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Time To move on?As the Chinese economy and supply base movesinto its next stage of development, founder of iPROSolutions, Martin Deas, asks is the party over ?

For 25 years, China has

been emerging as the

factory of the world and

buyers have enjoyed

cost reductions that

would never have been

possible in the West.

Buyers in

manufacturing sectors

have had it relatively

easy for the last 10

years. China has become a manufacturing superpower, new

suppliers have entered the market, cost reductions have been

plentiful and despite the challenges of managing suppliers

globally, the cost of materials, assemblies and finished products

have dropped dramatically.

Over recent years there have been skirmishes between China,

Europe and the USA over claims of unfair trade, an under-valued

currency, products being dumped at unfair prices and poor

quality. On the whole though, Western Governments have been

powerless to halt the low cost sourcing revolution and the east

coast of China has become the factory of the world.

As with Japan some years before, exports of low technology

products initially created growth, but as the cost of land and

labour increased, and as skills and prosperity increased,

competitiveness reduced, forcing businesses to seek new

markets in higher technologies.

Gradual erosion of labour cost competitiveness is now

underway in China. Despite the inevitable trend that will move

China from low technologies to higher technologies, with its vast

population, China is not about to run out of a plentiful supply of

cheap labour. China largely remains a poor country with 700M

people continuing to live in the countryside and 155M people

surviving on less than $1 per day. China will have a massive

supply of cheap labour for decades to come.

The shift up the technology ladder is also beginning in China.

Inflation, land prices and labour rates are all rising and while

China will have a massive supply of cheap

labour for decades to come

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extremely competitive

conditions remain, the gap

in costs between East and

West are slowly narrowing.

The effects are beginning

to show and China’s share of

low end manufacturing such as

textiles may have peaked and is

now declining.

A changing market

Just because Buyers are experiencing higher costs from their

Chinese suppliers, the drive for ongoing price reductions has not

stopped. The opportunities for cost reductions of 20 to 30 per cent

are, however less available than before. If prices are increasing or

cost reductions are harder to find, then strategic thinking is

needed to maintain the drive for cost or price reduction.

Looking at the past 10 years we can see that savings of 25 to

30 per cent have been achieved. Chinese suppliers have also

been targeting growth, so have been willing to give year-on-year

price reductions in response to regular price negotiations and

higher volumes. But will this continue and what market

conditions are buyers facing? iPRO has identified five key

influences on prices in China.

1) Labour rates

Wages have increased 30 per

cent over the last 24

months and 20 per cent

in the past 12

months. The

majority of China’s

thirty-one provincial

regions increased

minimum wages by over

21 per cent in 2010 and in

Shenzhen a further 13.6 per cent increase was implemented

in February 2012. Minimum wages in Guangdong province are

equivalent to approximately £110 per month, while in Beijing,

it's around £96 per month. Even after these increases,

compared to the West, wage costs in China remain low.

Rising wages not only reflect increasing food and energy costs,

but also a shortage of labour in specific regions. Businesses may

eventually have to relocate to the West and North to secure a

continuing supply of low cost labour.

2) inflation

Prices increased an average of 4.2 per cent per annum between

1994 and 2010. Suppliers have shown little hesitation to

increase prices and will often walk away from business if p44

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the numbers don’t stack-up.

3) Raw material prices

Although largely comparable

to the West, raw material

prices cannot be regarded in

the same way as in the West.

Labour costs are a much lower

part of the product price so

raw material becomes more

important. Chinese suppliers are therefore more likely to look

for lower priced materials as a way of reducing costs. Raw

materials are not free from Government influence, and the

local market price is often different from the export price.

Buyers must be aware of these differentials if they are to

manage costs over the long term.

4) exchange rate

As China becomes stronger economically, the calls for China to

address an undervalued currency become louder. Such is the

competitiveness of China that buyers have been able to absorb

adverse currency swings of 24 per cent RMB to UKP since 2002

and almost eight per cent in the last two years. The same is true

of the relationship between the RMB and

US Dollar. As the RMB grows stronger

however, buyers need to be aware of this

creeping into higher prices.

5) Chinese export tax rebate policyAll goods produced in China are

subject to VAT and in the tax rebate

programme, the Government pays the exporter a

partial VAT rebate, which can be used to reduce the price to

the customer or to increase profits. Over the past few years

the Government has increased the export tax rebate in

product areas where they want to increase exports and

reduced it where there has been a plan to reduce exports.

Buyers need to be aware of how export rebates operate, as

some suppliers do not include these in quotations, preferring

to keep higher margins.

While China continues to offer massive opportunities, buyers

may no longer find cost reductions to be at their former levels.

A sourcing shift to other emerging economies is an option.

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