A Pricier China – Buyers Keep Faith But Smarten Strategies

The relationship between buyer and supplier is maturing as the focus expands beyond cost to long-term benefits

The era of cheap Chinese goods may be nearing an end but, contrary to popular belief, major global buyers are not switching out of the country. Rather, they are identifying suppliers of quality and working in concert with them to respond to the many challenges building the Chinese economy. The deepening buyer-supplier relationship could accelerate China’s move up the value chain by transferring technology and improving productivity at the country’s factories. The buyers’ efforts also underscore the fact there is, as yet, no easy substitute for China. Nor is one likely to emerge in the next 10 years or so.

Size Matters

China’s manufacturing scale, its vertical supply chains, well-developed infrastructure, and its vast domestic market are compelling advantages for buyers. Opting for lower-cost producers such as Cambodia, Vietnam, and Bangladesh in Asia or Turkey and Hungary in Europe complicates the supply chain by stretching it across multiple borders since no one country has the capacity of China. At best, these countries are becoming part of the “China+1” strategy, which adds a production base in a lower-cost country as a hedge.

However, the challenges within China are also intensifying. Galloping wages, the most frequently cited reason for the higher cost of Chinese goods, are aggravated by acute labor shortages and an aging population. The United Nations forecasts that over the next 10 years, the number of young people in China between the ages of 15 and 30 will decline by 40 million. Officials in the southern Pearl River Delta, a manufacturing hub, estimate the region already has a shortfall of 600,000 workers. Even with the Yuan devaluation in the last 3 months against the USD, the yuan has strengthened, especially against the currencies of low-cost Asian countries, further eroding China’s advantage in the region. In my face-to-face survey of over 1,000 suppliers in China and Hong Kong conducted during 2011 and 2012, cost control, competition, sales growth, and staff issues emerged as the top concerns. Only 4 per cent of firms identified raising prices as a solution to higher costs, underscoring the intensity of domestic competition.

Need For Automation

Clearly, there is a need for China to modernise towards a world class manufacturing standard and at a faster pace than before. Equally clearly, many suppliers don’t know how to pull themselves out of the “faster, cheaper” trap and want more help from foreign buyers to improve. Meanwhile, the implications for buyers are serious. Chinese suppliers may cut corners to save costs, employing less staff and missing delivery times, or even refusing orders. Finding the right supplier and managing the relationship have therefore become vitally important, as some buyers have shown. Alongside factors such as location, capacity, and financial standing, smart buyers are also looking for unique advantages.

PQI, a Taiwanese manufacturer of USB and storage devices, wants suppliers who can innovate. Every supplier meets a certain quality level, so there is little to differentiate among suppliers based on quality, according to the company. The supplier’s ability to identify and use technology to advantage is also becoming more relevant in the drive to do more with fewer resources. Suppliers are eager to automate to cope with the manpower shortage, but many small and medium-sized Chinese suppliers find it difficult to obtain loans as the state banks prefer to lend to the giant state-owned firms.

Close Monitoring

Over 50 percent of suppliers in the survey said they would use operations management strategies, including improved production quality, production efficiency and R&D to deal with competitors. Techwise Circuits Ltd., which produces printed circuit boards for clients such as Mercedes-Benz at its factory in Huizhou in Guangdong province, has cut its labor force from 7,000 to 5,000 in recent years, largely in response to soaring labor costs. It has also automated factory floors and upgraded existing machinery to ensure its survival. Techwise funded the improvements itself, taking a hit to working capital and net profit margins, but some buyers are showing a willingness to invest, especially in the supplier’s machinery and tooling. While the supplier gains exposure to world class production standards, the buyer is shielded from the social and political problems that can come with full ownership in developing markets. Apple took this route with one supplier of LCD modules for its smartphones. The supplier was allowed to have 40 per cent of the machinery capacity and to have full control of it after three years.

Samsonite, which has factories in China as well as in Belgium and Hungary, allows its China supplier to use 30 percent of capacity to make suitcases for Samsonite’s competitors. While the latest design is not manufactured in China, Samsonite still has a caveat that the China supplier should not manufacture anything that resembles or is inspired by Samsonite designs. The supplier not only benefits from Samsonite’s quality standards and management techniques but also has the opportunity to learn to develop original designs, a crucial step to moving up the value chain and improve profit margins. In return, Samsonite is able to exercise rigorous control and closely monitor the supplier.

Simple Measures

Frequent feedback, even when there is no problem, and a robust performance measurement system that goes beyond traditional sampling are crucial for a strong supplier relationship. Apple, which is known for its excellent supply chain management, has over 600 engineers in Greater China who work closely with the supplier to fix flaws and even provide guidance on operational issues. Another major smartphone manufacturer, which has more than 500 suppliers, has a sophisticated measurement system that acts as a substitute for the audit process and influences purchasing decisions. According to an executive, suppliers with problems go on probation for six months, after which another factory audit is carried out.

My interviews indicate that 77 percent of suppliers receive formal performance feedback from their major customer once per year while 48 percent receive feedback on multiple occasions per year. Those who receive formal performance feedback rate their relationship with the customer as stronger than those suppliers who are not part of a formal arrangement. Suppliers also want more accurate forecasting. More than half of the suppliers interviewed said their major customer placed orders that were less than 80 percent of the promised quantity. Of course, small or mid-sized buyers may not have the capital and time to invest in constant supplier management. But even simple solutions can be effective. Since Chinese firms are relatively new to talent management initiatives, buyers can help with training programs. For example, one factory in Sichuan province provides an hour of English-language instruction each week. The survey showed that 51 percent of Chinese suppliers trust their major customer more than they did three years ago, while just 12 per cent suppliers trust their major customer less. In part, the results may be influenced by an improved global economy. However, they also highlight that many buyers are better managing their supplier relationships.

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