Written by Bruce Mitchell, Senior Advisor to Lombard Global, Inc.
Edited by William Billeaud, President of Lombard Global, Inc.
Why would anyone want to move their manufacturing operations to the other side of the world in an ancient country and culture ruled by a Communist government? Here is one of many possible scenarios.
A company with manufacturing operations in the United States continues to experience skyrocketing operating costs.
- High labor costs brought about by previous multiyear aggressive bargaining unit agreements.
- The principles of “lean”, “six sigma” and “total productive maintenance” may have been applied by internal and external resources (operations consultants) with little added measurable bottom line gains.
- Demand and pricing of increasing numbers of customers now located in Asia as a result of long delivery times and shipping costs.
- The firm may have had to make significant investment in inventory and warehouse costs in Asia to try to improve their delivery times.
- The Board of Directors may be witnessing more and more of the company’s competition moving operations to Asia enabling them to reduce their costs.
You either close the company’s doors, liquidate the equipment and eliminate all positions or consider moving operations to Asia and maintaining some jobs (Administrative, Engineering, Research and Development, Purchasing, Sales, etc.) in the United States necessary to support on-going operations. By keeping the company operating it can continue to provide a return for investors if it’s a publicly owned company. So what should you do? What criteria will impact your decision? Where do you start? China is 12 to 13 hours ahead of the Eastern Time Zone (there is only one time zone in China and no daylight savings), it has a very ancients and different history, language, culture and on top of that it is a communist country. But what is next? What are the steps? What might it cost? What resources will be required? Is this something you should consider?
1. Proximity to your customers.
Locate your operations in China is to be close to your market.
2. Existing Customer Interest
You may have existing customers encouraging you or perhaps even demanding that you establish operations there. They may like your quality products and want to purchase them but they don’t want to pay the higher prices associated with producing the parts in the United States. Delivery of your product may be an issue for your Asian customers. They anticipate they will see lower pricing and faster delivery once you are manufacturing in China. After you have established operations in China you can invite your Asian customers to your facility, which will have a positive impact on your sales as they recognize that you in fact do have a physical presence and are actually manufacturing your product in China.
3. Attract new customers
With an operation in China you can also more readily identify and invite potential new customers that would never have been able to visit your operations in the United States let alone even learn of their existence! Having an “on the ground” native sales force enables you to introduce your product to new customers. Having an actual manufacturing facility in China enables you to make inroads with new customers that we would not have been able to realize otherwise. This in combination with hiring Chinese sales and application engineers will enable you to go beyond the use of distributors.
4. Market Size
Where else can you find a potential market the size of the population of China? If you have a good product to sell to your customer it isn’t just a matter of lowering your operating costs but it can present the opportunity for a significant increase in both existing and new customer sales as you penetrate and grow your market share in this most populous (and growing!) country in the world.
5. Operational Costs
This is one of the main factors that are typically publicized when a discussion of manufacturing in China is the topic because many businesses think moving production will lower costs for them. However, there are many cost elements that add up to your total manufacturing costs. Before even considering the move, businesses need to do a lot of research to make sure that the company can manage financially if the move goes ahead. Thankfully, there are resources like Synario which can help businesses create contingency plans and map out their future so if the move doesn’t go to plan, the business doesn’t suffer a huge blow. Here are some of the factors to consider;
A. Labor – If you are in a highly labor intensive industry you have the opportunity to significantly reduce these costs as compared to the United States. Salaries for technical and management personnel are significantly lower and labor rates for hourly type positions are almost negligible to your bottom line.
B. Raw Materials and Supplies– You may have an opportunity to reduce material costs but that will depend on your specific raw material requirements. You can find out from Dynatect the sorts of materials and resources you may need and how much these will cost. You cannot anticipate savings on commodity type materials like nickel and copper whose costs are determined globally. One of the biggest challenges, however, is locating and then qualifying a reliable supplier.
C. Equipment– There may be an opportunity for you to save some significant equipment costs but it is also a “Buyer beware” market in China as not all equipment “is created equal” and you more than likely “get what you pay for”. You will need to research your equipment sources thoroughly before proceeding. You’ll also want to make sure that you know exactly what type of equipment you need and how each differs. For example, you need to be aware that compaction equipment will have a different purpose to access equipment.
D. Taxes -Taxation in China is complicated and it may not be a true justification for you. Currently U.S. companies can use income earned in China and re-invest it in the operations without tax implications in the United States. There are numerous options for foreign companies to invest in China and methods they can use to report taxable income is beyond the scope of this book. You should hire an established accounting firm with Asian experience to determine what is best for you.
E. Environmental costs– You might not expect that environmental costs belong in the advantage category but I have chosen to include it here. You can’t necessarily say that the environmental climate in China is better than in the United States, it is just different. When dealing with the local environmental agency they tend be very agreeable when you were considering investing in their city, but once you have made the commitment, the actual regulations and the level of cooperation can change. There are costs associated with hiring an environmental consultant to generate the required environmental assessment plus any modifications to your equipment to “meet the requirements”. The emission requirements for air, water, solid waste and noise bear some similarity to the regulatory requirements in the United States but there are some major differences including the fact that you are regulated by the density and flow rate of emissions per stack at a given stack height. There are no regulations limiting your total annual air emissions for VOC’s as long as you meet the individual stack requirement. There is an extensive report that must be filled out each year.
6. Management objective
You may also be receiving encouragement from top Management (the CEO, the Board of Directors, stockholders, etc.) to establish some level of manufacturing in China. There is likely considerable trepidation from top management taking such a large step from a position of comfort in manufacturing in the United States and knowing what it takes to be successful to moving operations to the other side of the world where the language, culture and government is so different.
1. Utility and Process Gas Costs
A. Electricity- The cost for electricity is significantly higher in China with several “hidden” costs that you should be aware of in their billing structure. We are talking possible two to three times the cost you pay for power in the United States. B. Natural Gas/LPG- Natural gas (or LPG which we had to use since natural gas is not available in all of the development zones) can cost significantly more in China. C. Process gases- Process gases like nitrogen and hydrogen are also higher in cost in China than in the United States. Since there is electricity involved in their respective processes the added costs for power likely more than out-weighed any labor savings.
You cannot purchase land outright in China. You are only able to purchase the “right” to operate on the land for a 50-year period. You can resell your property but you should recognize that the selling of real estate in China is not the same as in the west. In order to create more land mass along the coast of China for sale it is not unusual for the developer to remove truckloads of dirt by literally cutting down nearby mountains to use as fill in former swampy areas, shrimp farms or the like. This will add to your costs, as you will need to invest in additional foundation requirements including piling for not only your building and equipment but also the roads on your property.
3. Intellectual property risks
There continues to be challenges with copies being made in China. In my travels in China I have heard stories where the company manufactures a name brand product for two shifts a day and on the third shift the workers produce and sell the same product for much less! If you have a manufacturing advantage over the competition in your industry based on a process that you have developed that is known only to your company be careful. Your employees may share that information with your competition while still working for you or after they quit your company and/or they start up their own company to make the same thing!
4. Legal issues
China is nothing like the United States when it comes to litigation. Your first reaction to this might be favorable based on the fact the United States has become extremely litigious with ambulance chasers, doctor chasers, etc. – you name it. The lawsuits have been responsible for increasing the cost of medical care and motivating doctors to move out of states where the costs of malpractice suits have sky rocketed. This is not the case in China. And don’t hold your breath as it is not an advantage. There is no independent bar association and resolution of any legal issues can be challenging if you are dealing with the government. You should have any contracts reviewed by consultants familiar with Chinese contracts.
It will be critical to your success to get to know and develop a relationship with the local government. They can make your job easier or harder depending upon on how good that relationship is. Once you have developed a positive relationship you need to maintain that relationship which is best done by your local General Manager.
6. Employee Attrition
Although the current wages in China are very low compared with the West you should be aware that attrition can be a challenge in China. As each new company comes into a Development Zone the employees are not bashful about trying to increase their income by switching jobs. Chinese employees will sign a contract with the company, which is usually good for one year. We have experienced turnover in the labor force particularly after the long Chinese holidays, like the Chinese New Year’s celebration.
7. Language/ Cultural barriers
One could write an entire book on this subject but communication is critical in any business dealings and you need to understand that it is “different” in China and it is just not the language. Chinese is a very difficult language to learn or you need find not only qualified employees, but for your key positions these employees must have good English skills (both writing and speaking) to insure that you can communicate technical, legal and other business related topics. The speaking culture is also different from the West as we westerners are typically more direct in our communication of questions and their responses (subject to any open legal issues). In China you will find that you may ask a simple question (at least that is what you thought), it is then relayed in Chinese and they may talk for several minutes before you receive an answer. Also, “no” doesn’t always mean “no” and “yes” doesn’t always mean, “yes”. Does this sound interesting or what! There is also the issue that you won’t know how the employees are feeling. If you were based in the US then you would be able to see if the employees had low morale and are able to bring in something like a corporate speaker to motivate them but if you don’t know how they’re feeling then productivity could slip.
8. “Hidden” or “Extra Costs”
When you are implementing a building project there are numerous consultants that the government requires you to hire.
You need to be very diligent in enforcing safety rules, as the Chinese are not always safety conscious. They have a very “can do” attitude but they will take short cuts, which can be dangerous to their health and to the health and safety of others. China has no equivalent of the Occupational Safety and Health Act (OSHA) as we have in the United States. This will be a constant battle for you and it is important that you emphasize this with them frequently.
If possible you should negotiate your contracts in U.S. dollars but you might find that difficult to do for the same reason you don’t want to pay in RMB the Chinese would not want to have you pay in U.S. dollars as the value of the Chinese RMB increases and they are getting less for their rent.
11. Importing used equipment
There are additional costs besides just crating and shipping the equipment to the Chinese destination. You will also incur cleanup costs and inspection costs that can be in the thousands of dollars in order to meet the Chinese Customs requirements. The Chinese government also restricts importation of some equipment.
About the author:
As Vice President, Engineering in the Magnetics Division at Spang and Company for 13 years, Bruce Mitchell’s responsibilities included overseeing strategic business growth, production capacity maximization, plant expansions, maintenance, engineering and environmental initiatives. He managed department managers, a staff of buyers, project managers, designers, and electrical, mechanical, civil, and environmental engineers. He oversaw the Division’s global facilities and manufacturing equipment installations. Through his department equipment was identified and purchased. He was also responsible for the design and fabrication of in-house testing and automation equipment.
From 2003 to 2012 he had overall responsibility for the relocation of all manufacturing to China. Potential locations were identified and selected, Chinese equipment was sourced and purchased and installed in a pilot operation in parallel with the design and construction of a new Greenfield plant and later expansion into a second facility. The Asian expansions required the creation of two wholly-owned foreign enterprise. From his experiences he wrote and had published by Palgrave MacMillan in 2012, “13 Steps to Manufacturing in China, The Definitive Guide to Opening a Plant, From Site Location to Plant Start-Up”. Purchase from Amazon. Bruce held numerous engineering supervisory and managerial roles at Honeywell Corporation from 1974-1989.
Mr. Mitchell received his Bachelor and Master of Science degrees in Mechanical Engineering from Virginia Polytechnic Institute & State University (Virginia Tech), Blacksburg, Virginia and a Master of Business Administration from Virginia Commonwealth University, Richmond, Virginia.