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China’s Manufacturing Evolution: Chinese manufacturing Faces Die or Adapt Decisions

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  • China’s Manufacturing Evolution: Chinese manufacturing Faces Die or Adapt Decisions

    As originally published in Shanghai Business Review, September 2008:

    Rapidly rising costs for raw materials, labor, and transportation combined with currency movements signal imminent changes in China’s manufacturing landscape. In response, Western customers are rebalancing risk by raising the pressure placed on suppliers. Others have chosen to integrate themselves more deeply in the upstream supply chain.

    For local manufacturers, increasing costs and competition has led to difficulty in customer acquisition. The closing price gap is forcing elimination or adaptation. In Guangdong province for example, over 10,000 manufacturers chose not to reopen after the Chinese New Year holiday. On the other end, some local companies have started to embrace the value chain migration.

    In this review of China’s current supply chain development, we will consider three manufacturers. This comparison exemplifies critical differences in the present environment. It also shows how companies are learning to adapt. The initial stages of emphasis on productivity and efficiency are apparent. A higher awareness of customer expectations and service is also leading new competitive strengths.

    The Local Manufacturer
    The first manufacturer is a Chinese company. The company primarily serves local customers. The facility is located in a remote town roughly two hours from a large tier-two city. This location created a low initial investment, but may pose greater long-term challenges in transportation. Logistics to a major port leads to lengthened delivery times. Interactions with foreign customers have been minimal.

    The facility primarily utilizes Chinese machinery and maintains a local salary scale. The manufacturing overhead is comparably low. Raw material is commonly sourced from local distributors.

    Further operational observations are of particular interest. For example, the manufacturer relies on common Chinese business relationship building. Sales and technical people are sent to review the product and discuss details over lunch. Following the meeting however, communication deteriorates due to noticeably high employee turnover. Several attempts are made to discuss the project further, yet each time a new person represents the company.

    A price quote is eventually received. Among the three manufacturers, the price is nearly the highest. This indicates significantly higher profit margins included. Attempts are made to negotiate pricing and to provide potential solutions, which would assist in lowering direct costs. The key project lead is no longer with the company. Over time, it appears the manufacturer has lost interest in the project. Their low attention to service is noted throughout the process.

    The Joint-Venture Partnership
    The second manufacturer is a joint-venture between a Chinese manufacturer and a European industry leader. The Chinese partner was identified for their strong location and local network. The facility is closely located to a major tier-two city. This would indicate fairly seamless logistics with few transportation to major port accessibility risks. Shipments to port may be lengthened due to proximity.

    The foreign partner has brought investment capital, machinery and management assets. Conversations with employees yield important information. The entire executive and plant management team are from the European partner. Imported equipment is utilized throughout the facility. Assessing the bid costs, it can be assumed the manufacturing overhead is higher.

    The current customer base is global. A high concentration of capacity is designated for foreign customer production. Raw material is sourced from existing overseas distribution partners. Fewer local distributors have been utilized. This signals higher raw material costs.

    A price quote is received, which is the highest overall. The justifications are due to the management salary structure and high marketing budget, allocated in the manufacturing overhead. Identifying new customers has been a challenge. A nine percent discount is offered. Further process improvement in supply chain and operational procedures are discussed. The manufacturer acknowledges some policies are in place, but there is a lack of flexibility due to the expected return-on-investment (ROI) timeframe.

    Throughout the discussion with the manufacturer, a very high level of service is noted. Frequent communications are made to cover pricing, raw materials, and additional requirements. The company shows a very high attention to detail.

    The Wholly Owned Foreign Manufacturer with a Local Model
    The third manufacturer is a wholly owned manufacturer from Asia. The production facility is located in a district outside of a major tier-one city. This indicates lower investment costs, yet strong accessibility to major export processing ports. Transportation costs and time for the manufacturer would prove to be the lowest.

    The manufacturer has a global customer base. They are familiar with service expectations from customers in Japan, Europe and the US. Current capacity is used to serve existing customers primarily in Asia. Only 30% of the facility is utilized allowing for expansion.

    The company utilizes Chinese assembly line machinery. An understanding of the business environment is apparent due to cultural similarities. Local management is in place with the exception of a few executives who manage regional operations. The local salary structure is adhered to. Chinese distributors are integrated for raw material procurement. From the initial assessment, it is clear the manufacturing overhead investment and raw material costs are lower. A price quote is received that is forty percent lower than the second manufacturer’s revised price.

    Communication with the manufacturer is very strong. Attention to service and detail is noted. Daily discussions take place focusing on material inputs, design and production strategy. Cost targets are requested to identify whether requirements can be met. The manufacturer focuses on cost reduction measures in collaboration with outside input. For example, product design files are reorganized for better material yield. Continuous progress reports on sample development are given.

    Many other high value add services are observed. Time saving details are noticeable at the production facility. Minimal levels of inventory are maintained. The manufacturer expresses an interest in material identification and product design to serve aesthetic appeal and customer product line extensions. The material design options may also serve to reduce costs further.

    The Evolution of Chinese Manufacturing
    The changing landscape of Chinese manufacturing is apparent through the comparison of these three manufacturers. In order to secure new customers, local companies must reevaluate the upstream supply chain, make a stronger effort to understand customer expectations, and develop higher value add operations. The competitive advantage of low cost is simply not sustainable.

    The next phase of Chinese manufacturing will importantly involve supply chain operations. This includes increased communication, coordination and continuous improvement. Inherent in these collaborative efforts are a greater focus on higher value add processes that enhance productivity, efficiency and protect profit margins. This is achieved through cost reduction strategies in logistics, inventory and raw material purchasing.

    At the same time, service will be key. Although many companies have hired well-spoken bilingual sales associates, attention to service and detail goes far beyond language abilities. Similarly, creativity doesn’t necessarily create new product design ideas and material identification to further reduce costs. These are human characteristics commonly left out of the conversation.

    Herein though lies the value chain migration challenge for Chinese manufacturing. Supply chain operations are commonly considered quantitative, focusing on technical skill sets. Service is a more qualitative discipline. Within a company the two operate inseparably. With the integration of both factors, and a proven value added model, Chinese manufacturing will achieve a greater sustainable advantage in the years to come.