Increasing Cost Pressures in China Shed Light on Dynamic Nature of Supply Chain

Understanding the total costs – and benefits – of a global supply chain


By Bradley A. Feuling

For the last 10-15 years, China's prominence has grown in manufacturing. Foreign direct investment (FDI) continues to flow inward, albeit at a slower pace today. Exports continue to be an important driver for the economy but are rapidly giving way to local consumption. As with any maturing country, and in particular those that have reached their peak during an industrial revolution – China reached a high of 12.6 percent GDP growth in July 2007 –costs become an important catalyst to curb escalation.

In China, it is clear that costs are on the rise. In early 2008, 70.6 percent of exporters raised their prices, raw material prices rose 9.8 percent, and China's commodity price index increased 9.5 percent year-to-year. With these considerations and other such as quality variability, some companies have begun to relocate their supplier base closer to operations in the United States. Alternative locations for production and sourcing have also fueled a rise in global competition.

With any transition in the supplier base, important variables in the upstream supply chain change. These include service level, lead time, inventory positioning, capacity, and direct and indirect costs. As the world's supply chains continue to evolve, scenario modeling must account for these adjustments. In China, very few suppliers have the capabilities and knowledge to detail how these shifts may affect profitability. Alternative sourcing locations create similar complexities. Without such sophistication, inefficiencies are undoubtedly created, as are significant costs and environmental impacts.

Recent Cost Trends for Chinese Manufacturing

One area of concern until only recently has been increasing labor cost pressures affecting Chinese manufacturing. In 2006, a survey by Hewitt Associates and the US-China Business Council suggested average salary rates increased by 7-10.6 percent in cities such as Beijing. In a 2008 HSBC study, average annual salaries in manufacturing had increased by 105 percent from 2000-2006. More recently, labor cost pressures have subsided from the dramatic climb earlier in the decade. This is primarily due to increasing turnover created by the economic downturn and a growing population of graduated students finding employment difficult. The rising labor cost trend, however, cannot be ignored.

Overhead for facility investment, raw material and machinery are also on the rise. As China develops, areas most sought after, such as Shanghai, are now often seen as too costly. Between 2007 to 2008, real estate prices had climbed by an average of over 11 percent in 70 cities across China. Raw material input prices have rapidly increased, as have production equipment prices. China's production price index (PPI) increased by 7.6 percent in the first half of 2008, but in Q1 of 2009 fell by 4.6 percent. Overall, companies are experiencing lower overhead investment advantages than only five years prior.

Transition to Low-cost Destinations

With these realities, both local Chinese and foreign companies are considering alternative low-cost countries for production. Locations such as Laos, India and Vietnam, in order of export growth between 2002 to 2006, are becoming influential destinations. Similar to China 15 years ago, labor, overhead and production costs are key influences.

Vietnam gained the spotlight with FDI growing by nearly 92.5 percent year-over-year in 2006. With the recent downturn, many companies are altering their investment strategies globally. Asia Pacific continues to be an important focal point. The effect has curtailed the expansion of these countries that were once thought to be competitors to China. In addition, it is here that we begin to see clearly how dynamic global supply chain operations have become.

The Dynamic Nature of Supply Chains

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