Changing business landscapes – new routes to success

China’s economic growth tumbled to its lowest rate in more than three years last month. The world’s second-largest economy grew 7.4% in the three months ending in September 2012, down from the previous quarter’s 7.6%. This was the lowest growth for Beijing since the first quarter of 2009. The Chinese economy has been stumbling for months, due largely to government lending and investment controls imposed to cool an overheated economy and inflation. However, the downturn worsened sharply last year after global demand for Chinese goods plunged unexpectedly.

China must boost its productivity if it hopes to achieve sustainable growth in the face of rising labour costs in the long term.  The average labour cost in China has nearly doubled in the past five years, going from less than 25,000 yuan ($3,960) a year at the beginning of 2007 to more than 40,000 yuan a year in 2011. Commodity prices in China have increased 51% in the last five years, and energy prices were up 77%.

Economists have long warned that China may soon be reaching the so-called “Lewis Turning Point“, where the rural surplus workforce dries up and wages begin to soar – a phenomenon identified by the economist Arthur Lewis in the 1970s from research done on the economic history of Japan, which showed that rapid urbanization led to a growth in manufacturing, which in turn brought faster economic expansion, as has been seen in China.  However, eventually, the phenomenon comes to an end as wages rise and the country’s competitive edge disappears. According to a survey of more than 200 multinational companies in China, 85% of respondents said they could only pass less than a third of their own rising costs onto their customers.

With a majority of Chinese enterprises struggling to cope with low production levels, rising labour costs, outdated management methods and changing demographics, Chinese firms having been looking looking for methods of retaining their competitive advantage; one of which is labour substitution. More and more Chinese companies are buying industrial robots, in effect transforming themselves from dependents on manpower production to stewards of what they call “intelligent manufacturing”. In what amounts to a new phase in the evolution of Chinese manufacturing, the impact of automation on production lines could help to prevent price inflation and put a halt to a growing, although still small, trend of reshoring; when companies move manufacturing operations that were outsourced  back to their own country. The Boston Consulting Group  released a report in May 2011, predicting that manufacturers would flock back to the US over the rest of this decade as labour cost rises in China “erase the savings of offshoring”.

The International Federation of Robotics has predicted that by as early as 2014 China will become the world’s largest market for automatons. The IFR report said there were 74,300 operational robots in China at the end of 2011, up 42% from 2010.

The labour shortage is likely to worsen because China is ageing fast. Less than 20% of the population is under 14, down from almost a quarter a decade ago, according to the World Bank. Automation and robotics are increasingly seen as a way to keep China’s industrial base competitive, and are emblematic of a new industrial revolution in China driven by the changing nature of the labour force: the three-decade-old one-child policy has led to a shortage of labour; competition for workers is so fierce that employers have had to dole out raises in the high teens annually to retain them. China is now facing a challenging situation, as the dependency ratio of the population will begin to rise in 2013 and its demographic dividend will begin to vanish in 2030 when the proportion of working-age people equals the proportion of old and young in the whole population.At the end of 2011, there were 185 million senior citizens at or above the age of 60, accounting for 13.7% of the total population. The proportion is expected to reach 16% in 2015, 20% in 2025, and more than 30% by 2050, when there will be more than 500 million people aged 60 or over. The disappearing demographic dividend will increase labour costs further.

According to the Ministry of Commerce, the average wage of a manufacturing worker on the east coast of China is now more than 400 U.S. dollars a month, but in Vietnam, wages are just 160 dollars a month – and in India, just 100. The minimum wage in Vietnam’s capital, Hanoi, is 2 million dong ($95) a month. By contrast, in China’s cheapest province for manufacturing, Jiangxi, in the nation’s poor interior, monthly wages are around $137. So expensive has China become, that even Taiwan is starting to look attractive again.

This increase in production costs  has led many foreign companies to shift production out of China. This year, Adidas shut down its factory in Suzhou, in favour of cheaper labour in Myanmar. Footwear giant K-Swiss also increased its production outside of China, with more factory lines in Vietnam. However, Albert Ng, Chairman of Ernst & Young China, believes higher wages are a good thing for China, because rising labour costs is a sign of a society’s development

Bangladeshi clothing exports to China jumped to more than $100m last year, from $19m a few years ago. According to Chinese media reports, Vancl, China’s largest online clothing retailer, has already shifted a portion of its shirts and casual trousers orders to Bangladeshi factories. Meanwhile, western fashion brands such as Ocean and H&M are also making clothes for Chinese customers in Bangladeshi factories.

U.S. manufacturing has experienced a resurgence largely centered on rising labour costs in markets such as China as the key driver of re-shoring back to the U.S. However, a new PwC US report, A Homecoming for U.S. Manufacturing?, reveals that while rising labour costs are part of the story, a range of factors – including transportation and energy costs and protecting the supply chain – could drive a sustained manufacturing renaissance in the U.S. beyond any cyclical recovery, potentially improving investment, employment, production output and research & development (R&D).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

IB-style questions

1. Define the following terms:

  • Demographics
  • Productivity

2.  Explain why The Boston Consulting Group is predicting that manufacturers would flock back to the US over the rest of this decade.

3.  Analyse the implications for marketing, human resource management and finance that arise from Chinese companies deciding to automate production lines.

4.  Discuss the advantages and disadvantages for Western companies of outsourcing production to China.

Sources:

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