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China’s Supply Chain Rocked by 13.6% Labor Cost Increase

January 31, 2012 By 2 Comments

Asian drill press operatorThe supply chain in China, including thousands of mainland factories, is reeling from a 13.6% increase in the minimum wage, as reported yesterday by CNBC. As a result, the lowest salary is being pushed up to 1,500 yuan or $240 per month. The increase was caused by a series of strikes that occurred around the Pearl River Delta, a major Chinese industrial center.

Chinese export manufacturers in the Hong Kong area expect that the increase will result in the downsizing—or complete closing—of 1/3 of Hong Kong’s 50,000 factories in China. These suppliers are critical links in the supply chain that stretches all the way from China to Europe and the U.S.  In addition to the wage increase, another reason for the anticipated decline in Chinese production relates to the general downturn in global economic activity.

The gap between U.S. labor costs and Chinese labor costs is narrowing. In fact, a recent article in the New York Times described how GE is bringing back jobs to the U.S. at GE’s Appliance Park in Louisville, KY. In return, the union agreed to a two-tier labor structure, where the U.S. employees who are hired will be paid $10 to $15 per hour less than what the current union workers are making.

Let’s do the math.  The offshore jobs that are being backsourced to GE’s Appliance Park will result in U.S. workers making between $20,000 to $38,000 per year. The workers in China, who will receive the 13.6% increase in their minimum wages, will be making $2,880 per year. Thus, G.E.’s workers will be paid approximately 700 to 1,300 per cent more than their Chinese counterparts.  Jeffrey Immelt, GE’s CEO, is spearheading the U.S. government’s campaign to bring jobs back to the U.S. Are these new, Appliance Park jobs being brought back because of lower labor costs? Or, are political factors affecting the decision?

As discussed in an interview with a U.S. manufacturing executive who lived in China for 13 years, global manufacturers who are looking to minimize their labor costs are locating factories in Viet Nam, not China.  This strategy—chasing every cent of labor savings—requires rejiggering the supply chain every few years. Vietnam’s minimum wage is only US$85 per month (or $1,020 per year). Thus, Chinese workers are paid 282% more than Vietnamese workers. 

Although the labor differential gap between the U.S. and Asian countries is narrowing, it is still significant. Offshoring will continue to be attractive to firms with products that have

  • High labor content
  • Large Production volumes
  • Low variety
  • Low transportation costs

Products that meet these criteria—such as electronics assembly—will most likely never return to the U.S. Furthermore, in certain industries—for example, in computer and cell phone production—most of the companies that comprise the supply chain are situated in Asia.  Given this reality, moving production to the U.S. would be uneconomical. In these industries, hoping for backsourcing to happen is like waiting for an airplane to touch down that is simply not going to land [on U.S. shores].

In conclusion, the key determinant in terms of where to produce is based on total cost, not just labor cost. One must begin by looking at the manufacturing process to determine where the most economical location is. Although China’s increase in its minimum wage is significant, it is just one of many factors to consider.

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What do you think? Is there a future for manufacturing in the U.S.? Given the labor differential between China and the U.S., do you think that we can still compete?

 

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The Price of Your iPad Is Higher Than You Think

January 26, 2012 By Leave a Comment

There is a glaring lack of ethics in terms of Apple’s supply chain management practices, as suggested by the New York Times.  Many Asian suppliers are violating basic ethical principles. Here are some of the questionable practices cited:

  • Horrendous occupational safety violations
  • High suicide rates due to stressful working conditions
  • Long working hours:  repetitive 60-hour, 7-day weeks
  • Employment of children as young as 15 years-old

Although Apple has responded to problems in its Asian supplier base by conducting supplier audits, the worlds’ largest company—in terms of stock market value—has been reluctant to put its foot down.  The fate of a 22 year-old college graduate, Lai Xiaodong, is a case in point. He moved to Chengdu in southwest China to take a job at Foxconn, an electronics supplier that employs 1,000,000 people. He was quickly promoted to oversee a team that polished iPad cases. This process Chinese Factory with Chimneys Apartments Gansu Province, Qinghai, Chinagenerated dust, which is a known safety hazard.  Mr. Lai and 3 teammates died from a ghastly explosion, which also injured 14 other workers.  After the accident, which seared 90% of Mr. Lai’s body, Apple contacted “the foremost safety experts in process safety,” and assembled a team to make recommendations to prevent future accidents. In December, 2011—7 months after Mr. Lai was killed—another iPad factory exploded due to aluminum dust.  As a result, 59 workers were injured; and 23 hospitalized.

I was initially shocked after reading about the story of Mr. Lai, and Apple’s apparent lack of commitment to correcting poor worker-safety practices. Although allowing unnecessary accidents—resulting in worker injuries and deaths—cannot be condoned, we must take a more nuanced view regarding Apple’s predicament, from both a historical and cultural perspective.

In a supply chain management class that I recently taught, we discussed the ethics associated with the use of child labor in developing countries. One of my students grew up in India. He indicated that poverty in India is severe, and compulsory education is not mandated by law.  To survive in this environment, some families require that their children work. Were we to impose our ethical values and prevent children from working in Indian factories, we would be depriving Indian families of sorely needed income. It is easy—but wrong-headed—to believe that our ethics and moral values are superior to the moral values held by other societies.

The reasons against using child labor are not moral as much as they are practical ones. It is bad business to permit children to build Apple’s products, if young people are simply being used as a means to an end.  Consumers in the west will no longer think that it is “cool” to own i-Phones, if they have been built by Chinese teenagers.   How many parents would want to be part of a 21st scene, taken from a 19th century Dicken’s novel?

In Viet Nam, Nike has implemented an innovative solution to this dilemma.  Although some of Nike’s Vietnamese suppliers employ children, they also provide employees with a regular wage, free or subsided meals, free medical services and training and education. Nike, as well as western consumers, benefit from low labor costs. At the same time, the workers improve their standard of living and also receive access to education.

Regarding the various safety issues that were described by the New York Times, one has to put them into a cultural context. I recently interviewed an executive who lived in China for 13 years, setting up factories and growing American businesses. During the course of our conversation, he made the point that public safety is non-existent. When walking down the street, you have to always be on the lookout for possible hazards. There may be a big hole in front of you, which is not blocked off with barriers. Or, there could be an electrical wire dangling at eye-level. If unaware, you could walk right into it. If a lack of public safety is the norm in China, how can one expect the private sector to be any different?  Would we be correct to impose our ethical standards—as relates to public safety—onto the Chinese?  Specifically, should we preach that barriers should be placed in front of Shanghai’ s sinkholes?

Getting back to Apple, from a business perspective, the company must enforce strict, safety practices for all of its suppliers; otherwise, more articles—such as today’s scathing indictment in the New York Times—will appear, tarnishing Apple’s brand. Only by adding teeth to Apple’s supplier responsibility reports and recommendations, will the company avoid future, public relations disasters.

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In conclusion, with global competition, superior supply chain management results in consumers receiving products at low prices. But our western ethical tastes are repulsed at stories of worker abuse. Apple must take strong, corrective measures against suppliers who use workers solely as the means to an end, namely, achieving low, production costs. In supply chain management, good ethics makes for good business.

 

 


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Supply Chain Management in China

January 23, 2012 By 6 Comments

Interview with James L Waite who set-up factories and grew American businesses in China

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Interview by TIMOTHY M MOJONNIER

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You lived in China for 13 years. When did you live there?  I arrived in January 1997 and returned to the U.S. in November 2010, with occasional trips back to the U.S.  During my time in China, I spent 8 years in the Shanghai area, and the balance in the south, Guangdong area.

What was it like living in China for all those years? What were the biggest challenges in adapting to the local culture?  Initially, my wife and I felt uncomfortable going into the streets, and shopping by ourselves. Because we were foreigners, the prices were higher and the Chinese way is to negotiate for everything. We also had to acclimatize ourselves to being long term expatriates (expats). Most expats typically live in a country for 2-3 year assignments. Since we lived in China for over a decade, we always had to make new friends. In addition, dealing with a translator was a challenge, because the translator would just translate the words, but not the meaning.  Furthermore, the Chinese do not always speak their mind, and they do not speak directly.  After being there several years we were able to understand the meaning of Chinese conversations. We also learned how to communicate basic things and feel comfortable shopping in local open air markets and moving with the flow in the crowded streets. In conclusion, once we got over the initial shock of living in a different culture, we realized that the Chinese are a warm people, who enjoyed being around Americans, in part because it provides them with an opportunity to practice their English. Chinese business people are all educated and very smart. It was a pleasure working with them, and we have developed many friends who visit us when they pass through Chicago.

What did you do before you lived in China?  After graduating from the university, I worked in the Chicago area for 7 years in construction and design engineering. Later, I held manufacturing management positions such as V.P. Manufacturing and General Manager. I was employed in industries that produced air pollution control equipment, pumps, industrial testing equipment, laboratory testing equipment, etc.

What did you do during your stay there? I had three primary engagements. First, I managed a joint venture between an American ball valve manufacturer and a Chinese company. The assignment entailed overseeing the relationship between the two organizations as well as running the business. Second, for Sloan Valve Co., a global manufacturer and distributor of flush valves and faucets for high end commercial buildings, I developed a business plan that described a strategy to enter the Chinese market selling American products in the China market. The plan was funded, and I started up the operation in China, where I worked for 6 years. Third, I worked for Weber-Stephens, establishing a supply chain management company. The focus was on finding suppliers, qualifying suppliers, and monitoring their performance. I traveled to many places in China for all 3 companies, and gained an understanding of what products are made in various locations and the Chinese customs to do business.

Given ever increasing levels of inflation and local labor rates as well as the appreciation of the Renminbi, is China still an attractive country to outsource production to? If so, why?  $1.90 per hour is the highest Provence minimum wage (Guangdong Providence), which includes all of the employer costs to put an employee on board. However, the City of Shenzhen recently announced increases for the minimum wage effective starting Feb. 2012 = $2.17/hour including burden. Skilled Chinese workers can command more. Still, outsourcing work to China provides a manufacturer with significant labor savings, but you need to have the correct strategy for why you are doing business in China. Companies trying to penetrate the local market have the best opportunity. The Chinese like western products; they desire the things and life style we have. Look at Apple’s phones; they had a sale on their latest model and the demand was so great that they cancelled the sale, and shut shops down. Demand for these types of products is unbelievable. But outsourcing labor-intensive work to China—while developing channels to enter the local Chinese market—is not an easy thing to do. However, the return can be great. Finally, if you are only focused on reducing labor costs, then outsourcing work to places like Viet Nam may be a better option. However, this strategy involves chasing a few cents savings and moving to new factories or new vendors every few years.

What are the main challenges associated with running a business in China? That’s a big question. It depends on whether you are just sourcing components from China or making product for the local Chinese market.  If you are only manufacturing and exporting, then quality is especially important. Also, retaining good employees is always a challenge, especially given wage inflation. Pirating good employees is an issue. You need to have cultural sensitivity, understanding what people expect from an employer. Having a first-rate Human Resources policy and activity is important in order to retain good employees. Also, it is very difficult for small manufacturers. The Chinese think that bigger is better. They believe that it is better to work for a big company, which is especially an issue when dealing with the government. The bigger the company, the greater the likelihood that officials will work with you. If you are a small guy, it is difficult to attract their attention.

What are the main opportunities associated with running a business in China? For the years 2007, 2008, and 2009, the American Chamber of Commerce in Shanghai and Booz & Co. conducted a survey of about 1,000 manufacturers to understand why they came to China. The following is a list of the major reasons, ranked from most important to least important:

  1. 83%:  Access to the local Chinese market
  2. 66%:  Labor cost savings
  3. 51%:  Access to the broader Asian market—having a business in China provides you with
    the ability to export to other Asian countries without import duties
  4. 44%: Material savings
  5. 41%: Strategic move against key global competitors

In November 2011, you returned to China for a month. How have things changed since you were last there? Previously, China put a lot of effort in infrastructure projects, but at the time I left, there was a downturn in this activity. I was surprised to see a great amount of construction still going on. Housing prices are finally coming down, enabling the middle class to buy their own apartments.  Business in general is just booming; people are busy, hustling, you can just feel the energy in the streets. You don’t feel that here [in the U.S.] at all.  Nevertheless, the Chinese business people are concerned. Previously, the economy was growing at a 10 % clip, but it has slowed to 7% projected GDP growth in 2012. However, the government is committed and will make the 7% growth happen. Inflation has increased, and there is concern about an anticipated leadership change in the highest levels of government.

What does your firm do?

Ops-Asia helps businesses to be successful in Asia and/or the U.S. We focus on small to mid-sized companies that don’t have the resources to do this type of activity. The primary market segments served are industrial products, building materials, household appliances & automotive components. We assist firms in 4 areas: business development, operations competitiveness, project management, and supply chain management.♦

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James L. Waite is President of Ops-Asia, which has offices in Shanghai, China and Northbrook, IL

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Reducing Risk in The Automotive Supply Chain

March 18, 2011 By 18 Comments
Earthquake and Tsunami damage-Sendai Port, Japan

Aerial View of Devastation of Sendai, A Major Japanese Container Port (credit: DigitalGlobe, http://www.digitalglobe.com/)

The effects from last week’s earthquake and  tsunami and the ongoing nuclear crisis in Japan are beginning to disrupt global supply chains. Yesterday, it was reported that GM had to halt production of vehicles at several plants, due to parts shortages from Japanese suppliers. Toyota has suspended production of parts in the mother country that were intended to be shipped overseas. Finally, most Japanese automotive assembly plants remain closed (source: HIS Automotive)

The automotive supply chain is as complex as it gets. There are approximately 20,000 parts in a car, and if only one of those parts is unavailable, then the finished product cannot be shipped. At the top of the pyramid are Tier 1 suppliers that furnish major components, such as engines, that go into a vehicle platform. The Tier 2 suppliers furnish the parts that the Tier 1 suppliers require, such as the piston rod assembly that is part of the engine. As shown in the following schematic, there are typically 3-5 levels in the automotive supply chain, which is comprised by 1,000s of suppliers:

Supply Chain Management Structure for the Automotive Industry

THE AUTOMOTIVE SUPPLY CHAIN

Japanese companies produce many of the components that all OEMs require. For example, the transmissions for the new Chevrolet Volt plug-in-hybrid are sourced from the Land of the Rising Sun. In addition, Japan is a major source of electronic components, furnishing many of the over 30 microprocessors that are found in a typical car. The art and science of managing such a complex global network, spread out over dozens of countries, is challenging even under the best of circumstances. But the Tsunami’s external shocks to the global supply chain are testing the mettle of even the strongest producers. For example, supply chain management at Honda is being stress tested, given that at least 113 of its suppliers are located in the affected areas. As of Tuesday, it had been unable to establish contact with more than 40 of them (Source: Automotive News).

Furthermore, many Japanese components are transported by container ships, which take 30 days to reach U.S. and European docks. So, it is likely that many problems will show up a month in the future when automakers run into parts bottlenecks.

But more than meets the eye is at work here. As reported in Industry Week magazine, the dominant operations strategy of US manufacturers has been Just-in-time (JIT) inventory control or lean operations.  Although producers have benefited greatly from these approaches, this latest disaster sheds light on JIT’s inherent risks.

For example, well-functioning JIT systems operate with less inventory, because inventory—in excess of what is needed—is wasteful. Another implication of JIT is reducing the number of suppliers for each component, which results in significant economies of scale. Some firms have reduced the number of suppliers to sole-sources of components. For instance, Somic, a Japanese firm, made all of Toyota’s steering linkages.

But when a critical supplier is unable to produce material, the entire system breaks down.  For example, several years ago a fire broke out in Aisin Seiki, a supplier that produced more than 99% of Toyota’s brake valves. Most of the 506 machines used to produce the valve were inoperable. Toyota maintained only a 4-hour supply of the valve, so,  the world’s #1 car maker’s production lines quickly shut down. This resulted in Toyota losing production of 70,000 cars. But Saturday after the fire, Toyota and Asin officials summoned many of Toyota’s other suppliers, gave them blue prints, and assigned them the task of making the critical valves. Toyota was able to survive.

But the current calamity has affected not just one sole-supplier of a relatively mundane component designed for a single automotive OEM. Rather, the fate of dozens of factories in northern Japan is unknown. And these firms furnish 100s of different components for many OEMS. In effect, the scale of this current disaster is far more massive than what Toyota encountered with its brake valve.

Clearly, automotive OEMs must rethink risk mitigation strategies to deal with large scale disruptions of their supply chains. There are number of avenues open to them, including:

  1. Challenging suppliers to develop disaster plans so that they can make provisions to move to alternate sites for production, in the event that  they are unable to produce product at their main plant.
  2. Eliminating sole-source suppliers, and developing the capabilities of additional companies. Having one supplier is probably too few, but having five suppliers is too many in terms of achieving economies of scale. One strategy would be to give 80% of the work to the primary supplier, and 20% to a secondary vendor that is located in another country. Part of contingency planning should include provisions for ramping up production of the second supplier, in the event of a calamity.
  3. Analyzing where suppliers are located, and limiting the number of critical component suppliers that are geographically situated in a risky area. For example, an analysis of Volvo’s supply chain indicated “10% of their parts came from 33 Japanese suppliers, 7 of which were located in the catastrophe area,” according to the New York Times.
  4. Review insurance policies and consider taking-out contingent business interruption insurance that protects against losses relating to the inability of suppliers to deliver. Although some of the OEM’s had this coverage, the WSJ suggested that there were so many limitations and exclusions attached to their policies that claims will probably be insignificant.

In light of Japan’s deepening nuclear crisis, it is time that global manufacturers reassess the design of their networks to mitigate against risks associated with large scale disasters.  Those suppliers that do reassess their supply chains, can only benefit by reducing their exposure to the next calamity that will surely occur.

What other actions could be taken to reduce risks in the operation of a global supply network?

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