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Is China’s Low-Wage Edge Waning?

China's cost advantages in manufacturing and exports seem to be rapidly waning, according to numerous reports. There's a segment of the electronics market, however, that never really believed China was a bargain to begin with. Key players in the electronics supply chain are among them.

From a strict labor standpoint, China's wages are clearly lower than many other nations'. Any manufacturer heavily dependent on physical labor has a clear advantage. However, as EMS consultant Charlie Barnhart and other analysts report, labor is a small portion of the expenses in electronics manufacturing. Total landed cost is a better measure for supply-chain savings.

Nevertheless, electronics manufacturers perceive a significant price difference between China and the West. Supply chain companies have followed their customers offshore. Component makers have established factories in China and have kept prices low. The procurement market in the Far East has become accustomed to paying less per component unit. This continues to be a big problem for the channel.

Distributors, in particular, make their money on volume component sales. In many cases, a distributor's profit is tied to the per-unit price of the parts they sell. A 25 percent margin on a $5 component is higher than the same margin on a $1 part. (As US companies heard during the recent presidential campaign, “Do the math.”) Global manufacturers typically source components in low-price regions, eroding their partners' margins.

As China's wages and currency appreciate, however, OEMs and EMS companies in China are now faced with rising costs. “Annual wage increases between 9% and 35% in China, combined with rising logistics expenses, are leading to higher core supply chain costs in a traditionally low-cost country,” research firm Gartner notes in its annual ranking of the “Supply Chain Top 25.”

By Western standards, there is room for efficiency in the China supply chain. In the US, OEMs began decades ago to consolidate their supplier base. Engaging multiple suppliers for the same components keeps prices competitive, but supplier management also requires investment by the OEM. Simple transmissions of supply and demand data via EDI are unique to each supplier, so multiple engagements mean multiple costs.

In China, supplier, distributor, and customer relationships are highly fragmented. Broadline distributors, such as Avnet and Arrow, that carry multiple lines of components are the exception in the region. Small and midsized distributor partners in China carry a select group of brands, similar to the manufacturers' rep model in the US and EU. As a result, OEMs have to engage with numerous partners to fulfill a bill of materials (BOM.)

Experience has taught Western companies that managing fewer suppliers cuts down on expense and increases efficiency. However, Western companies are hesitant to impose their practices in China. Business relationships there are based more on tradition than on the bottom line. In a series of articles published on the Website The China Sourcing Blog one author identified only as “Luca” writes:

    Contract management with Chinese suppliers generally relies less on contract enforcement and more on relationship management, so many of the standard contractual clauses traditionally used by international procurement teams are either not applicable or not enforceable in China, and thus create unnecessary burdens on suppliers and ultimately increase the total costs of the contract.

For many Western companies, the cost savings in China have so far offset wage and transportation expenses. However, that advantage is quickly eroding. Companies in the Far East — both companies headquartered in the West and those indigenous to China — are concerned about costs. In their annual “Change in the (Supply) Chain” survey, UPS and IDG report:

    Our survey results show that at a regional level, the top priority for Asian high-tech companies has been to reduce total supply chain costs. Given the inability, at least in the short term to medium term, to materially affect demand and sales growth, many companies have focused on successfully preserving their bottom lines with aggressive cost containment and capital preservation efforts.

    However, it is encouraging that, in the context of the past two years, Asian high-tech companies have done what they can to keep an eye on the customer/consumer with efforts to improve service levels. It seems clear that these businesses recognize that while competing on cost is not going away anytime soon, they also must be service competitive.

This realization is a big opportunity for electronics distributors. In upcoming blogs, I will look at how the channel has scaled its product and service offerings to align with customer requirements in the Far East.

9 comments on “Is China’s Low-Wage Edge Waning?

  1. harpat949
    November 16, 2012

    I don't think so judging by the prices of Chinese products sold over the internet. There are camparable items at one tenth to one fourth the US made prices. Without quoting what the chinese labor rates are and what the labor cost differences are, the article looks more like wishful thoughts than reality. The biggest worry the Chinese have is competing with other third world countries for labor and not with USA.

  2. Nemos
    November 16, 2012

    I believe will be a great step forward if we disconnected the labor cost from the final product. I know that it sounds extremely difficult to be happening and it is against the fundamental laws of the economics. But take a moment and think about it … What would be the benefits of doing that ?  

  3. _hm
    November 17, 2012

    Cost is perceived as one advantage. One more reason to have facility in China is Chinese market. Chinese law and compliance may force many firm to have local facility for manufacturing. Since manufacturing is done in China, supplier needs to be preset there too.

    When Chinese market contracts, many organizations will depart China quickly.

     

  4. Eldredge
    November 18, 2012

    @hm –  You bring up an improtant point. Access to a significant market in China isone motivation to do business (manufacturing) there. If that market does not develop, it will take away from the attractiveness.

  5. Ariella
    November 19, 2012

    @harpat949 “The biggest worry the Chinese have is competing with other third world countries for labor and not with USA.” I tend to agree with that. Even “American” brands often rely on overseas labor for production because they don't want to pay American wages and benefits, and they, certainly, don't want to have to negotiate with a union.  

  6. Barbara Jorgensen
    November 19, 2012

    I agree with harpat's point. The wage issue is not US-China; it's China vs ROW.

  7. _hm
    November 19, 2012

    @Eldredge: Another Chinese wishes is to graduate to value added product from low cost assembly. As China is getting powerful, they are more visisble in value added market where ROI is very good and it also has bright future.

     

  8. elctrnx_lyf
    November 23, 2012

    Increasing wages are dfinitely a big concern for chinese manufactures, also many western companies are looking to bring back the manufacturing to local companies. I suppose there will be much erosion of differences in the future to enable the OEM companies to do as much as local production possible.

  9. Mr. Roques
    November 25, 2012

    Well, chinese manufacturers AND the chinese government should be worried. 

    China has the benefit that even if wages increase, they already have the built capacity and trained HR to do the work. If a company decided to move to another country, they would need to consider the wage difference but also the CAPEX needed to install new factories and/or train workers.

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