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Going global

Going global

31/03/2007 | Channel: Manufacturing, Business, Technology

IS CHINA ALL THAT IT IS CUT OUT TO BE? ASKS RAEES LAKHANI, DIRECTOR OF CLIENT SERVICE AT RESOURCES GLOBAL PROFESSIONALS

In recent years China has come under the spotlight as the world's new manufacturing 'hub' of the 21st century.While globalisation has paved the way for many companies to move production to China, and almost all major companies have at least considered the opportunity, the future financial benefits to this low-cost country alternative continue to be debated. It is almost unanimously agreed without debate that as of this time, China does support the lowest total cost of production and acquisition of goods, the items are non-technical, manufacturing simplistic items, with little design change needs.

Many European companies though, have been devastated and even been put out of
business by the enormous shift in production to China by larger companies. Small production runs are becoming more expensive and scheduling delays is increasingly commonplace. Logistics of delivery of produced goods is becoming yet more complicated, while staying on top of the political and trade issues takes on more importance.

Lower initial costs of production, driven primarily by lower wage scales, have moved China into the limelight.However, these benefits must be carefully weighed by a company when performing the analysis of moving part or all its production to China.

Set out below are some thoughts that need to be considered when performing analysis for China as an alternative production centre.

Cost of manufacturing:
China has become a dominant force in global manufacturing due primarily to its low-cost labour.With salaries around ten per cent of those in Europe and the US, and about 50 per cent of those in Mexico, China may make sense for companies whose labour costs make up a high percentage of the total costs.

Wage rates across China do vary however. In the south (with the exception of Hainan) they can be at least 25 per cent higher than those in the centre and north. The general rule is that the further north you go, the costs become cheaper, but the technical know-how reduces as well.

In terms of overhead costs, China's are higher on a percentage basis than those in Europe and the US, but due to lower wage scales, still result in lower total overhead costs.

Transportation factors

While the world has become a much smaller place due to technology and communication improvements, the logistics and economics of moving products from China to points around the globe is made up of a constantly changing formula.

Although container transport costs are rising due to excessive demand and limited shipping channels, a volume driven decrease in shipping prices is yet to be realised. Rates also vary depending on the port used, with those out of Tianjin for example, cheaper than those out of Hong Kong or Shanghai.

Naturally, size of components is a key factor in the decision to source in China. Since container prices are fixed, costs can be spread against thousands of small widgets packaged into one container. Equally, a single item manufactured and assembled that requires careful packaging may bear the entire cost of the container. Emergency orders that require airfreight can eliminate the benefits of manufacturing in China. Airfreight may run at approximately $1.50 per pound.

Production planning is much more critical when sourcing to China. Six to eightweek
shipment times from production facility to port are common. Internal country logistics must also be considered in the delivery equation.

Ownership of inventory and the effect on a company's financial statements must also
be quantified. Product ownership is often assumed at the manufacturing facility's port. Higher lead times generally result in higher inventory levels needing to be held. A company which has high inventory turnover ratios will see increases in the value of the inventory that it needs to hold and a corresponding decrease in its inventory turnover ratio.

Scheduling and production planning
A company's ability to schedule and plan production runs is one of the most critical components of the cost equation. Due to the logistic and some communication issues, manufacturing in China adds a few additional factors into the equation.

The high number of companies now turning to China has led to increased lead times for production. Furthermore, because China relies on considerable raw materials being imported, the complexity of this collaborative scheduling has again had a net effect of longer lead times.

Manufacturing delays are also becoming increasingly commonplace. As such, companies are finding that they need to hold higher inventories at head office to avoid supply chain delays.

Forward planning is critical when manufacturing in China. Production run quantities must be clearly arranged months ahead of time as last minute changes are difficult to schedule since production lines are running at near capacity.

Technical capabilities and technical support
While low-cost labour manufacturing has become China's strength, its ability to support that production with robust technical support has been less than successful.

China's manufacturing works at its ultimate return on investment (ROI) when little changes to specifications or quantities are experienced. High quality engineering
assistance is not readily available. As a result, production in China has proved most cost effective to those companies requiring high volume, low technical, and minimal change production.

Companies like SGS and Intertek recognise the potential and provide inspection, verification, testing and certification services in this area on behalf of international clients. Sometimes the supplier is asked to bear or share the cost of these services.

Quality
The single largest complaint for imports from China is continuity of quality. To address this issue, quality assurance (QA) processes should be implemented before, during and post production to ensure that faulty goods are not received. Penalties cannot compensate for the damage done to customer services in an out-of-stock or faulty-stock situation. Again, companies like SGS and Intertek are strong in this area.

Other factors
Additional areas that need to be explored for consideration and discussion of China as a manufacturing alternative:
  • Language barriers are real within China and vary between different regions. In addition to dialects, cultures also differ greatly amongst the regions.
  • China's current country leadership is probusiness and continues to try to keep labour costs low. A shift in leadership could drastically change financial elements of the China alternative, since labour costs are the primary driver to moving manufacturing to the country.
  • Many large customers of Chinese manufacturing are driving production schedules. Unless you are a material player, you must be flexible with your manufacturing production times.
  • Ethical issues are still very real in China.With the significant growth cycle and the unending source of customers, China does not have the infrastructure, people, or controls in place to manage its expansive growth.
  • Customer service is not China's strong suit since the customer-base still outweighs its production capabilities.
  • The shift of much of the world's manufacturing to China will result in further trade discussions and therefore increases the probability of politically driven requirements. Increased tariffs, sanctions, and logistic costs are more of a likelihood than not.
  • Political and customer driven pressures on companies may also increase in frequency and severity.
Corporate governance
A company's choice of manufacturer or supplier is becoming increasingly critical. Ethical and environmental audits covering all aspects of risk should be performed at the outset and depending on the results at least every six months thereafter. There are a number of large organisations which perform these tasks and lend credibility by
signing reports and opinions. For example, Walmart and Nike provide stakeholders with access to the results of these audits, which includes information relating to labour-force (age, hours, overtime, conditions and pay) and local legislation. Depending on the product, the audit can be extended to include information on the source of supply i.e. suppliers of your supplier. Once again, suppliers can be asked to bear or share the costs, which is generally negotiable. Total cost of product should factor this in as well.

Conclusion
In less than two decades, China has moved itself from a closed bordered country to one which welcomes companies to utilise its people and facilities as the world’s
manufacturing centre. Its pro-political environment for this move has allowed it to
surpass one-time leaders Japan, Korea, and Mexico as the country of choice. Its
openness and aggressiveness in maintaining this position will most likely keep it in the
top spot for some time to come.

With aggressive growth comes naturally a significant amount of risk for companies
choosing to move part or, in some cases, all manufacturing to this location. These risks include:
  • Political changes within China
  • Local country consumer pressures
  • Changes in tariffs
  • Trade restrictions
  • Labour pricing changes within China
  • Logistic issues with product deliveries
Any company that is considering moving production to China must perform its own
risk and financial evaluations. A manufacturing entity ignores the benefits that China brings to the table at its own commercial and competitive peril.We all hope that Burberry's recent announcement (February 15, 2007) to move its production to China will be a success. However, given all the factors that companies need to consider in making the final decision (a glimpse of these have been touched on in this piece), an automatic move to China for all manufacturing entities cannot be treated as a foregone conclusion and the only way forward for all companies.