Production costs rise in China

By Brad Perriello -- Industrial Distribution, 6/5/2008 8:37:00 AM

The migration of large portions of the U.S. manufacturing base to China was largely driven by the low production costs available there. But a number of factors are combining to increase those costs, meaning the price of products carrying a “Made in China” label are set to rise.

Joe Rocco, president of contract manufacturer Eastek International Inc., tells me that several developments are contributing to the rise in production costs. Chief among them, he says, is a drive to increase the minimum wage for Chinese workers.

“The Chinese government is increasing the minimum wage to bolster the middle class [and] trying to drive domestic consumption,” Rocco explains. “The minimum wage in Guangdong Province rose 12.5 percent on the first of April.”

Couple that with changes to labor laws there that went into effect Jan. 1 and you’re talking about a further 15.5 percent increase in labor costs, he adds.

“That is a continuation of a trend over the last three years of double-digit minimum wage increases,” Rocco notes.

Another factor is the rising cost of raw materials. Brass and copper prices are increasing, meaning a concurrent rise in the price of electronic components containing those metals, he says. Other metals, especially steel, are also getting more expensive, as are thermoplastic resins. Because they are derived from petroleum products, their price is increasing as the cost of crude oil surges to record levels.

Increased demand and decreased supply also play a role.

“As both the Chinese and Indian economies demand more materials, that’s simply a question of supply and demand,” Rocco says. “For the Olympics, the Chinese government has mandated the shutdown of factories within a certain radius of Beijing and that has a had an impact [on supply].”

And that’s not all. Inflation in China is increasing at an 8.5 percent clip year-on-year, he notes, and the weak value of the dollar against China’s Renminbi currency means American manufacturers get much less bang for their buck.

“It’s projected this year that there will be an 8 percent rise [in the value of the Renminbi against the dollar],” he says. “My personal opinion is it’s going to be higher than that, partly because of the weakness of the dollar more than any Chinese government action.”

Taken together, these increasing costs create pressure on manufacturers to raise their prices in turn.

“Companies can only absorb so much of these double-digit pricing changes,” Rocco explains, adding that some of the effect can be blunted by increased productivity through lean manufacturing initiatives and the introduction of robotics into manufacturing processes.

One method that won’t work is moving to the lowest-cost supplier you can find.

“You’ve got to be careful who you select. One reaction to rising prices is to cut back and find a shortcut,” he says. “Hopefully, you select a reputable contract manufacturer [with adequate quality assurance and quality control procedures.”

At Eastek, Rocco says the company analyzes the raw materials it receives for lead content and has extensive QA/QC procedures for both incoming and outgoing products.

All in all, however, China is still a destination for low-cost manufacturing, despite the rising cost of producing goods there.

“Overall, China is still a very, very competitive place to operate. It’s just not as easy a place to operate [as it once was],” Rocco says.

That opinion is supported by the results of an April survey of 1,555 executives at companies around the world conducted by The McKinsey Quarterly.

The survey indicates that rising production costs haven’t yet reduced China’s competitive advantage; 41 percent of respondents say they face more competition from China than from any other emerging economy. Seventy-seven percent say the main component of China’s competitive edge is its low production costs.

But that edge does not extend to Chinese companies, according to the survey. Forty-one percent of respondents say Chinese firms are weaker competitors than companies from other regions, citing low product quality, marketing skills and brand strength.