export-driven economy, manufacturers will find it increasingly difficult to maintain the value proposition of the products they sell and other countries will step in to fill that gap. In a way the rise of China as the World’s manufacturer is akin to the rise of Japan as the World’s auto supplier beginning in the late 60s through the 70s, starting off as a low-cost alternative to more expensive western cars.
The difference is Japanese manufacturers tackled quality issues head-on through initiatives like Total Quality Management and in-house suggestion systems. China has yet to implement widespread quality management initiatives at the level the Japanese did (they have been making some changes following all the food contamination issues that came up over the past year) and only better quality can justify a higher price that they will need to charge to keep up with wage increases.
From the perspective of retailers that source from China, increasing prices and no change in the value proposition, will force them to look at alternative sources like Vietnam and the Philippines–fundamental economics of labor cost advantage.
Yes, there are cost increases that will make the decision as to where production takes place for North American sold products no longer a slam dunk to move to China. However, over time, as Chinese consumers begin their transition to the middle class, as do Indian consumers, production and brand expansion will make both of these markets high growth opportunities.
Having production based there will give some companies an advantage for shipping and market growth.
So short term yes…the change in the Chinese economy will make the decisions as to where to base production harder, but pulling out entirely would be a bigger mistake.
This is no surprise to smart retailers. The ongoing problem of price inflation in China has motivated many manufacturers to partner with a Chinese company, look for alternative sourcing from India, Pakistan and Vietnam, among others and begin to engineer their products to maximize production capabilities while minimizing cost.
But don’t worry, China will remain our number one Asian supplier, in the categories they excel in, for many years to come. Their manufacturing acumen, abundant work force and improving infrastructure will support significant growth although a higher price tag will be part of the result.
Agreed that China isn’t so cheap anymore, and also that it’s not much of a surprise. In fact, China has been outsourcing some of its production to Vietnam for some years.
BUT…China is also very good at what it does. Particularly when it comes to textiles, China has become a world-leader in innovative fabric design so I don’t see it becoming less of a powerhouse any time soon.
Also, I really do question the notion that gross margin is decreasing. We ask this question of our survey respondents quite frequently, and there is really NO data to indicate any gross margin compression–among winners or laggards. I think this is mostly a myth.
A rising tide lifts all boats. China has discovered that Capitalism works. It eventually works its way down the ladder to the workers. This is a good thing as far as society goes. I agree with previous posters that it will just move to a different country.
It makes it tougher on retailers, but nothing is easy today. Inflation is back, whether due to better paid Chinese workers or high fuel prices, etc, etc.
I’d like to respectfully disagree a bit with Jerry Tutunjian. The “race to the bottom” isn’t an endless enterprise. Even the most complex regression analysis finally has to get back to a single point of origin. Translated into commercial speak, that means one of these days we will run out of cheap production markets.
I’m not sure relying on the Chinese to broker business with less expensive manufacturing nations is much of an answer either. Over time, that casts them in the role of middlemen and we all know how middlemen add cost.
The real problem isn’t the Chinese–it’s us, or more specifically, our apparently insatiable need for a constant flow of lower and lower cost consumer goods. We can’t have it both ways. Either we start lowering our demand and learn to live with less or we’ll be forced to start paying more which should have the predictable effect of forcing us to live with less. The result is the same. The only option is whether or not the process is voluntary.
Besides the wage and production cost inflation of Chinese imports, corporate buyers must now factor into their purchasing decisions the costs of western quality control inspectors necessitated by China’s proven lack of regulation AND the untold billions of dollars of revenue losses due to Chinese product imports that have had to be recalled worldwide.
It is no wonder other low cost production countries are being sought out and developed.
You ain’t seen nothing yet.
Although, in theory, China stopped pegging the yuan to the dollar, it still actively manipulates currency exchange rates. The pressure is building and if it ever is allowed to float, the appreciation versus the dollar will further increase prices. With $1.5 trillion in currency reserves, SOMETHING has to give….
Industrialization has been fairly rapid for China and like most of her predecessors such as Taiwan, Korea and Japan, the process of maturation becomes shorter and shorter.
Some of China’s issues are global and therefore apply to every potential manufacturing country (cost of raw materials, global economy) while other costs and pressures are truly unique to China (supply of labor, wages, currency, etc).
China and its manufacturing base has peaked in terms of numbers and we will (and are) seeing large numbers of factories falling to these pressures. However, the big will get bigger, will enjoy some economies of scale which will partially offset internal issues. They will also begin to subcontract parts offshore and will invest in companies off shore for entire production lines.
China will enjoy her role of manufacturing giant for many years to come, whether in China or in Vietnam, India or Brazil. They have the cash to buy and invest in these countries and will do so.
This is no particular relief or bad news–depending on which side of the fence you are sitting. Just as Japan did decades ago, China will subcontract or open factories in the poorer countries of Southeast Asia or Africa. The race to the bottom is and endless enterprise.
We are already seeing movement from China to Vietnam and other lower cost countries. This will continue and more constraints and restrictions will be put on China. The FDA is now sending full time inspectors over there. Recently, China was caught for price discounting (dumping) large plastic bags.
Their new environmental regulations will rightfully add costs to products and materials manufactured in China. In fact, more environmental regs and transparency will make it tougher on China and US Companies that are bringing in their products: just look at things like fuel, greenhouse gases, carbon footprints, grow local, etc. I think China is in trouble and while they are still growing their exports–it will slow and new High Growth Opportunity Countries (HGOC) like Vietnam will come on board!
China will continue in its #1 position but rising wages and inflated commodity prices will force manufacturers to consider options. However, it’s hard to ignore the improvements in infrastructure over the past 20 years that keep China at the front of the pack. The other consideration, especially for apparel vendors, is speed. As “fast fashion” becomes more important (to compete with specialists like H&M and Zara), the big national chains like Target and Kohl’s will consider delivery time–not just price–as a key factor in their sourcing decisions.
Why can’t smart, innovative people in this country get together and form a one of a kind coalition of modern, state-of the art factories that can produce goods at fair prices that U.S. consumers will pay for, and also put people to work in the good old U.S.A.?
I know…I sound naive, but it can be done, if only we keep government out of it (within reason). There are plenty of areas with lots of land, fresh water, and good transportation to set up these “new factories.” Place bonuses and extra incentives on the workforce to produce high quality goods, and have everyone involved in the process, along with the huge potential for success.
The right attitude is needed for this to succeed, and I think this country is sick and tired of the junk they are buying elsewhere. Every consumer product made elsewhere, could be made here, and it would take a complete restructuring of how we do things from top to bottom. All of us need to check our egos at the door to do this right, and there has never been a better time to do so. Self reliance is not a bad thing, and we can prove to the world, that we still are the innovative leaders.
Does this sound too pie in the sky??? I wouldn’t write it if I didn’t believe it, but it is going to take a huge commitment from all involved; workers, and management will have to be as ONE if this is to really work.
China is experiencing a congruence of growing pains in manufacturing capabilities, socio-economic development, external demands, and political issues.
As manufacturers and consumers we only feel the pinch where we depend on China the most; low cost manufacturing.
Eventually China will stabilize, but it is an opportunity for other countries to increase their role in the manufacturing world since the demand for low priced goods will remain.
Additionally, the growing demand of green products allows for additional countries to pick up the demand since they can create the custom infrastructure for green manufacturing while China has to rebuild and redesign their structure (to meet the green demand).
China will always be the biggest producer because it has the largest population. And rising prices help retailers. The worst thing in retailing is deflation, not inflation. Inflation means your inventory gets more valuable, and you can raise prices because your competition’s sources are the same as yours. Isn’t it easier to raise prices when everyone else has to do it, too? No one is being singled out.
Prices in American dollars may decline (or not rise so sharply) if we end our foreign war involvement. Losing foreign wars kills the dollar. American inflation was high during and after losing the Vietnam war. Canadian dollars were strong, and so was German currency because those countries’ war commitments were proportionately much smaller than the USA.