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Rising China Wages, Inflation Threaten OEM Margins

Annual double-digit wage increases are becoming the norm in China, especially in fast-growing urban production centers where local and foreign manufacturers are battling rapid employee turnover and finding it increasingly difficult to recruit and retain skilled and semi-skilled workers.

The rising wage problem has become acute in some industries, including high-tech and automotive, due to the higher level of skills required in these segments, even for entry-level positions. In the last year, electronics manufacturing services provider {complink 2125|Foxconn Electronics Inc.} more than doubled salaries for some of its factory workers to 2,000 yuan (or $300) from 900 yuan, in a desperate bid to reduce turnover, placate employees, and reduce negative publicity from a spate of suicides that resulted in the loss of more than 10 lives within the space of just a couple of months in 2010.

Other manufacturers are facing similar pressures. Employees at a Honda Motor Corp. components plant in Zhongshan, China, went on strike last June, in an unusual development in the Communist country. Honda's initial concessions to the workers were less than they were expecting, but after the strike crippled the company's operations, the Japanese auto maker eventually agreed to wage increases that ranged from 24 percent to 32 percent.

Anecdotal stories like these can seem to be creating a mountain out of China's molehill wage problems. After all, the country's average labor rates have historically been only about 7 percent for comparable positions in Western countries, as {complink 21|Accenture} points out in a new report. Also, salaries represent only a fraction of the total cost of production for high-tech goods, accounting for perhaps less than 5 percent in many cases.

However, a related social and economic problem brewing in China has the potential to cause greater havoc in the electronics supply chain. Inflation is rising giddily in China, despite strong regulatory efforts to rein it in. This, according to top Chinese government officials, represents the biggest challenge the country faces in 2011 and beyond.

China's Premier Wen Jiabao acknowledged the severity of the situation in his state-of-the-nation speech on March 4, noting that inflation could rend the country's social fabric as the rising cost of living continues to affect the poorest segments of the society. “We cannot allow price rises to affect the normal lives of low-income people,” Wen said in the speech.

China's government is especially sensitive to the economy's inflationary trend because rising prices have, in the past, resulted in widespread discontent in the hinterland, even causing protests by farmers and villagers. In his speech, Wen said the country was paying closer attention to rising prices and would introduce measures to curb inflation and limit economic growth to around 8 percent.

OEMs should be paying close attention to this problem. While OEMs may be able to cushion the effects of higher wages with some small price increases, or even absorb wages without making a major dent on margins, higher raw materials costs could be more difficult to pass onto customers or explain to investors. Western and local manufacturers in China therefore need to carefully monitor the country's pricing trends and initiate and implement plans to mitigate the effects on their operations.

“In today's global economy, the best companies sense shifting sands well before those changes transform the landscape. And they respond quickly and creatively to the shifts,” Accenture said in a report. “Wage increases in China count among these potentially transformative changes. China's economic growth has intensified competition for skilled labor within China among multinational and local companies doing business there.”

Accenture recommends four actions it believes companies can take in response to changing conditions in China: Focus on operational excellence; expand across West China and the ASEAN countries; optimize across the globe (that is, diversify production base); and grow the local market. For full details, read the full report.

8 comments on “Rising China Wages, Inflation Threaten OEM Margins

  1. Anand
    March 10, 2011

    Bolaji,

      Beijing is fearful of inflation's historic potential to spark social unrest. Inflation effect from rising crude oil prices will become significant once the oil price crosses 130$. Dont you think its good idea to hedge gainst further increases in international commodity prices?

  2. Jay_Bond
    March 10, 2011

    Rising wages and inflation is going to be inevitable in China. In fact, the biggest thing they need to curb is their outstanding growth rate. I agree with Accenture's recommendations for the four actions. If manufacturers can at least grab onto one of these ideas, they have a good chance to stave off any large threats to their margins.

    Anandvy, while there are many concerns over the rising cost of Oil, many experts agree that the current rise of oil and gold will peak and drop back off. Over the long term the cost of oil and other natural resources vital to the manufacturers are going to rise and come under tighter controls. These manufacturers should start trying to come up with contingency plans to keep costs under control.

     

  3. Mr. Roques
    March 10, 2011

    Excellent article. Going a 'little' ahead, is China heading to a collapse or a sudden stop in growth? 

    If they continue to increase wages, then companies that outsource to China can start bringing those industries back home and then China will have to deal with overpaid, unemployed, workers?

  4. tioluwa
    March 11, 2011

    I find this post very interesting and informative.

    It has become very clear, even as stated in previous posts on this forum, that the playing field is getting leveled.

    I expecially like the referece to social and economic problems within china, there is little talk about it but the wave of soical unrest in the middle east can easily spread.

    it is an enlightenment to me, to know that staff wages on contributes a 5% to cost of production, rather, inflation rates are a great threat.

    I'm not too good with economic issues, but what are the causes of Inflation in china?

  5. t.alex
    March 11, 2011

    Mr. Roques,

    In fact trends of reversing outsourcing have been spotted. With this steady rising in inflation and workers' wages, China is getting less and less competitive.

  6. mfbertozzi
    March 14, 2011

    Excellent article and posts gents. As Bolaji mentioned and based on your thoughts, it seems the match is still open; I am convinced OEM quality is still the challenge and the threshold to overtake for manufacturing from China (they received also recently restrictions on sales by several foreign companies), what about based on your experience?

  7. stochastic excursion
    March 15, 2011

    China is an interesting economic case study since its industry is evolving so rapidly and with such far-reaching impact.  Here's another example of scarcity changing the value of an item, this time of human resources–China's skilled labor.  Skilled workers in China have more purchasing power which in turn creates demand for other resources.  Some of these are limited resources like housing and fuel.  However a middle class also spends money on charities and investments, and typically uses banking resources. 

    Not clear that higher demand for limited resources can be equated with inflation.  In fact, the opposite is true.  A glut of precious metals, such as during the gold rush, serves to drive prices up since one of the main uses of such a commodity is as currency.

    What else is interesting is that China's skilled labor has intrinsic value that rivals the Western nations'.  The size of the American middle class has fallen off remarkably, but work that needs to be done hasn't just disappeared, it's just literally gone to the ends of the earth.

  8. Mr. Roques
    April 16, 2011

    It will take some time, China is still to big to fail… but I think it will eventually even out. The wages will go up, and some other country will capture those jobs … maybe even China will outsource to a cheaper country.

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