Having served the world as a manufacturing base for decades, is China still competitive for manufacturers? A number of factors indicate that its competitive lead will be chipped away, not least if the renminbi is allowed to appreciate against the U.S. dollar and costs rise. Some experts predict that low-value-added exporters may be driven elsewhere while manufacturers of high-value-added, complex products for domestic consumption will face even stiffer competition to thrive. Against this backdrop, as a new survey suggests, manufacturers in China are learning quickly about staying competitive in this ever-shifting landscape.
It certainly doesn’t help matters much that there’s uncertainty and tensions brewing on a number of fronts. Among the foreign IT industry, for example, the ugly exchange between Google and China, and a new rule that stipulates sellers of high-tech goods must contain Chinese intellectual property as part of an “indigenous innovation” campaign, have rattled nerves.
Yet despite all this, experts say there’s much that’s working in China’s favor. Costs are still low and the skills level is high. Meanwhile, the pent-up demand of a potentially huge domestic market combined with improving IT, infrastructure and regulatory regimes all put China well ahead of other low-cost countries.
While the recent announcement of China’s first trade deficit since 2004 makes it unlikely that the renminbi will be allowed to appreciate against the U.S. dollar much soon, March’s $7.24 billion deficit is also a sign of the fast expansion of China’s domestic market. The auto sector, for example, was up 170% in March from the previous month.
China‘s burgeoning domestic market is indeed a very important allure for many firms, according to the latest China Manufacturing Competitiveness Study published by the American Chamber of Commerce (AmCham) and management consultants at Booz & Company. More than 80% of 202 manufacturers surveyed said their primary motive for being in China is to provide products for the Chinese marketplace, up from 71% two years ago.
While booming local markets are key, there are other reasons for China’s appeal, including political stability. A couple of years ago, companies were hedging their bets and adopted a “China plus one” strategy, so that they set up operations in China and in one other nearby country. Many chose Thailand as the second country and the current strife is bad news for businesses there.
The stable currency has also been helpful, adding an element of predictability to budgeting and keeping costs down. Two years ago, the AmCham study found that the rising RMB was the most serious worry for the companies surveyed, but since then government policy has calmed those fears. The AmCham study also notes that “although factories in China are generally still in the early stages of implementing innovative manufacturing practices, these lean techniques and processes are even less prevalent in surrounding low-cost countries.”
Lian Hoon Lim, partner and manufacturing expert at AT Kearney consultants, says companies are benefitting from what he calls “the cluster effect,” The big three clusters in China are the Yangtze River Delta region around Shanghai, the Pearl River Delta region running from Hong Kong to Guangzhou, and the region around Beijing and its neighbor Tianjin. In these areas companies have access to a “skilled labor, an experienced local managerial workforce, material and component supply, and good infrastructure,” says Lim. “If you took those four factors and looked at the countries in Asia, including in the subcontinent, you would find that quite a lot of them lack one or more of these four points.”
Yet China continues to grapple with one of its trickiest growth challenges: Attracting and retaining top employees. The drop in global demand for exports from China during the economic crisis meant layoffs and a softened labor market. But by the end of 2009, as China’s economy re-accelerated, labor was again in short supply. In the fourth quarter of 2009, labor demand growth in major cities outpaced supply for the first time since the second quarter of 2008, according to JP Morgan Global Watch Data. As a result, manufacturers have had to hike wages to attract workers.
“The increasing costs and tightened labor market are driving companies to consider other options for their lower cost, export-driven operations,” observes Stephen Li, a principal at Booz.
The AmCham study found that in 2009, the costs of labor and logistics as well as labor availability were viewed as less competitive in China than they were than two years ago. Yet 28% of the companies surveyed last year said they plan to move or expand within China in the next five years, compared to 17% in 2008. Cities in southwest and central China, such as Chongqing, Chengdu, Wuhan and Zhengzhou, are among the new destinations cited. For companies considering moving outside China, more than half said they wanted to stay in Asia, identifying India and Vietnam as their top choices. Latin America and Eastern Europe ranked a distant second and third.
But for companies staying in China, the study shows that they are readjusting their arsenal of tools to attract and retain staff, offering higher pay and training. Most respondents — 79% — said they are providing training and career development rather than relying on compensation to attract and retain workers. “Leading companies are recognizing that attracting and retaining talent in the post-downturn [environment] will mean refreshed value propositions incorporating growth and development opportunities,” says Li.
Case by Case
But despite all of China’s appeal, foreign companies are right to exercise caution, weighing up the advantages and disadvantages of being based in the country accordingly. AT Kearney’s Lim says that of the six clients he has worked with over the past three years, only two gave the country a vote of confidence.
Lim reckons that the business case for investing in China has changed for many companies in recent years. “If a firm wanted to expand in 2007, it was a ‘no brainer’ to go to China.” Along with the rising costs, he notes the “viability of long-distance supply chains” as having “prompted a rethink” in how firms view China as a potential manufacturing location.
One of the six — an industrial-goods firm — wanted to set up a joint venture but couldn’t agree on the terms with the potential partner so did not go ahead. Another — an aerospace components manufacturer — set up shop elsewhere due to intellectual property concerns in China. A third client, who was in the medical industry, decided the return on investment in China would not be worth the effort, while a fourth didn’t go ahead with an investment in China, for undisclosed reasons. However, a plastics manufacturer did because of the high demand for its goods in China, as did a maker of industrial equipment because it expects China to be a hub for its sector in the future.
China is competitive for textiles, says Lim, but less so where the value-added and complexity is low, such as bed linen. Men’s shirts, on the other hand, are “quite complex; you need to cut many different pieces, the stitching and sewing is complex, and you have cuffs, buttons and collars, and many different sizes.”
Then there are white goods and consumer electronics. According to Lim, the competitiveness is a function of the combination of labor costs that are relatively low but at skills level that is relatively high. “A company could set up elsewhere — say, Cambodia — where the cost of labor is very low,” says Lim. “But the productivity and familiarity with the industry is not there, and most of the raw materials would have to be imported.”
Made in China
The catalyst causing many companies to re-thing their China strategies started when oil went from $40 to $150 a barrel. Suddenly, transportation costs for goods from China to Europe and America became markedly more significant. Despite the fact that the price of oil has stabilized, “people are more sensitive to the risk of it spiking again” says Lim.
To address the challenges, companies are devising “long-term strategies, which focus on product competitiveness and their supply chain,” says Li.
But whatever the sector or supply chain, another on-going challenge, meanwhile, will be to please China’s consumers, who are unpredictable and have varied tastes. As Edward Tse, chairman of Greater China at Booz, writes in the analysis of the study, “Although China’s markets are open to global products, they are also extraordinarily local, rooted in traditional customs and tastes, with extreme variations from one region to the next…. With markets and tastes continuing to change, it is difficult to predict what kind of path China’s consumers will follow.”
The result, he says, means that “companies seeking to take advantage of the Chinese market cannot be complacent but must upgrade processes, retain talent, keep a tight reign on costs and get to know their customer.”