Outsourcing to China or setting up manufacturing plants in China has offered a variety of advantages to businesses over the past decade, ranging from reduced wages to lower costs from less stringent environmental and regulatory compliance. The question is whether these advantages will continue to make China more attractive than expanding in the United States. The challenge for multinational companies will be to design a global footprint and determine which business processes are best suited to outsourcing and which should remain in the United States. The question for smaller companies is whether outsourcing to China is worth the time, effort, and risk. The decision process is often a balancing act, and the dynamics can change unexpectedly and rapidly. The dynamics began to change in 2005 and will continue to change over the next several years.
Four years ago, Business Week ran a story, “How Rising Wages are Changing the Game in China” that noted that in 2005 wages surged 40 percent. In 2007, the wages in China rose another 30 percent and have continued to rise an average of 15 percent a year since a 2008 labor contract law went into effect January 2008.
Thirty years of pro-market reform and explosive economic growth made China into a manufacturing superpower. But now China may be facing the inevitable consequence of that economic ascendance — labor unrest. In recent months, a wave of strikes in China has hit Japanese companies and their suppliers. The strikes affected more than 100 companies, including Honda Motor Company and Toyota. The strikes were concentrated in southern China, which produces many of the country’s exports. The strikers mostly belonged to China’s 150 million strong migrant labor workforce, which flows from villages to cities and industrial regions looking for work.
Foxconn Technology Group, which is the world’s largest contract manufacturer of electronics goods such as iPhone and iPads, more than doubled the basic worker pay to 2,000 yuan ($293) a month for their Chinese workers after ten worker suicides. Foxconn plans to charge more for their products and will speed up factory automation programs to cover wage increases.
Marc Chandler, global head of currency strategy at Brown Brothers Harriman, opines that Fordism may be coming to China. Fordism refers to a type of political economy, which recognizes that despite great disparities in power, workers need to earn high enough wages to purchase the products they create in order to complete circuit of production.
The second force pushing wages higher is that the supply of migrant workers has reportedly fallen by 20 percent from its peak. As a result, some companies are moving production to the interior of China where many migrant workers come from to secure lower wage workers. In addition, the working age of the Chinese population, laborers between the ages of 15 and 64, peaked this year. This birth bulge was a major reason that China instituted its One Child policy 30 years ago. Thus, with every passing year, the number of workers in that age group will shrink in size.
The effect of higher wages will only have a significant impact if the labor content of a product manufactured or assembled in China is high compared to cost of raw materials and components.
Makers of toys, trinkets, Christmas trees, and cheap shoes have folded by the thousands or moved away to Vietnam, Indonesia, or Cambodia. However, even with higher wages, Chinese wages are estimated to be about three percent of manufacturing wages in the U. S.
Another factor is that the rising cost of fuel has increased shipping costs by 71 percent over the past four years. Delivery times have also increased because container-shipping companies have reduced routes and reduced the number of ships per route. The ports in Asia are filling up with decommissioned freighters.
The August 18, 2010 issue of “Today’s Machining World” reported that Wham-O Corporation, maker of Frisbees, Hula Hoops, and Slip ‘n Slide, decided to bring half of its Frisbee production and some production of its other products back to the United States. Wham-O’s products take up a lot of container space per dollar value. These products are not labor-intensive, primarily produced by injection molding presses. They are cheap, light, and bulky so a container of Frisbees may hold only $5,000 worth of product. When container costs from China rose by 50 percent to $4,500 from as low as $3,000 at the bottom of the recession, the cost advantage of manufacturing in China disappeared according to Kyle Aguilar, President of Wham-O.
Higher labor costs and higher shipping costs aren’t the only factors contributing to China losing its luster as an outsourcing location. Quality problems are the number one factor bringing some manufacturing back to the United States. Quality control issues have the potential to cost companies millions in terms of lost customers, potential litigation, and the logistics of shipping a defect product back to where it came from (if the Chinese company will take it back and give credit). General Electric, Caterpillar, NCR, and Diagnostic Devices have all moved production back to the U. S. for one reason or another.
The quality problems with products made in China are demonstrated by the product recalls by the Consumer Product Safety Commission week after week, month after month, and year after year. For example, in the August 2010 list of product recalls, 70.8 percent – 17 of 24 – were for products made in China. Only one product recall was for a product made in USA. This ratio of recalls of Made in China to Made in USA products is roughly the same report after report.
There is no question that outsourcing to China and other countries will continue for the foreseeable future, especially for the multinational companies that have products to sell within the countries in which they have set up manufacturing operations. Manufacturing products locally for consumption within a foreign country will be crucial to profitability as transportation costs continue to increase globally.
The best locations for outsourcing will change over time just as they have in the past 50 years. The purely financial benefits of lower cost in China will erode over time. The challenge for Americans is how to keep as many companies as possible manufacturing their products in the United States in order to maintain our middle class and protect our national security.
Rural US may be a viable alternative.
Excellent analysis