Manufacturing a Supply Chain Upheaval

Manufacturing a Supply Chain Upheaval

When a major U.S. manufacturer sent the 4,000 workers at its Chinese factory home for the Lunar New Year holiday in February, as management consultant Pilar Dieter tells it, the company got a surprise at the end of the break. More than 70 percent of the workers didn’t come back.

“Their families, their parents told them, ‘Stay here, stay home,’ ” said Dieter, a principal based in Beijing with the Solidiance consulting firm. “That left the company scrambling, without success, to keep the factory working at the previous level. But they had to shut some lines down.”

For that company and others, the experience marked an upheaval in the foundation of their factory work that has fueled China’s economic growth engine over the past decade. Rising labor costs have become an entrenched part of the new China economic story, but supply chain executives at the inaugural Journal of Commerce Shanghai Container Shipping Conference last week suggested they were seeing something deeper, a shift in the demographic and economic foundations of China’s society that is only starting to be felt in changing global trade patterns and restructured supply chains.

“The era of cheap products is gone,” said Tommy Lui, senior vice president and logistics chief for Greater China at Hong Kong-based consumer goods giant Li & Fung. “We see the era of inflation has actually arrived.

“China manufacturing costs increased by double digits last year, and will do that again this year and probably the next year. Worker wages will double from what we have been seeing, and this is actually very clever social engineering from the government of China. They are trying to bring their GDP into better balance,” Lui said.

“China is changing from being a net exporter to being a global importer. That is changing supply chains and changing trade lanes,” he said.

The growth in labor costs that was fairly modest took off in late 2009 when publicity mounted over working conditions at the huge factories run by Foxconn, the Taiwan-based outsourcing specialist that employs more than a million workers in China.

Thirty provinces, regions and municipalities raised minimum wages an average of 22.8 percent last year, according to Dieter, and wages are expected to grow nearly 140 percent through 2015. What’s more, she said, the wages have been growing the fastest not in the coastal cities such as Shanghai and Shenzhen but at inland sites such as Ningxia and Xinjiang.

“The last couple of years, labor prices have gone through the roof,” said Mark Shandley, vice president of supply chain and procurement at outsourced manufacturing specialist Flextronics. “We know of a competitor that overnight saw a 20 percent increase in salaries. You have to respond to that.”

The supply chain executives say that’s because of deeper demographic patterns. The model of building sprawling campuses with factories and dormitories, self-contained cities that draw in rural workers looking for jobs, looks to be faltering.

“Look, what we’re finding is that people don’t aspire to these factory jobs,” Shandley said. “They don’t want to live far from their families and lead that life. So businesses have to recognize that.

Sidebar: Shorting China

“Companies are moving inland. Instead of opening a factory in one location and drawing people from various parts of the country to that site for the jobs, the idea is that now you find a city that has the population and infrastructure in place and you draw workers from the local area,” he said.

For retailers, manufacturers and the logistics and transportation carriers that serve them, the shift is triggering major changes in supply chains built over the past decade to carry goods from manufacturing sites near the coasts.

“The western and central areas will be the engine for economic growth,” Yan Jun, president of Shanghai International Port Group, told the conference. “In the 12th five-year plan, economic development in western China is being given a top priority. The western GDP growth rates are targeted in the double-digits, and that means there will be accelerated development along the Yangtze River.”

The region, he said, hosts half of China’s automobile manufacturing and 35 percent of its steel output.

“The demand for logistics services in the Yangtze River area will go up, but the demand for quality logistics services will go up even higher. The links of the supply chain in this region will get even longer and more extended. The supply chains will be stretched. Consumption will be increased, and the logistics networks will be further challenged to meet this demand.”

That means new infrastructure is being planned to better connect the inland cities to the more well-known population.

Guo Xiaobei, president of the Institute of Comprehensive Transportation, a government-affiliated planning group, said China’s transportation infrastructure spending in the next five years will be greater than in the previous two five-year plans combined. The major emphasis will be on rail, most of it high-speed passenger rail, but that will free up tracks for freight rail and help bring intermodal capabilities up to world standards.

“Then we can consider things such as double-stacking in rail operations,” he said.

Those rail operations, logistics officials said, will be as important to domestic operations as to international trade.

The rising costs, they said, also mean greater buying power and ripe markets for consumer goods and electronics companies.

Daniel Yu, logistics manager in China for PUMA, said the sports apparel maker has to look hard at its sourcing, considering costs in China now are 15 percent higher than they are in Vietnam. And Vietnam benefits from participation in a free trade agreement among Southeast Asian nations that eliminates tariffs on many goods produced in the country.

That has PUMA looking beyond China for manufacturing, but PUMA also plans to double its sales in China in the coming years.

Dieter said it’s one sign of a broader change in direction and strategy. Dell, she said, recently moved several billions of dollars worth of manufacturing from China to India under a “China + 1” strategy to mitigate the impact of changes in China.

Yet the computer manufacturer is investing $100 billion in China over the next 10 years, adding service and operations centers “in order to supply booming demand in West China,” she said.

Li & Fung is building up a domestic China distribution network to meet those consumer markets. But the manufacturing in the country may be a casualty of China’s new economic revolution.

Li & Fung sells fairly low-margin consumer goods, not the high-end electronics that may more readily absorb higher labor costs in the coastal regions or higher logistics costs involved in longer supply chains. Instead, the company already is looking at alternatives, including moves to South and Southeast Asia, Lui said.

“Bangladesh is an interim answer, but it is not a long-term answer. India is the answer in the long term, but their infrastructure is not ready for this now. The real beneficiary is Indonesia, which has factories and workers in place,” he said.

And where does that chase for low-cost manufacturing end? Lui said it eventually will lead to Africa. “We are actually looking at major manufacturing sites in Africa,” he said. “This is the last place you will be able to find cheap labor in the next 20 years or so.”

For now, however, it means extracting as much cost from the supply chain as possible.

Related: Cross-Strait Trade No Longer Dire.

“We’re seeing a shorter and shorter life cycle for distribution channels,” Lui said. “Everyone is asking, how can I respond to my market faster? We are seeing more concurrent manufacturing — companies not even placing an order for goods until sales are made, even up to the point of sales that hit forecasts. Only then will they place an order with the Chinese factory.”

Contact Paul Page at ppage@joc.com.