Front page news of the business section of the South China Morning Post (SCMP) on June 1, 2011 is an article by Denise Tsang explaining that Li & Fung is bullish on the opportunities for exporting from the Pearl River Delta, despite the increased costs of labor in the region.
For those who have not heard of Li & Fung (can’t be too many people in the China sourcing industry that have not yet heard of them), Li & Fung is the granddaddy of HK trading companies. They even wrote the book on how to compete in a global economy without owning any factories.
Summary of the media’s take a China sourcing over last 18 months
2010: OMG, China is getting expensive and factories will leave China. The sky is falling, the sky is falling. Where is the next China?
2011: Wait, factories aren’t leaving China. Maybe there is no next China…
The SCMP running the headline “Li & Fung bullish on the Delta” is a headline in itself as the debate is finally getting past the Chicken Little “sky is falling” sensationalism and starting to dig into why factories are not leaving China.
For the past few years, headlines in major papers have been announcing the end of China’s dominance as a sourcing destination, often sighting the rising cost of labor and the strengthening currency. In reality, China has not lost its position as the premier sourcing destination and factories are not picking up and leaving China as some so-called China experts have been predicting.
Li & Fung’s bullishness is a headline, only because, unfortunately, a certain group of press has been getting it wrong for some time by making the false assumption that rising costs mean that factories will move out of China. So it is about time that a major player like Li & Fung comes out against the prevailing currents in the media and sets things straight on China sourcing.
There is no next China. Good, I’m too old to learn Vietnamese.
The SCMP article points out that there is no alternative to China for a huge portion of the buyers who have come to China for production during the past 20 years. It is also worth pointing out that as China moves upstream in terms of providing more of the all important “value add”, the products they export are less and less labor intensive. Think DVDs and refrigerators as opposed to socks and underwear. For a growing number of products, the increase in the labor rate does not impact the costs of the final product on an equal percentage.
What makes Li & Fung’s announcement so impressive is that their portfolio is dominated by textiles. So if T-shirt and Blue Jeans crew and are still staking their future on China, then the rest of us who buy items further up the value chain like toys, electronics and car parts can breathe a sigh of relief that we don’t need to move production to Bangladesh anytime soon!
The next China is China
Yes, labor costs in China on the coast are going up, no doubt about that. Li & Fung boss expects a 5% increase each year thought at least 2015. I believe him. Plus, like an old man on Viagra, the RMB appreciation is going to see a well controlled but very steady rise for the next few years.
For the reasons explained early, factories are not leaving China. But factories are moving inland. The press was right to sense a shift is taking place, but they got the destination wrong. It isn’t Mexico or Indonesia, it’s Chongqing, Hengyang and 100 other cities of 1 million plus capital each in the interior whose names you have never heard of.
SCMP’s article contains an amazing graph. Check this out and it is clear that there is a massive gap between costs in the current production bases on the urban (coastal areas) and the rural interior. So plenty of room for factory bosses to set up shop and tap into this interior before having to look outside of China.
Attention Walmart shoppers, get ready for a price hike.
I suspect foreign buying offices would happily source from places like India, Indonesia if they could get a comparable level of quality, lead time and price as currently found in China. But they can’t (insert sinister laugh from Beijing government planner a la Vincent Price in the Michael Jackson Thriller Video). As the SCMP put it, “increased costs may force some factories out of the Pearl River Delta but the mainland will remain the workshop of the world” because they have the manufacturing experience, access to capital, infrastructure and supply base well entrenched.
The result is that as production prices go up, buyers and suppliers will look for ways to be more efficient in production. Luckily, because China has had the “throw another body at it” mentality for production for most of the last decade, there is plenty of room for improvement. But it will be hard to make up for the rising costs of labor and exchange rate through production efficiency alone, so I’m willing to bet that the prices will start to rise out of China and there is not much Walmart can do about it other than to pass the costs on to the buyer at one point or another.
The world is in an inflationary period, period.
Wishing you successful China Sourcing!
Author, “The Essential Reference Guide to China Sourcing” (chinasourcinginfo.org/book/)
(Shameless Plug: I’m gonna be a daddy in August. Help with her college fund. Buy my book.)