10 October 2008

The Changing Face of China Sourcing.

Probably nobody in the West nowadays lives a day without using something that is made in China, from clothing and electronics to kitchenware and bathroom essentials. Western companies in the meantime are increasing their sourcing to China in order to keep their product costs competitive.

But China may no longer be the cheapest place to get your products made, not least because its currency has already appreciated by more than 10% over the last year, whilst the new labour law, effective from late 2007, now imposes stringent severence and overtime payment undertakings on employers. Moreover, hefty increases in raw materials, reductions in export VAT rebates, and tightening processing trade policies have all contributed to increased costs of Chinese manufacturered products this year.

However, China’s single largest buyer, Wal-Mart, has said that soaring production and commodity costs would not damage its ability to source goods from China, and it even expected to see an improvement in product standards. For them, China has been a stable source of products and will likely remain so in the coming years. But can the same be said for other smaller Western buyers?

Why sourcing from China?

According to two senior directors of McKinsey in China, MNCs are sourcing only half what they could do, and are not getting anywhere near the full savings potential of what they source in China. “Sourcing in China is big, but much bigger days are ahead,” said the two McKinsey directors.

Even despite the increase in China’s manufacturing costs (in some industries by over 10%), it is still among the best choices for offshore sourcing.  And the reason is simple: no other country can produce goods on such a large scale with such low costs. China also benefits from a strong work ethic and stable political environment and, while other emerging markets might compete on price, China is also able to compete on quality, with continuous improvement in manufacturing excellence.  In terms of alternatives, Vietnam, with only 85m people, is just too small, and India does not yet have an adequate national infrastructure.

Sourcing Options

The traditional way of sourcing from China has been for the Chinese manufacturers to produce according to a set of drawings supplied by the foreign buyers. But in an increasingly competitive landscape, Western companies are now becoming more sophisticated in their relationships with the Chinese, and are finding ways to get even more value from their suppliers. For example, after agreeing requirements and concepts, the Chinese designers and engineers are then left to work out by themselves what the products will look like, and how they should function. Another trend is that multinationals are starting to implement design-to-cost practices in China, which involves removing premium features from products to cut costs. All these approaches can help to drive down China sourcing costs.

Strategic aspects of sourcing

China is now one of the biggest markets for many products, from mobile phones to PCs and cars, and yet many foreign firms fail to realise that Chinese consumers can have markedly different preferences to westerners, with cultural differences in consumption and purchasing habits.  For example, the appearance of a mobile phone on the Chinese high street is just as important as its function.  Sourcing from China can help companies to better understand these inclinations, giving overseas firms key market intelligence on local product buying trends.

A partnership mind-set

The supplier-customer relationship is evolving rapidly for both sides, as the dynamics change from a one-way to a two-way partnership. We have seen Chinese suppliers becoming distributors of western products across China, whilst Western customers have turned into buyers, extending their role to become resellers in their home market for their Chinese suppliers. In other cases, Chinese suppliers have bought patent rights from their Western customers for use in Chinese and other selected markets, and sometimes even sell foreign products under their own brands.

To benefit from these changes, Western companies should design a three-step strategy: they should aim to secure alliances with reputable Chinese manufacturers, they should develop a long term partnership-oriented engagement model, and they should look to invest in upgrading their Chinese suppliers’ technology and management skills. Then the Chinese market will be there for harvesting, in terms of both cost reduction and revenue generation.




Ting Zhang is Founder and CEO of China Business Solutions, a leading UK consultancy dealing exclusively with the Chinese market.