Christmas orders shipped from the factories in late summer and October was the trade show season in China. With new orders in hand from the shows, November 1st start of next annual production cycle for many manufacturers, exporters and importers. So I thought this an ideal time to look back at the past few years and bring out my crystal ball for 2013.
Let’s start by stating the mind set of most of the typical buyer over the past few years:
2010: “OMG, China is getting expensive and factories will leave China. The sky is falling, the sky is falling. Where is the next China? I better get some production going in SE Asia to be safe.”
2011: “China is even more expensive than last year. But wait…, why aren’t the factories leaving China? This doesn’t make sense. BTW, why is my production still not online yet in SE Asia?”
2012: “Damn, I had no idea how hard it would be to get production running in Cambodia. Ouch, China is still getting more expensive”.
Here is what I think they will be saying in 2013.
“Unbelievable, China labor and production cost are still rising. But now I see what is happening- factories are indeed moving, but they are moving to the interior of China, not overseas. China is the next China.”
Winner and losers
When the global economy heads south, brands owners are often forced to cut costs to retain market share. This is an opportunity for some and a nail in the coffin for others. Let me explain:
Those brands who have long ago established a China supply chain have most likely been twisting the arms of their suppliers for many years. Now they find themselves in a real jam, because as labor and production costs rise in China, the Chinese boss’ arm can’t be twisted much more if he stays at his current location in coastal China. To make matters worse, in most industries, exception being low end textiles and footwear, there simply is “no next China.” The mainland will remain the workshop of the world for at least 5 to 10 more years in the majority of production classifications because China has the manufacturing experience, access to capital and established infrastructure in terms of logistics and legal.
Yes, it may come as a surprise to say that China’s legal structure is well established, but just try to set up a wholly foreign owned factory in Vietnam or Cambodia, then let’s compare notes with China about lead times, regulatory hurdles, legal transparency and corruption. There is no painless place to do business among the low cost Asian countries, but China is a headache while Vietnam is a migraine and Laos is a lobotomy.
There is no “next China”
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 DVD players and refrigerators as opposed to socks and underwear. For a growing number of products, the increase in the labor rate does not have a major impact on the costs of the final product.
And even when the labor rate does have an impact on the final cost of the end product, because it is not a simple matter to move production out of China, the most common solution is that 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 improvements in efficiency and automation. 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 continue to rise out of China and there is not much brand owners can do about it other than to pass the costs on to the buy side at one point or another. In other words, attention K-Mart shoppers, get ready for a price hike.
The “next China” is Western China
For the reasons explained earlier, factories are not leaving China. But factories are moving inland. The press and many professional buyers were right to sense a shift is taking place, but many got the destination wrong. It isn’t Mexico or Indonesia, it’s Hengyang, Hefei and 100 other cities you have never heard of in the interior of China. HP, Samsung and Foxconn didn’t leave China; to the contrary, in the past few years they invested big in places like Chongqing and Xian in the west of China.
The question we should be asking
In my mind, the more interesting question is “why aren’t more factories leaving the coast for the interior?” I own and operate 3 wholly owned foreign enterprises with a payroll of about 200 full time employees in Shenzhen on the coast of China. (Small operation by Chinese standards.) If labor and land costs continue to rise, while tax breaks dry up, at some point in the next few years I will be forced to move some or all of my assembly lines to the interior. But it hasn’t happened yet for the following three big reasons:
a) I’m concerned the savings in labor would be offset by the increases in logistics.
b) Margins are so tight that a project’s profit and loss may be determined by the amount of VAT rebate received back from the government at exportation. We know the people and process involved at our local port. If we move inland we start the process all over again. As the VAT rebate can be as high as 17% of export value, delays or lack of refunds can be catastrophic to a business.
c) I’m not sure I can find employees with the professional and language skills I need at this time in the interior.
A look in the crystal ball
While the large companies are already making the move, someday there will also be a tipping point for the mid-sized factories like mine where it makes sense to move to the interior. Samsung and HP are making the move now, but for the smaller guys, my gut tells me our move is 3 to 5 years away. Glad Hunan dialect is a lot easier to learn than Vietnamese when you already speak Mandarin.
Tough times call for new strategies. The situation at my sourcing agency.
The slow global economy does have a silver lining for innovative sourcing agents like PassageMaker. As mentioned earlier, when the global economy heads south, brands owners are often forced to cut costs to retain market share and margins. For those brands that have been sitting on the fence about China sourcing, they now must source from China in order to stay in business. While big buyers in the US got off the fence many years ago, there are still large players in places like Australia, S. Africa, S. America that have not yet gone China direct. But in the slow economy, they too are jumping off the fence and on to the China sourcing bandwagon. 5 years ago, 70% of PassageMaker’s revenue was from USA clients. Today, some of our biggest clients are from Australia and our fastest growing segment is among Spanish speakers. Revenue from US clients is below 40% of our total revenue in 2012. To demonstrate my theory that the rougher the economy is back home, the more important outsourcing becomes, in the past 3 months we have added 6 projects for clients in Spain. Last year we had no Spanish clients. Know anybody that speaks Greek who wants to work in China?
We are even doing project management out of China in Spanish to keep up with this growing side of our business. Luckily, with job prospects bleak in Spain, we have not had problems finding highly qualified native speakers of Spanish to work as managers in our China offices. The interesting things is that these Spanish clients have been buying from China for many years, but in the past they were happy to work w Spanish trading companies and brokers as the seller’s margins in the past could afford the extra middlemen. Today, those middlemen are cut out as the large Spanish buyers are forced to go China direct to keep costs down. As PassageMaker is a buying agent in China, rather than trading company or middleman, we pick up the clients that want to “outsource their China sourcing” rather than deal with brokers back home or face the supply china on their own.
About the blogger
Mike Bellamy – author of, “The Essential Reference Guide to China Sourcing” (chinasourcinginfo.org/book) and founder of PassageMaker Sourcing Solutions (www.PSSchina.com)