Rising costs have become an issue for all firms in China, although the effects are felt most keenly in manufacturing. Producer price growth finally eased in September, having risen steadily throughout the first half of the year, but export orders are falling as global economic problems take hold. The same month, CLSA’s purchasing managers index, a survey of business conditions in China’s manufacturing sector, slipped to the lowest level since it began in 2004.
These figures are broad-based but they take into account the range of pressures – from rising raw materials costs to more demanding labor requirements – that firms in China are facing. Many foreign operators were originally attracted by the country’s low overheads. Now they find themselves struggling to maintain profit margins.
"For many years every business in China was looking at growth. Now growth is not as exciting as it was before because markets are maturing, while prices are rising everywhere," said Clement Homolle, general manager at LowendalMasaï China, a consultancy.
Given the Chinese government’s stated desire to ascend the product value chain, Homolle doesn’t hold out much hope for manufacturers at the low end of the spectrum. The majority of LowendalMasaï ‘s clients, however, tend to be more focused on higher value-added products, notably aeronautics, automobiles and nuclear power.
Companies in these sectors are not going to hotfoot it to Vietnam, but neither are they immune to rising costs. LowendalMasaï inspects their production processes and identifies potential savings. Something as simple as a well-thought-out contract can make all the difference.
"If you are buying something that has a high copper content, it makes sense to sign a contract on both the procurement and sales sides," Homolle said. "By tying the contract – on both sides – to some kind of index, you aren’t agreeing on a price but on a price formula for the next few years that takes into account several factors. This allows the companies to hedge their risk."
Further savings can be made once the raw materials reach the factory. Chinese factories have, in the past, been infamous for their poor productivity: Four workers would operate a single machine simply because cheap labor allowed it. Although changing cost structures are eliminating this inefficiency, people aren’t the only thing being wasted.
"The quantity of a raw material that you need to manufacture a single item can be up to six or seven times higher in China than in Europe," said Homolle. "If you have high raw material content, this can have a huge impact on price."
The solution lies in paying attention to suppliers. The Bosch-Siemens joint venture that ranks as the world’s number three household appliance manufacturer claims to have made average savings of 19% by sourcing products from China rather than developed countries. Homolle notes that further savings of 21% come from suppliers with whom the German company has been in partnership for more than one year.
Familiarity with a supplier’s methods also puts a foreign company in a relative position of strength when it comes to negotiating future contracts.
Attention to detail
Ultimately, savings hinge on detailed breakdowns of a company’s cost structure. A US firm sourcing auto parts from China might be losing out due to unfavorable shifts in the dollar-renminbi exchange rate. By contrast, a European luxury brand might be leaking cash as a result of poor control over its logistics operations here.
In many respects, the challenges companies face in China are not so different from those they have faced historically in the West. Consequently, similar solutions – such as redesign to cost, where a business is broken down into particular functions and each function examined in the context of its perceived value and importance to the company in question – can work in multiple markets.
Where China does differ is in the speed of development. Homolle cites logistics as a prime example of how quickly things can change.
"In most cases the warehousing and distribution solutions you have in place were designed a couple of years ago – but China’s logistics industry is moving so fast that after two years your systems are probably already out of date. You need continuous improvement."
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