Analyzing the pros and cons of outsourcing to China

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  or check out our information packet linked to this post.