Several people have commented on “Moving Back to America,” a recent article in The Economist. The gist of the article is summed up in the first paragraph:
When clients are considering opening another manufacturing plant in China, I’ve started to urge them to consider alternative locations,” says Hal Sirkin of the Boston Consulting Group (BCG). “Have they thought about Vietnam, say? Or maybe [they could] even try Made in USA?” When clients are American firms looking to build factories to serve American customers, Mr. Sirkin is increasingly likely to suggest they stay at home, not for patriotic reasons but because the economics of globalization are changing fast.
Mr. Sirkin may be right for other reasons, but his clients shouldn’t heed his advice just because wages in China are rising. Instead, they should perhaps consider looking in another part of China.
It is true, of course, that higher per capita incomes are great for workers, but that they also mean higher wages for manufacturers. Greater prosperity is creating tremendous wealth in the country, but that wealth also translates into higher rents as cash-rich Chinese bid up property prices. Whether it’s wages, rents or raw material prices, China’s increasing level of economic activity is impacting costs across the board.
Within China, however, wage levels and property prices vary greatly and are highest in China’s first-tier cities like Shanghai, Beijing and Guangzhou and the coastal cities where foreign companies have tended historically to locate their operations. Competition for managers and workers is also greatest in the country’s most developed cities. High turnover of trained managers is one of the most frequently heard complaints from multinationals operating in China.
Rising costs, greater difficulties in attracting and retaining key employees and power shortages in many coastal areas may cause companies to re-think their China manufacturing strategies. But should they? Should they look at Vietnam, as Mr. Sirkin suggests?
If they do, they would do well to remember what happened in 2007. In that year, investment applications by foreign companies totaled $20 billion in Vietnam. This came on the heels of an influx of clothing and footwear manufacturers seeking relief from rising costs in China. The result was a dramatic increase in office rents and expenses. Due to this investment boom, the Vietnamese economy hit the wall in 2008. Inflation peaked at over 25 percent in May of that year, and a proliferation of labor strikes dragged foreign manufacturers into the country’s economic crisis.
Despite rising costs, there is still a strong case to be made for China. It’s easy to forget just how large China and its economy are, and the many advantages this gives to businesses. China’s huge population and economy dwarf those of other countries in the region. As compared to China’s population of 1.3 billion and its GDP of $5.9 trillion, Vietnam’s population is only 85 million and its $104 billion economy is a fraction the size of its neighbor to the north. Companies should avoid making knee-jerk reactions that they may come to regret later. Rather than heading off to seemingly greener pastures, manufacturers should instead look hard at moving operations to China’s interior provinces.
Based on my own experience of managing sales and manufacturing operations in virtually every corner of China, here are five reasons why companies should consider setting up operations in less travelled parts of the country.
Reason #1: Improved infrastructure
China’s impressive investment in its transportation infrastructure over the past 15 years now provides access to even the most remote cities and provinces. As I began to make countless five and six-hour car trips on barely passable roads to visit newly acquired factories in my early days in the country, I must admit that I began to question the wisdom of our strategy of picking the best factories, regardless of location. It seemed there had to be an easier way to build a business in China!
Hope came in the form of the hundreds of workers, picks and shovels in hand, that I saw on every trip. They were working on new highways that promised to shorten my trip in the future. At the time, I could not have imagined that China would soon make massive investments in its railways as well. I recently took the high speed train from Guangzhou to Zhuzhou in Hunan Province. Fifteen years ago, the trip would have taken at least ten hours by car and not much less by train. Today, it takes four hours by car and two hours by train.
Reason #2: Lower costs:
Other than perhaps transportation to the country’s ports, costs are decidedly lower in second and third-tier cities in the interior. Labor, land, construction, management, supplier and overhead costs are all significantly lower than in the larger, more established cities in the coastal areas. This will likely remain so for years to come.
Reason #3: Strong Local Government Support
I’m a big proponent of the “big fish in a little pond” approach to site location. In China’s smaller cities, your factory may be one of the largest and best companies to work for in the area. As a result of its importance, it will receive strong support from the local government. The party secretary and city mayor will welcome your investment, large or small, and will bend over backward to help you develop your business. This can take the form of streamlined approvals, access to bank loans, less red tape and less hassle from local bureaucrats.
Reason # 4: Lower Management Turnover
For the same reason that IBM located factories in small towns in upstate New York, locating plants in interior Chinese cities can help reduce management turnover. All things being equal, Chinese managers would prefer to work close to their immediate and extended families. If you offer attractive employment opportunities to the local residents, they will have little incentive to look elsewhere.
Reason #5: Enhanced Insight Into China’s Vast Local Market
Beijing, Shanghai and Guangzhou have more than their fair share of luxury restaurants, high-end shops and fancy restaurants. However, their high end markets represent only a small portion of the total China market. Locating at least some of your operations in less developed parts of the country will provide your company with valuable insights into China’s much larger local market.
There are, of course, drawbacks to investing in second and third tier cities in China’s interior. Outside the larger cities, English capability falls off dramatically and living conditions for expatriates can be more problematic. If a company relies heavily on foreign managers, it may be more challenging to move inland. However, this may simply make the case for localizing management even more compelling.
In the end, you need to evaluate your company’s particular circumstances in making location decisions. If you are thinking about leaving China due to rising costs, though, I urge you to re-consider. The answer may be as simple as picking up stakes and moving to another part of the country.