China’s Achilles’ heel – Obstacles to Low Cost

Several issues negative to China as a solid, long-term base for low-cost manufacturing are becoming apparent:

Efficiency & Productivity: A company I’m working on is in the process of acquiring a China based digital electronics manufacturing company.  In the search for an acquisition candidate, I visited twenty-four manufacturing companies.  A large number of them were located in newly constructed 5 and 6 story manufacturing buildings.

But when asked:  “since China has large open land areas, why not build a single story building – isn’t it more productive?”

The answers:  China’s manufacturers are not concerned with productivity largely because of low hourly wages but also because some are unaware of traditional low-cost manufacturing initiatives.  Manufacturing knowledge seems backward perhaps equal to the USA’s in the 1970s.

Many owners prefer the crowded and land restricted East Coast location for their manufacturing facility because they live in nearby Hong Kong – they do not want to live on Mainland China.

There are indications that wages in China are headed up which begs the question of China as manufacturing’s best long-term, low-cost alternative.  Productivity will become an issue, but a fair number of manufacturers are locked into high-cost manufacturing plants.

Wages are certainly headed up somewhat, but the greater threat to China as a low cost alternative is that the foreign plants and quality managers are largely located on the East Coast.  It would be very difficult today to locate a plant, for example, 500 miles West of Shanghai because of:

(a) The lack of freight forwarding capability within the country.  Although China has invested heavily in infrastructure they do not have the trucking capability to deliver components town-to-town, south-to-north, etc.  There are no large, 18-wheel trucking companies in China.  Most deliveries are made in “light blue color” trucks, medium in size as are used in USA construction – e.g., a dump truck.

(b) Top quality management is not readily available any great distance from a major city.  Management will live in a remote location but the cost will be much higher and they tend to work four days per week – arrive Monday at Noon and depart Friday at Noon.  Their long-term commitment is a concern.

As wages rise, to keep China’s economic engine running at flank speed, the need will come to locate plants in more remote areas where there is higher unemployment with lower wages.

There is a near-term, simple solution to the trucking obstacle that should be explored prior to establishing a China based plant on the East Coast that would also solve the higher wage factor.

Electrical Capacity: Limited electrical power capacity.  Peak power use is Monday through Friday during daylight hours.  China has mandated that manufacturing plants must be closed two working days between Monday and Friday because electrical usage is outstripping supply, particularly during the summer months.  There is a serious electrical capacity condition in China.  It is expected to be a negative factor for the next five years.

In the summer to avoid any lost production time we selected to run our China plant Wednesday through Sunday and with plans to run late night shifts which is permitted under the rules.  However, we recently received notice that our plant must be closed on Wednesdays and Thursdays during winter months from December through March.

Terrorist Activity & Civil Unrest: Although not related to manufacturing costs, there is a surprising amount of terrorist activity in China.  A suicide bomber blew up a bus in Fuzhou City – there were two reports describing the incident.  The police said it was a farmer who was heavily in debt and had lung cancer.  Independent reports tie the incident to the Islamist insurgency that is occurring in China.

Somewhat supporting the independent reports, the US Embassy has reported that Chinese police are advising hotels that Islamic extremist elements could be planning to attack four and five star hotels.

These and other incidents have seen an intensifying crackdown on domestic dissent.  For example, China employs thousands of censors screening the emails that China citizens send over the Internet.

During my trips to China, it is quite obvious when we see the children ages 13 to 16 that they are going to be difficult to control compared to the older generation.  They are spontaneous, typical USA style teenagers, not shy, fairly aggressive.  The Chinese government will not be able to control them unless they regress to an even more closed, restrictive society.

External Demand: China is overly reliant on external demand of its production for its financial stability.  Domestic demand, while it exists, is quite low.  A meaningful reduction in exports will negatively affect China, as it requires the cash derived from its exports to sustain its large infrastructure investments.  A recession in the USA or Europe, its principal export markets, could trigger this issue and have serious consequences.


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