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China’s global competitiveness hit by seven hammers

There have been many articles recently written with attention-grabbing headlines about major economic changes within China, which are affecting the global competitiveness of China’s auto supply base. I call these influences the “7 Hammers” on China’s global competitiveness directed to the suppliers exporting products to international auto OEMs and their Tier 1s.

I will first explain the 7 Hammers briefly, including some comments from Chinese company presidents. Then I will comment on the impact they may have on future sourcing strategies at major international OEMs and their Tier 1 suppliers.

RMB appreciation

The RMB’s 16 percent appreciation in the last three years is having a profound effect on companies deriving much of their revenue from export. While nearly all the costs of making their products in China are rising, the revenue received in RMB terms, continues to drop by 5 percent or more per year.

Most customers do not like granting price increases of any kind, but the major OEMs are beginning to acknowledge that a 15 percent exchange rate swing is a lot to expect any supplier to absorb. Therefore, these OEMs are beginning to develop currency adjustment policies. Suppliers would still like quicker adjustments than the OEMs are willing to give but at least customers are opening up to negotiations on the topic.

European customers, paying in US$s, are more willing to grant price adjustments because Chinese products have become cheaper as the US$ to Euro has dropped in value 20 percent during this same time period.

Raw material cost-rise

Prices of major commodities and raw materials continue to increase at a double digit pace over the last several years. This is a global phenomenon and therefore, nearly all automotive customers have developed periodic automatic adjustments to the contract price based on a pre-established formula.

The cost of steel in China is slightly higher than the global market price because of huge domestic demand and requiring imported raw iron material. The cost of aluminum tends to be a bit lower because of the local source availability.

Change of VAT refund policy

Effective in 2008, the 12 percent duty refund for certain exported As-Cast (or As-Forged) products has been eliminated. There was so much export demand for raw casting and forgings that it was impacting domestic availability. This 12 percent hit effectively makes those targeted “low value added commodities” non-competitive globally. Fewer contracts for these types of products will be awarded in the future and some, but not all, of the existing business may move to new non-Chinese sources in the future.

Annual salary expectations

Employees are feeling the pinch of inflation on housing, food and grocery cost appreciating 10-17 percent per year. They expect comparable wage increases to offset these rising costs. With domestic growth so great, if they do not get what they expect, they could easily move to a factory down the street for a little more money.

High employee turn-over requires retraining and short term staffing shortages often results in quality mistakes.

The search for good strong middle and upper management staff is keeping recruiting agencies extremely busy. Finding and retaining those employees is becoming a challenge.

Companies have to be creative to inspire commitment from their key staff members, beyond just pure salary. Incentives are beginning to be offered to lure and retain outstanding performers such as housing and car allowances, loyalty bonuses, 20-40 percent relocation cost subsidy, education assistance, talent development and career planning sessions and outside of China assignment opportunities.

Needless to say, to be on top, in this highly competitive market, the better Chinese companies need strong, capable staff. The cost to retain that staff, both hourly and salaried, is rising annually.

Staying on the subject of finding and retaining good capable staff, I have an excellent quote from a Honda executive at a recent conference in Guangzhou: “We came to China not because of the low cost labor force, but because of your huge talent pool; to pick the very best, and train them for our team.”

Your employees are your company’s greatest assets. In China, you have plenty to choose from. Pick the very best. Do’t settle for less. Train them, inspire them, challenge them, and then you will keep them.

New labor law

The biggest impact to the bottom line of pure Chinese companies this year has been the new China labor law. This requires companies to pay for overtime, full social benefits, and makes dismissal more difficult than in the past. The amount of compliance in the past varied greatly.

This is a fair and good thing for the Chinese workers, who often have moved away from their families in the countryside to improve their income. The effect on the company’s financials, however, is as much as another 20 percent increase on their true labor costs.

China’s labor costs remain significantly lower than most Western counterparts, but against new low cost country competitors, China’s labor advantage no longer is significant.
Environmental regulations

Now all Chinese companies are being audited for compliance to the stringent emissions and waste disposal requirements. China’s uniformly applied green environmental policies will have an impact on the affected companies.

Oil price

With oil exceeding $140 a barrel, one of the carriers to an international OEM is raising their rates 13 percent this week. There are concerns that the cost of transportation from China to Europe or the U.S.A could double in the next two years. This questions whether globalization is still viable.

Sea freight is between 20 percent and 50 percent of the cost of getting products from China to Detroit, so it will have a greater impact on the cost of large bulky products. If oil costs continue to rise, the land transportation cost from Mexico or California, which are basically the same, will rise significantly as well. Better utilization of sea containers, which today typically are only 70-80 percent full, and changes in packaging especially for retail products, will free up enough space to reduce the increasing oil cost’s affect on the ocean freight portion.

Several logistic companies still are worried about enough ships and sea containers on this side of the world to meet the demand for exports from China, to the U.S.A, later this year.

I visited many companies in April and May and listened to the presidents explain their current state of affairs. They all reported they were extremely concerned that their margins have been eroded significantly. I asked what they intended to do. And they came up almost unanimously with the following solutions: cut spending, better utilize existing staffs (both hourly and salaried), reduce scrap, get lean (although a few admitted they were not exactly sure how to do it), talk to local governments and ask their customers for a price increase.

The author is Global Sourcing and Supplier Development Manager of the PAC Group based in Troy, Michigan.

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