A Conversation on doing business in China

baysourcelogo The following is a recap of a January 21, 2009 panel discussion hosted by the Orlando Chapter of ACG (Association for Corporate Growth) on the ins and outs of doing business in China. David Alexander, president of BaySource Global www.baysourceglobal.com was one of the featured speakers along with Brian Su of Artisan Business Group and Jim Gaynor, CEO of Lightpath Technologies.

ACG Moderator: Discuss how this global recession has impacted doing business with and in China

Alexander: The Credit crisis affecting all industries. Volumes are down and many factories dependent on U.S. retail and consumer volume have closed. People are strongly revisiting “In-Sourcing” due to attrition in volumes. A local trade association predicts that by late January, Dongguan and its neighbors Shenzhen and Guangzhou will lose 9,000 of their 45,000 factories.“Many factories are looking at completely empty order books,” warned Stephen Green, head of China research at Standard Chartered, who believes the export sector may even shrink next year. Green believes China will see 7.9% growth in 2009 – well below the double digit figures of the past five years.“Government statistics show that 67,000 factories of various sizes were shuttered in China in the first half of the year,” said Cao Jianhai, an industrial economics researcher at the Chinese Academy of Social Sciences. By year’s end, he said, more than 100,000 plants will have closed. The wave of factory closings began in Guangdong province, where the nation’s economic reforms were launched three decades ago. The region accounts for about 30% of China’s exports, but over the last couple of years, Shenzhen, Dongguan and other cities in the area have sought to clean up the environment and create an economy based more on services and higher-value products. Makers of labor-intensive goods such as shoes, garments and furniture no longer felt welcome.”Stanley Lau, deputy chairman of the Federation of Hong Kong Industries, a trade group with 3,000 members, has estimated that as many as 15% of the 70,000 factories run by Hong Kong businesspeople in the mainland will close this year. He says many more are likely to shut after Chinese New Year in February, when millions of migrant laborers will return home for several days. “Once workers go home, they can close down the factory quietly,” he said in an interview in Hong Kong.

ACG Moderator: Given this recession, specifically, how has the outsourced manufacturing space been impacted?

Alexander: People have been forced to re-analyze bringing manufacturing back due to lower volumes. Less scale means reduced leverage with factories. Reduced demand = longer lead times with higher volume/less frequent orders. Carrying costs of capital increases; customer response times impacted. IKEA for instance has recently opened a plant in Virginia.In an April survey of nearly 1,000 companies by RSM McGladrey, the number planning to move offshore fell by 20% from a year earlier

ACG Moderator: Further explore the costs of shipping/freight as they impact this model

Alexander: Increased energy costs toward the end of 08 meant freight as a % of COGS increased. There were fewer containers coming into port—first declines since 2006; down 1.5% from Nov 07. At $150 barrel 40’ container $8,000 vs. $3,000 a year ago or $100. At $200 it would be $15K. Through July 19, U.S. railroads had carried 5 million shipping containers, down 3.4% with the same period last year. Containers that slow to 23mph from 29MPH save 20% but this means freight lines have to add containers. However, freight increases alone not cause in wholesale trade pattern shift back to US mfg. The Economy is key driver. Higher fuel costs will also cause a shift in Lean inventory. May see proliferation in warehouses to be closer to customers. The Freight Transportation Services Index dropped 1.4 percent from October to November to 107.6, the lowest level since January, 2004. The index is down 4.9 percent from its historic peak of 113.1 reached in November, 2005, the Department of Transportation’s Bureau of Transportation Statistics reported.
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ACG Moderator: Discuss the Chinese economy both how it’s being impacted by this economy internally and how externally the commodity markets are being impacted around the world.

Alexander: China’s exports fell in November for the first time in seven years and manufacturing activity shrank in December for a third straight month. Material costs will always fluctuate globally and are consistent around the world. With fuel and energy costs subsiding a bit and with material costs softening, Labor is still the key driver for the feasibility of offshore manufacturing.

Still it seems like the economy is chugging along normally though. In the city where one colleague lives there were more than 4000 cars newly registered in the first week of Jan alone. This is a city of 3M people and the roads are already crowded. We are not sure how many weeks like that one in Jan. we can survive and still keep cars moving along. Also, remember, the Chinese are good at saving money. The China economy is predicted to be as large as U.S. by 2030. All this said, this crisis has been a time of reckoning. Americans are buying fewer Chinese DVD players and microwave ovens. Trade is collapsing, and thousands of workers are losing their jobs. Chinese leaders are terrified of social unrest. Having allowed the renminbi to rise a little after 2005, the Chinese government is now under intense pressure domestically to reverse course and depreciate it. China’s fortunes remain tethered to those of the United States. And the reverse is equally true. The Treasury conducts nearly daily auctions of billions of dollars’ worth of government bonds. For the past five years, China has been one of the most prolific bidders. It holds $652 billion in Treasury debt, up from $459 billion a year ago. Add in its Fannie Mae bonds and other holdings, and analysts figure China owns $1 of every $10 of America’s public debt. The Treasury is conducting more auctions than ever to finance its $700 billion bailout of the banks. Still more will be needed to pay for the incoming Obama administration’s stimulus package. The United States, economists say, will depend on the Chinese to keep buying that debt, perpetuating the American spending habit.Many firms in the auto, luxury, travel & tourism and real estate industries have begun reporting a significant decline in spend. Where the greatest opportunity lies, is in the rural economy. It is the economy that has lagged far behind the others – It is the economy that has more than 700 million people – It is the economy were small nominal gains can equate to large.

ACG Moderator: Discuss the idea of building markets in China coming from the U.S. or Europe

Alexander: According to The Kiplinger Letter, for 2009, trade will shrink worldwide by 2.1 percent to $115 billion and U.S. exports will drop 0.5 percent. It said the hardest hit areas will be machine tools, chemicals, plastics, mining gear and turbines, while medical products, farm goods and construction equipment should weather 2009 relatively well. Kiplinger predicted no worldwide growth for gross domestic products in 2009, and negative growth in the U.S. There are still good opportunities for growth. Certain products that sell well in China and come from USA are mostly niche items. Examples: Zippo Lighters, cosmetics from famous names like Estee Lauder cars, and famous brand clothing. Western brands will always be in demand.

ACG Moderator: Discuss how the Chinese government is impacting companies that want to either invest in China financially or via a joint venture or with manufacturing facilities – VAT rebates, and clean industry versus smokestacks

Alexander: In July, 07 VAT rebates were rescinded for 553 industries. The gov’t just increased the VAT refund for exported goods to help with the economy. The price of raw materials is way down now so batteries, and other items have gone down in price about 30%. China will increase the export tax rebates for some machinery products as of Jan. 1, 2009, in a bid to alleviate cost burdens on exporters (back to 17%). The most recent increase took effect on Dec.1, covering 3,770 items of labor-intensive, mechanical and electrical products, or 27.9 percent of the country’s total exports.

ACG Moderator: Discuss product quality concerns in Chinese manufacturing

Alexander: Any U.S. concern marketing a product manufactured in China is ultimately responsible for product/project management. This means clearly stating product specs and tolerances, material specs, defect rates, etc When we leave too much in the hands of Chinese manufacturers is when we run into issues.China does need better IT and process control. There is a lot of opportunity for IT/IS but also the Chinese don’t know they need this. They don’t even use part numbers in most businesses… Our biggest opportunity from US to China is to engrain our production management know-how. One of the main problems in producing quality here is that the workers and managers themselves don’t know what to expect in a quality product because they don’t consume such items. “They have no feel for what quality is.”There is also little accountability for goods that fail after some time in service. Example: If you buy a new house, everything will be perfect when you buy it but things will soon start to break because they weren’t made well. They might try to fix it but how can you fix a tile floor if all the tiles were installed following a standard that is not up to par? Example: they paint bare wood or walls without priming the wood first. The paint looks great for a year, then it lifts off in big sections but it’s too late for anyone to be accountable then. Your average Chinese homeowner has no idea how to paint or do other home repairs compared to the average American.This is why you need to have your interests well looked after. Also, a serious weakness of Chinese engineers is their reluctance to ask questions. This has to do with the cultural myth of “lose face.”Because of the importance of relationships and family sometimes they will hire their friend/family member instead of hiring the best person for the job. This also limits their success in some ways. Take Auto parts for instance. The Speed at which China has been industrialized means quality concerns and recalls are growing. Their revolution happened in a quarter of the time that ours did.The Chinese are unfamiliar with or don’t care about U.S. auto quality standards. Under federal law the importer of record is responsible for recalls and quality concerns. Many small importers (anyone can be importer) aren’t familiar with regulations and suppliers don’t have the capital to handle recalls.We also have to communicate the long term implications of the business opportunity to the Chinese factory. If they think a project is ‘one and done’ then this impacts price Everything is a negotiation.

ACG Moderator: Discuss the cultural differences especially as it relates to building relationships in China.

Alexander: The Chinese always consider their relationship with another person when they do business with that person. For example, they can never turn away from doing business with a friend even if there is a better product they should be seeking. At least they can’t do it in front of everyone so they might do it secretly. The Chinese prefer to deal with people they know and trust. Western companies have to make themselves known to the Chinese before any business can take place. Furthermore, this relationship is not simply between companies but also between individuals at a personal level. The relationship is not just before sales take place but it is an ongoing process. The company has to maintain the relationship if it wants to do more business with the Chinese. The relationship sometimes begins based on money then moves to integrity and trustworthiness. Frequent contact is important.

ACG Moderator: Discuss other emerging markets such as Vietnam, South America and Mexico briefly as they relate to the evolution of the Chinese markets and increased shipping costs.

AlexanderMuch is predicated on fuel costs. Also higher expenses, plus higher taxes and stricter enforcement of labor and environmental standards, are causing some manufacturers to leave for lower-cost markets such as Vietnam, Indonesia and India.Despite its huge pool of unskilled rural laborers, China’s supply of experienced, skilled talent falls far short of demand. The gap has been pushing wages up by 10 percent to 15 percent a year.Inland cities like Luoyang and Wuhan, outside the traditional export zones of Guangdong and the Yangtze River Delta, near Shanghai are emerging. In inland China, wages still lag far behind the richer eastern and southern coastal areas.

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The $6 Haircut

There’s a great commercial running now for Office Depot featuring an independent barber, Dan who walks out of his shop one day to see “Nitro Cutz” has opened across the street offering $6 haircuts.  http://www.youtube.com/watch?v=9UiIVImKsRk&feature=email

Unflappable, Dan, walks into an Office Depot to prepare his counter strategy which we later learn is simply to put up a sign that reads, “We Fix $6 Haircuts.”  Brilliant.  

Office Depot

In 2005 when we began to offer our clients our sourcing and project management services in China, we assumed our only competition would be others who jumped on this bandwagon.  Were we wrong.  Our greatest barrier to acquiring new clients became the honorable but misguided efforts of those managers who had been led to believe that a web search and a few returned emails from China meant they were well on their way to implementing their companies’ low cost sourcing initiatives. $6 haircut indeed. 

In the past decade technology has enabled much more efficient  information transfer between continents.  FTP sites and inexpensive phone rates via Skype, Vonage and other VOiP carriers have improved the cost and speed of sharing data.  Social Media, blogs and email have given us the perception that barriers to communication have fallen.   Airfares to and from China are reasonably priced and with over 1 billion people in a country the size of the U.S. there are plenty of agents ready and willing to take on your manufacturing project.  All of these new advantages,  highly valuable as they are, present no assurrance that your new found business associate in Asia has the know-how, experience and resources to deliver you a quality product and service. 

Now, even some of the top private equity firms in the U.S. have followed the models of Fortune 1000 companies opening offices in China to centralize sourcing and purchasing.  I write about the “Five Things You Should Know Before Launching in China” http://bit.ly/c5eeBg which lists key considerations prior to investing in this front-loaded, fixed cost model.  

Faced with the downturn in our economy, manufacturers and distributors are re-thinking which initiatives make the most sense for offshore manufacturing outsourcing.  This is a good practice and new criteria have been distilled into this decision making process.  What is clear now however, is that many are finding the “$6 haircut” actually costs triple that or more when you leave this vital decision in the hands of those without the know how or qualified personnel in place.   What are the true costs of poor quality, defects, and missed product launch deadlines?  How many personnel on your  payroll have to get involved to solve the various challenges that result in poor execution?  Need to airfreight and rush that order in?  You just doubled, tripled or worse your shipping cost of goods. 

When taking a project to China, it is imperative that you confirm you are working with engineers who understand Western quality standards, tolerances and material specifications.   Be sure you have a dedicated team of advisors who have an interest in your success, respond to your project timelines, and share your same sense of urgency.   Are your China contacts truly invested in your business and do they have only your best interests in mind? 

Many of our new clients are now those who assumed the $6 quotation they received would net them a $12 profit.  There are multitudes of willing entrepreneurs in China willing to take your $6 time after time.  Buyer beware the $6 haircut.  There is great peace of mind knowing you can walk out with both ears, without a mowhak and ready to face the day with confidence.

 

David Alexander is President of BaySource Global www.baysourceglobal.com a leading sourcing and project management firm with offices in Shenzhen and Shanghai.

Analyzing the pros and cons of outsourcing to China

To make the right decision, conduct an extensive cost analysis of your total delivered cost.

Wayne Forrest — Purchasing, 2/3/2005

If you’re considering setting up shop and outsourcing in China to reduce your sourcing costs, make sure that you first conduct a detailed cost analysis to determine that it truly will be a less expensive approach for your company.The reason: China isn’t necessarily a low-cost haven for companies looking to outsource. Two recent studies have concluded that while the cost of manufacturing products in China is less than the United States, businesses often underestimate the complexity of managing trade with China and, in some cases, companies might be better off redesigning their products and maintaining production at home.

Indeed, success in a China trade strategy requires companies to take a “true end-to-end management approach.” That’s the advice from Aberdeen Group’s China Trade Management Strategies Benchmark Report. The survey was cosponsored by technology providers E2open of Redwood City, Calif. and Manugistics Group in Rockville, Md. The survey found that 42% of respondents had order cycle times of more than 60 days. In addition, 89% of the respondents that had the highest logistics costs also had the longest order leadtimes. The report says those numbers are a “clear warning sign that price-based supplier selection is the wrong strategy in China.”

“If you just do it based on pricing negotiations and have not thought through the logistics of delivery, assurance of supply, flexibility of supply and quality, your total cost very quickly outweighs the price savings you made in the negotiations up front,” says Richard McCluney, vice president of account operations for E2open.

The survey cites four important criteria for success in China trade management: lowest total delivered cost; delivery reliability; supply chain flexibility; and regulatory compliance and risk minimization.

Yet, U.S. manufacturing—particularly in regard to China—”seems to be experiencing a lemming mentality when it comes to outsourcing,” suggests “A Case to Consider Before Outsourcing to China,” a recent study conducted by Boothroyd Dewhurst, a company that specializes in software tools that provide manufacturing assembly knowledge for the product design process.

While all companies strive to reduce manufacturing costs, the report found that few firms analyze and act on the greatest potential for cost savings—the design of products. “The part cost is about 70% of the cost of a product,” estimates Nicholas Dew-hurst, Boothroyd Dewhurst executive vice president and coauthor of the study. “If that’s true, then you’re barking up the wrong tree if you’re [only] looking at labor, which is the smallest piece of the pie.”

“When they look only to outsourcing for cost reduction, [companies] run the risk of becoming myopic in the design process,” says the study. Another common error: too often, companies look at the current design of a product and naturally—and mistakenly—assume that its redesigned predecessor will cost the same amount to produce, says Dew-hurst. “I think a lack of real involvement of the purchasing or supply chain group in that early design process has some impact on getting a full understanding of what the costs are.”

As Dewhurst explains, many companies design a product, send the plans to three suppliers for quotes and then choose the lowest bid. Not only does that “take a significant amount of time to arrive at the design,” but when you use that type of conventional process, “it is already too late [to have an impact on] the cost you want to produce it for.”

Similarly, many companies do an inadequate job of setting the initial target cost, revise design closely based on the original product and pay too much attention to what the competition is doing, says David G. Meeker, consultant with Neoteric Product Development in Acton, Mass. and coauthor of the Boothroyd Dew-hurst study. “Gone are the guys who could look at a product and, in their heads, know the process and costs of design and manufacturing and how it could be done less expensively.”

But how realistic is it to set a low cost for redesign and production?

“You have to absolutely do it, because you won’t know if you can bring a product to market and get the kind of [profit] margin that you want,” Dewhurst says. “If the market will bear a price of $100 and you have to make it for $75, the problem is this—how do you know that’s a good target? We see a lot of manufacturers arbitrarily picking numbers; they’ll set the cost at $75 and then see if they can do it.”

If the process is done correctly, Dewhurst maintains that a finished product’s time to market is shortened. “If you have a product that has 10 parts in it and you can make it with five, that’s five fewer things you have to carry through the development process.”

China connectionThe Boothroyd Dewhurst study also notes that some products are not good candidates for overseas manufacturing, whether they are redesigned or not. For example:

  • Products which utilize a highly automated process.
  • Products—which because of their weight and size—increase shipping costs by air or ocean.
  • Products which require scheduling flexibility.
  • New products which may require engineering and design changes to ensure quality.
  • Products with proprietary intellectual rights and/or patents that may be copied and marketed less expensively.

To assess the bottom line, companies must total all additional costs associated with overseas manufacturing, whether it be travel, shipping, legal, material or labor expenses. In other words, find the total lowest delivered cost of making a product.

China imperativesTo successfully do business in China, adds E2Open’s McCluney, it’s also critical to have key people in the sourcing process—perhaps Chinese-Americans—who know the local customs and can conduct accordingly.

“As the supply chain gets longer, if you don’t spend a lot of time making sure you’re making the right decisions on sourcing and trying to save a penny here and a penny there, you get a more convoluted supply chain,” he says. The most successful companies take key sourcing people and place them in cities such as Singapore and Shanghai because those are key areas for identifying good suppliers.

Common mistakes among companies attempting trade in China include assuming that supplies will sail through Customs easily and misjudging infrastructure capabilities in the Chinese market. McCluney used to work outside of Shanghai, where, at one time, roads were quick to travel. Today, getting from one place to another can take three times as long. “Because of the huge increase in traffic, you now have to rethink where you have your suppliers based,” he says. “A good assumption six months ago might not be the right thing today or in six months time.”

“If you do a lot of work up front to prequalify the supply base, then you are getting your assurances and benefits of the lower cost,” McCluney says. “If you just go for a successful price negotiation without all the other pieces, you may end up missing orders, not being able to fill orders, if demand changes, and your costs go up.”

On the horizonIf adventurous companies can find a way to handle China’s idiosyncrasies, they should do so quickly. Why? Meeker believes that the cost of doing business in China will not stay inexpensive forever, especially if and when China begins to more seriously enforce regulations that pertain to the environment, minimum wage, worker safety and the like—and have foreign manufacturers pay part of the tab.

“It’s not a stretch to think that at some point in the future—I don’t know if it is one year, five years or 10 years—China will have to do something and the costs [to do business in China] will only go up,” Meeker says.

E2open’s McCluney believes the Chinese market will “continue to grow, but I don’t think it is the be all and end all. I think the economics that make people look at China trade might work right now, but you have to reassess your strategy,” as the economic and political climates in the country change.

From Reactive to Proactive: Redefining Safety Standards in the Promotional Industry (A Four-Part Series)

The following article is the final installment in our monthlong Promo Marketing Headlines series titled, “From Reactive to Proactive: Redefining Safety Standards in the Promotional Industry.” For the past four weeks, we’ve discussed product testing, quality assurance and how both suppliers and distributors can work in tandem to ensure the items they sell are safe for children and adults alike. Read on for the last chapter, which addresses the dangers and benefits of offshore manufacturing.  From Promo Marketing Magazine written by Christen GruebelPart 4: The Global Sourcing Gamble There’s a reason why Tylenol is still on drugstore shelves across America. Johnson & Johnson’s response to its 1982 cyanide debacle (and the subsequent redux in 1986) was prompt, honest and ethical. It’s really no wonder, even 25 years later, the event is still upheld by public-relations practitioners as the paradigm for crisis management.

Accepting blame is certainly tougher than assigning it, yet what saved the Tylenol brand was swift admission, and an open line of communication between Johnson & Johnson and America.

While this situation and that of the recent product recalls have similar elements, in today’s news stories, by contrast, the perceived “enemy” of global outsourcing has taken center stage as the guilty party—not the companies.

They may be apologizing. They may be collecting harmful items. Yet, the common implication that China is at fault for each and every product defect is a conception that they aren’t going far to discourage, either.

Shades of Gray

It’s no coincidence that with cheap labor comes the added risk of sub-par quality, however, there’s a big difference between design flaws and manufacturing defects. According to a study titled, “Toy Recalls—Is China Really the Problem?,” published in the September 2007 issue of the Asia Pacific Foundation of Canada’s proprietary publication, Canada-Asia Commentary, “A design problem will result in an unsafe toy irrespective of where it is manufactured. … Only toy companies can prevent problems associated with designs.”

For example, instances with lead paint are manufacturing defects. But anytime a recall involves something like choking hazards or sharp points—it’s a design flaw. Whether the mistake occurred in the Chinese factory or in the boardroom where the design was finalized, one fact must hold true: A company must accept accountability for the products it puts on the shelves.

“Product recalls have happened across a vast number of industries for a good number of decades, regardless of their manufacturing origin,” noted David Alexander, president of BaySource Global—a sourcing company that partners with American companies to facilitate day-to-day business dealings in Asia. He added, “Any company marketing and selling a product to the U.S. consumer is ultimately responsible for the safety and performance of that product.”

Cause and Effect Patterns

But why has China become the scapegoat? Mel Ellis, president of Humphrey Line, suggested it’s because, in general, trade with China just isn’t fair trade. And the reasons that send American companies overseas—cheap labor, low overhead—are the very same ones that lead to product defects. “There is no effective OSHA in China, and they recently executed the head of their FDA. They can use child labor … their wages are very low,” he added. Not to mention, Ellis said, “We know that our intellectual property rights are not respected in China.”

To wit, most Chinese factories are far from centrally located. According to Don DePalma, president and chief research officer at Common Sense Advisory, a research and consulting firm based in Lowell, Mass. that aims to increase the quality of international business, “The reality probably is, the factories that you’re operating in are not in the first-tier cities … but are probably in the third- and fourth-tier cities where labor is cheaper. And those are places where ‘you can’t get there from here.’”

Although Ellis manufactures his entire product line in the United States, he has a sense of how the recalls will affect promotional products suppliers and distributors, whether they import or not. “First, companies with very high brand equity values may be reluctant to trust our distributors to provide products that are free from defects. This may result in reduced demand …” He went on to say the potential for injury as well as significant financial liability for those involved in a recall will also contribute to a modicum of instability in the industry moving forward. However, he has hopes that China will respond from the market pressure to develop higher standards.

Yet, until that happens—and even after it does—the burden of stewardship falls squarely on the shoulders of the company that puts out the product. DePalma maintained that it will cost more for companies to adhere to more stringent corporate principles, but in the long run, the potential for brand damage is too great not to.

Outsourcing Infrastructure

Whether you’ve already gone overseas, are weighing the advantages or considering a partnership with a company that is doing either of the above, the tips below are good starting points to ensure safety and quality assurance at every turn.

• Develop a code of ethics and stick to it. This step is simple. If your company does not have corporate moral code, create one. Determine the values upper management wishes to uphold and keep the line firm through every offshoot of the company. Alexander discussed some common elements in the factories he uses that ensure the working conditions are above reproach—that they are safe, clean, pay fair wages and are free of child labor. This is an important way to do due diligence with regard to offshore manufacturing, and as an added benefit, it helps maintain brand integrity.

• Keep quality control stateside. While numerous suppliers readily admit to allowing their Chinese manufacturers to take the lead in testing and product safety, some matters are best done in the homeland. Companies should have a usability lab, a safety lab and quality assurance lab in the United States, DePalma said. “It all comes down to the sorts of things that you hope are part of every company’s design and product-review process. … You want to make sure whatever you’re manufacturing does no harm.” Build quality assurance into the equation.

• Maintain an iron-clad “process.” Though quality needs to be a domestic concern, documenting standards for overseas manufacturers will leave corporate expectations unambiguous. This process of checks and balances, said Alexander, is “cradle-to-grave.” He added, “This means creating a documented paper trail outlining all specifications and requirements for a product from inbound raw materials inspections, in process quality systems, all the way to packaging and shipping.” Bear in mind, the process also must be correctly translated.

• Bring a third-party inspections company on board. Companies such as Alexander’s BaySource Global have overseas teams that can handle the ins and outs of global sourcing so you don’t have to. Among other things, Alexander reported that companies trying to do this on their own typically make mistakes in the following: “Not performing quality audits at factories …, making broad assumptions that what was said was understood, leaving anything to chance, not having someone present during manufacturing runs, [and] … not managing the process.” Similarly, if the third-party contractor has locations overseas, conducting unannounced factory checks is a more practical possibility.

• Expect to pay more. The catch-22, of course, is that while suppliers of promotional products might go to China because the price can’t be beat, cementing responsible business practices will add to the bottom line. While Alexander maintained that the extra costs incorporated into the product are far outweighed by the benefit of his company’s services, at the end of the day, whether or not a company can allocate its budget to accommodate these extra expenses is a choice, not a law.

Stories that relate to this series:

CCTV International—

“China: New quality standards cause toy recall”

http://www.cctv.com/program/bizchina/20071030/102525.shtml

Paulson Addresses “New Dynamics” In U.S.-China Relationship

Global Business News

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10/23/2007 10:49:19 AM The shifting relationship between the U.S. and China, including protectionism and currency value, was the focus of Treasury Secretary Henry Paulson’s speech at a U.S.-China relations conference Tuesday. He stressed the need for “bilateral cooperation” as globalization and interdependence continue to define the global economic landscape.“There is hardly an issue – from trade, to national security, to climate change – or a place – from North Korea to Iran to Sudan – where American and Chinese interests do not increasingly overlap,” Paulson said, emphasizing the growing inter-reliance.

Paulson made no bones about the fact that the U.S.-China relationship is complex and historically strained. However, looking forward he discussed the United States’ role in what he termed the “re-emergence of China.”

Specifically, he cited the growth of U.S. exports to China, which have grown five times faster than U.S. exports to the rest of the world. Additionally, Paulson pointed out that China is now the United States’ fourth largest export market.

“U.S.-China economic interdependence is deepening,” Paulson told the audience.

The United States is not the only nation affected by China’s substantial growth, Paulson said. China is now a major player and maintaining a strong relationship with the United States and other major economies is essential to stability in the global system.

“Because China is now integrated into the global economy, what happens in China’s economy affects the entire international community,” Paulson stated. “The U.S.-China relationship has become central not only to each nation’s interests, but also to the maintenance of a stable, secure and prosperous global system – which benefits the world.”

One of the more sensitive issues is how China will meet their expanding energy demands in an environmentally considerate manner. China and the United States are similar with respect that they are the two largest energy consumers in the world, and as a result they emit the most greenhouse gases. Paulson reminded the audience that environmental protection is a global goal, not restricted to individual countries. “What happens with China’s environment impacts all nations,” he said. “Air and water know no boundaries.”Consumer safety with regard to the recent wave of recalls of Chinese-made products has cast a shadow over China’s exports.

“American consumers have very real concerns about the safety of food and product imports from China,” Paulson said. “Recent and repeated reports of tainted food and product imports are causing fear and uncertainty in American consumers and harming the “Made in China” brand here in the United States.”

Increased communication to confront the new dynamics of the relationship – “deepening interdependence, a strained policy consensus, and the rise of economic protectionism” – was the cornerstone of Paulson’s speech. He was very direct about the importance of continued cooperation.

“Solidifying these habits of cooperation is critical to sustaining America’s broader China policy, both at home and abroad,” he stated. “A weak and insecure China is not in America’s economic or security interests.”Of the three new dynamics, the protectionism movement in China is what Paulson considers the most dangerous to continued growth.

“In my judgment, the greatest risk to China’s long-term economic security is that protectionists prevail,” he cautioned.

Paulson also forced the issue of currency appreciation, which has come under fire in the United States Congress and in the 2008 presidential race. Many believe that China is keeping its currency devalued, allowing cheaper exports and inhibiting other countries from importing products.

“Currency appreciation to date has not slowed the Chinese economy,” Paulson stated, addressing Chinese concerns that valuing the yuan would harm the economy in the long run.

He added that allowing the yuan to strengthen at a faster rate would be an important and necessary step in an effort to implement a “fully market-determined currency in the medium term.”

“Accelerating the rate of appreciation and introduction of flexibility will help China deal with the imbalances that have grown in the economy and make monetary policy much more effective in responding to inflation,” he told the audience.


 
Analyzing the pros and cons of outsourcing to China by Wayne ForestIf you’re considering setting up shop and outsourcing in China to reduce your sourcing costs, make sure that you first conduct a detailed cost analysis to determine that it truly will be a less expensive approach for your company.The reason: China isn’t necessarily a low-cost haven for companies looking to outsource. Two recent studies have concluded that while the cost of manufacturing products in China is less than the United States, businesses often underestimate the complexity of managing trade with China and, in some cases, companies might be better off redesigning their products and maintaining production at home.Indeed, success in a China trade strategy requires companies to take a “true end-to-end management approach.”

That’s the advice from Aberdeen Group’s China Trade Management Strategies Benchmark Report. The survey was cosponsored by technology providers E2open of Redwood City, Calif. and Manugistics Group in Rockville, Md. The survey found that 42% of respondents had order cycle times of more than 60 days. In addition, 89% of the respondents that had the highest logistics costs also had the longest order leadtimes. The report says those numbers are a “clear warning sign that price-based supplier selection is the wrong strategy in China.”“If you just do it based on pricing negotiations and have not thought through the logistics of delivery, assurance of supply, flexibility of supply and quality, your total cost very quickly outweighs the price savings you made in the negotiations up front,” says Richard McCluney, vice president of account operations for E2open.The survey cites four important criteria for success in China trade management: lowest total delivered cost; delivery reliability; supply chain flexibility; and regulatory compliance and risk minimization.

Yet, U.S. manufacturing—particularly in regard to China—”seems to be experiencing a lemming mentality when it comes to outsourcing,” suggests “A Case to Consider Before Outsourcing to China,” a recent study conducted by Boothroyd Dewhurst, a company that specializes in software tools that provide manufacturing assembly knowledge for the product design process. While all companies strive to reduce manufacturing costs, the report found that few firms analyze and act on the greatest potential for cost savings—the design of products. “The part cost is about 70% of the cost of a product,” estimates Nicholas Dew-hurst, Boothroyd Dewhurst executive vice president and coauthor of the study. “If that’s true, then you’re barking up the wrong tree if you’re [only] looking at labor, which is the smallest piece of the pie.” “When they look only to outsourcing for cost reduction, [companies] run the risk of becoming myopic in the design process,” says the study.

Another common error: too often, companies look at the current design of a product and naturally—and mistakenly—assume that its redesigned predecessor will cost the same amount to produce, says Dew-hurst. “I think a lack of real involvement of the purchasing or supply chain group in that early design process has some impact on getting a full understanding of what the costs are.”As Dewhurst explains, many companies design a product, send the plans to three suppliers for quotes and then choose the lowest bid. Not only does that “take a significant amount of time to arrive at the design,” but when you use that type of conventional process, “it is already too late [to have an impact on] the cost you want to produce it for.”Similarly, many companies do an inadequate job of setting the initial target cost, revise design closely based on the original product and pay too much attention to what the competition is doing, says David G. Meeker, consultant with Neoteric Product Development in Acton, Mass. and coauthor of the Boothroyd Dew-hurst study. “Gone are the guys who could look at a product and, in their heads, know the process and costs of design and manufacturing and how it could be done less expensively.”But how realistic is it to set a low cost for redesign and production? “You have to absolutely do it, because you won’t know if you can bring a product to market and get the kind of [profit] margin that you want,” Dewhurst says. “If the market will bear a price of $100 and you have to make it for $75, the problem is this—how do you know that’s a good target? We see a lot of manufacturers arbitrarily picking numbers; they’ll set the cost at $75 and then see if they can do it.”If the process is done correctly, Dewhurst maintains that a finished product’s time to market is shortened. “If you have a product that has 10 parts in it and you can make it with five, that’s five fewer things you have to carry through the development process.”

China connection The Boothroyd Dewhurst study also notes that some products are not good candidates for overseas manufacturing, whether they are redesigned or not. For example:

  • Products which utilize a highly automated process.
  • Products—which because of their weight and size—increase shipping costs by air or ocean.
  • Products which require scheduling flexibility.
  • New products which may require engineering and design changes to ensure quality.
  • Products with proprietary intellectual rights and/or patents that may be copied and marketed less expensively.

To assess the bottom line, companies must total all additional costs associated with overseas manufacturing, whether it be travel, shipping, legal, material or labor expenses. In other words, find the total lowest delivered cost of making a product.

China imperatives To successfully do business in China, adds E2Open’s McCluney, it’s also critical to have key people in the sourcing process—perhaps Chinese-Americans—who know the local customs and can conduct accordingly.“As the supply chain gets longer, if you don’t spend a lot of time making sure you’re making the right decisions on sourcing and trying to save a penny here and a penny there, you get a more convoluted supply chain,” he says. The most successful companies take key sourcing people and place them in cities such as Singapore and Shanghai because those are key areas for identifying good suppliers.Common mistakes among companies attempting trade in China include assuming that supplies will sail through Customs easily and misjudging infrastructure capabilities in the Chinese market. McCluney used to work outside of Shanghai, where, at one time, roads were quick to travel. Today, getting from one place to another can take three times as long. “Because of the huge increase in traffic, you now have to rethink where you have your suppliers based,” he says. “A good assumption six months ago might not be the right thing today or in six months time.”“If you do a lot of work up front to prequalify the supply base, then you are getting your assurances and benefits of the lower cost,” McCluney says. “If you just go for a successful price negotiation without all the other pieces, you may end up missing orders, not being able to fill orders, if demand changes, and your costs go up.”

On the horizon If adventurous companies can find a way to handle China’s idiosyncrasies, they should do so quickly. Why? Meeker believes that the cost of doing business in China will not stay inexpensive forever, especially if and when China begins to more seriously enforce regulations that pertain to the environment, minimum wage, worker safety and the like—and have foreign manufacturers pay part of the tab. “It’s not a stretch to think that at some point in the future—I don’t know if it is one year, five years or 10 years—China will have to do something and the costs [to do business in China] will only go up,” Meeker says.E2open’s McCluney believes the Chinese market will “continue to grow, but I don’t think it is the be all and end all. I think the economics that make people look at China trade might work right now, but you have to reassess your strategy,” as the economic and political climates in the country change.

Chinese Manufacturing Slows with VAT

There continues to be much discussion on China’s manufacturing edge in addition to simply low cost labor. A discrepancy in currency and industry rebates by the Chinese government are attributed as other major advantages when comparing manufacturing in the U.S. vs China.  Reforms continue to take place, reducing the disparity that so many legislators are screaming for.  The following article was written by Jr Wu in last month’s WSJ.

  

  

Chinese Manufacturing
Shows Signs of Cooling

By J.R. WU
August 2, 2007

BEIJING — China showed signs of slower manufacturing growth in July, according to the latest purchasing managers’ indexes, suggesting the country’s breakneck expansion could moderate.

The China PMI, issued by the China Federation of Logistics and Purchasing and the National Bureau of Statistics, fell to 53.3 points in July from 54.5 in June, marking a decline for a third consecutive month.

The CLSA China Purchasing Managers Index also fell in July, to 53.2, off its 27-month high of 55 in June. The CLSA China PMI, also issued yesterday, is compiled by CLSA Asia-Pacific Markets and U.K.-based NTC Research.

Both indexes recorded declines in new orders and export orders in July from June, indicating a potential slowdown in China’s export-driven growth.

“The drop in export orders suggests that a rush of orders to beat the July cut in export-tax rebates was important in accelerating first-half growth,” said Eric Fishwick, deputy chief economist at CLSA.

China said in June that starting July 1 it would scrap or cut the export-tax rebate on more than 2,000 types of goods to help slow growth in its huge trade surplus, or margin by which exports exceed imports.

The move pushed the country’s trade surplus in June to a monthly record of $26.91 billion on strong exports. Underpinned by the surging trade, China’s economy grew 11.5% in the first half from a year earlier, strengthening 11.9% in the second quarter alone.

The federation’s PMI data have been showing steady declines in new export orders, purchase quantities and input prices from highs above 60 points earlier this year. That may indicate slower growth in manufacturing in the second half, the federation said.

New export orders in the federation’s PMI have been steadily declining each month since April’s 62.3, falling to 55 in July. CLSA’s PMI indicated new export orders fell to 51.1 in July from 56.5 in June.

But manufacturing still remains strong, as a reading above 50 indicates growth; a reading below 50, contraction.

China raised its benchmark lending and deposit rates for the third time this year in July and has said it would increase banks’ required reserves for the ninth time in a year to stabilize price expectations and curb excess liquidity.

When the latest increase in the reserve-requirement ratio goes into effect Aug. 15, the interest-income tax will also be reduced to 5% from 20%, effectively raising deposit rates further and giving savers’ more incentive to leave their money in

Whose responsibility is the quality of goods manufactured in China?

 Eyes on China–The Costs of Progress

 On August 1, Mattel recalled approximately 1.5 million toys made by a manufacturer in China because of dangerous levels of lead in their paint. The recall marks a continuation of the quality control problems that importers of Chinese-made exports have been experiencing over the past two months in products ranging from pet food to fish to tires. Four days earlier, the Chinese government ordered the country’s banks to increase their reserves and thereby reduce the amount of money they can lend to business — part of an effort to cool down an economy that is growing at its fastest rate in 12 years. But quality concerns and rapid growth aren’t China’s only worries. There is also the government’s need to keep forging ahead on preparations for the Olympics next August in Beijing, despite some criticism about overdevelopment, human rights abuses and unsafe levels of pollution. The Wharton School recently interviewed Wharton finance professor Jeremy Siegel about his views on China’s growth. In a podcast, they asked Wharton management professor Marshall Meyer, who visits China about five times a year, for his perspective on how the Chinese government is handling its economy, and some of these other issues as well.  The following is an excerpt from this interview.TranscriptKnowledge@Wharton: Let’s start out with Mattel’s recall, which affects toys made for the company’s Fisher Price unit. How serious a blow is this to the reputation of China’s manufacturing sector, which already has a big image problem because of earlier recalls?Meyer: Well, it’s certainly a blow. I think that it just adds to the concerns that people have about the ability of Western companies or Chinese companies manufacturing in China to control the quality of the product. Knowledge@Wharton: Is this something that the government is going to crack down on? Or is the Chinese government claiming that the U.S. has the same problems and that in fact other countries have similar manufacturing problems? They’re on the offense.Meyer: Yes, the propaganda barrage from the central Chinese government has been, in my judgment, surprisingly muted. I think that they recognize they’ve got a problem. But I also think that there’s a false premise in your question, if you’ll forgive me, when you refer to “the government.” There are many governments in China, and the ability of the central government to control commerce in China is very limited. There’s no counterpart to the U.S. commerce clause in the Chinese constitution. And so, whatever regulations or laws the central government makes, they are sometimes changed and often ignored by local governments.   Knowledge@Wharton: So, what would be a good strategy for U.S. companies, or other international companies that are sourcing production from China, to deal with this issue? Meyer: There are a couple of things. First of all, they must simply pay a lot more attention, at some cost, to the quality of the product that they are getting from China. There’s no substitute for being there on the ground and knowing exactly who your sources are, and who their sources are. This is a particular problem in China because of the contracting. The subcontracting system often makes it less than transparent about who’s actually making a product.Let me give you an illustration of the system, if I can. Suppose that I am in Shanghai, and I want to take a taxi out to Suzhou, which is about 45-50 minutes away. You find a cab driver and hypothetically you negotiate a fare with the cab driver for say 300 RMB or 350 RMB. And you hop in the cab and you think that you’re on your merry way to Suzhou. And he’s going in the right direction, but all of a sudden before he gets to the freeway, he stops, he sees his buddy and he waves him over — and basically he turns you over to his buddy. Maybe he gives the buddy 300 RMB and pockets the other 50 RMB right away. This kind of thing happens throughout China.So that when Mattel says, for example, “We’ve been dealing with this source for 15 years, and we felt that we could really trust them,” they still might not know who the source is taking raw materials from, and in turn, from whom their source is getting the raw materials.Knowledge@Wharton: How extensive a problem do you think this is?Meyer: I think given the price pressures that this is going to be extremely extensive because everything in China is driven by price. There are lots of small producers…. You go to [one location] where 80% of the toys come from, and you’re going to see hundreds and hundreds of these little shops producing components for these toys. Who knows where any particular piece is coming from? And so this is going to be difficult to handle unless and until both the Chinese and American firms go back to actually owning their sources of supply. Then they’ll have a little more control over them.Knowledge@Wharton: Some people have suggested third-party testing as a way to get around this. But I suppose that has its own problems, including expense.Meyer: You know, it’s as people say in the quality literature — you don’t want to fix the problem afterwards; you want to prevent the problems in the first place. That is why control is so important — and that may mean taking a greater ownership stake in firms that are now subcontractors.

Offshore Manufacturing advice

BaySource Information Packet For purchasing and operations personnel, attempting to “get to China” can be a daunting proposition.  BaySource consists of U.S. based professionals who work with key decision makers to identify ways to reduce the acquisition cost of manufacturing parts/components, sub- assemblies and /or finished goods.  We help our clients dramatically lower their cost of goods by working together to identify areas of spend where we can drive an immediate financial impact.  With our Asia based infrastructure we develop immediate solutions for margin improvement.  Our strategic focus is middle market organizations that may not have the organization established or the sourcing presence in China today.  Think of the time and effort companies spend in developing a Far East sourcing strategy.  The challenge of establishing a China office alone can consume most middle market companies for twelve months or more!  The managing of financial exposure, establishing legal entities and navigating the vast cultural differences can take most companies off their primary focus of running their day-to-day businesses.  With our existing team throughout China, we provide the sourcing expertise and cost reducing opportunities that most companies need today. Our ability to quickly “connect the dots” in terms of matching supply chain needs with immediate options for savings is a complete “no cost / no risk” solution for companies wanting to source in China.  We understand productivity, quality and speed to market but most importantly how to meet and exceed the requirements of U.S. based companies. 

For more information and to see videos of one of our factories in action, go to www.baysourceglobal.com  or check out our information packet linked to this post.

A Positive Outsourcing Outcome

Visit to FactoryTualatin firm finds that outsourcing leads to growth
The Portland Business Journal – May 19, 2006
by Sean Meyers
Special to the Business Journal
Finally, a story about outsourcing to China that even a labor official might love.
In the late 1990s, Sure Power Inc., a longtime Tualatin designer and manufacturer of vehicle electronics, was feeling heat from customers and pressure from the market to simultaneously reduce product price and dramatically increase quality.

Like many other U.S. manufacturers caught in a similar bind, Sure Power turned to China. That’s nothing new, but the results of the effort might surprise some opponents of outsourcing.
“I can’t attribute a single layoff to outsourcing to China,” says Steve Scheidler, Sure Power president. “In fact, the result has been just the opposite.”
Local employment has increased 53 percent to about 160 and taxes paid to the state of Oregon have increased by 204 percent, not counting additional income taxes paid by the new employees. Sales are up 188 percent. Why? Outsourcing portions of manufacturing have freed up more of the company’s 115,000 square feet for research and development, he says. That has made the Tualatin location more competitive by making new products easier to build.
Outsourcing has improved cash flow and allowed Sure Power to better manage resources. “The purpose in going to China was not to shutter our factory. Our customers were compelling us to get aggressive on price and design,” Scheidler adds. “It’s allowed us to compete and gain business we may not otherwise have received [and] gives our customers a perceived best-cost opportunity even if that savings is not real or is insignificant.”
Going global may be the most important decision in the 47-year history of the company. “When you step back and take a look at the globe, doing business in another country today is not that much more complicated than doing business in an adjacent county,” he says.
“Really, what’s the sense in building an expensive new factory when there’s so much factory capacity already available around the world? I think we need to quit being afraid of outsourcing. The U.S. is the No. 1 economy in the world for a reason. We might take a hit, but we bounce back.”
Sure Power produces about 1 million parts annually, mostly for use on heavy truck, military, bus, marine and other nonpassenger vehicles. His father, Ralph, started the company by inventing a “battery isolator” that prevents the direct current electrical systems in boats and recreational vehicles from discharging when not in use. The product is still widely used today. Next stop? Outsourcing projects to Eastern Europe, but it’s still in the early development stages, Scheidler says. “I think it would be a good way to break into the market and get them to buy our products.”
Scheidler got the advice he needed to establish a foothold in China from suppliers that made referrals and from other manufacturers “who had already been there, done that.” He says he doesn’t know of any other manufacturers who have increased local employment while outsourcing to China.

What assistance would Scheidler like to see from government agencies for companies that want to outsource?
“I’m not the kind of guy who looks to the government for any help,” he says. “I’m not trying to be negative, but my feeling is, ‘Just stay out of the way.’”
So far, the government has been doing a pretty good job of that, says David Alexander, president of BaySource, a Tampa Bay, Fla., consulting firm that specializes in manufacturing in China. “The only assistance that I’ve seen provided to U.S. manufacturers that want to set up projects overseas, at any level of government, is by providing general information on trade.”
Many small or midsized manufacturers turn to a consultant to speed the process and to reduce setup costs, he says. A company that sends a fact-finding mission to China will spend an absolute minimum of $5,000 per person, with $8,000 to $10,000 being a more realistic figure, he says.
Alexander has daily contact with two very large Chinese manufacturing companies that often have the part an American manufacturer needs already sitting on the shelf. If they don’t have it stocked, they can often design and cast a new part and crank up production within a week, he says.
That’s an incredible turnaround time compared with a typical American manufacturing environment, says Alexander, who previously ran a U.S. factory that produced a famous brand of hair and beauty products.
Outsourcing is helping U.S. manufacturers improve efficiency, quality and profits, and stories like Sure Power’s are not as rare as people think, Alexander says. “We’re not looking to shut down factories. We’re in business to help companies stay in business.”
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