Toy Production and Manufacturing
in China and the Effect of Cost Increases
by Angel
Morales
As a manufacturer or trader, you may be contemplating additional markets for future production of goods. Remember back in the day when Taiwan and Japan used to be the main production hubs where millions of items were manufactured? The labor cost used to be considerably lower thus making sense to have manufacturing facilities in both of those countries. Then the relay was handed off to China. China not only ran with it but absolutely ran over the competition. No other country had managed to develop so quick and so thoroughly when it came to production of goods.
While all of this sounds great for China, things are about to change.
A lot of Chinese industries have taken a hit where it hurts: the bottom line. The consistent increase of costs in China, during the last 24 months, have driven businesses and factories in China and Hong Kong to narrow their margins to numbers that would scare away the most risky investors in the US and around the world.
The Hong Kong trade Development Council announced in September 2007 that the labor costs (wages, social security contributions, welfare benefits, etc.) had increased by some 25% during the past 2 years. Consider also the increase in the cost of utilities in provinces where a lot of manufacturing facilities have roots: increases which range from 10% during off peak hours and up to 27% during peak production hours; and add the sewage treatment charges which have increased by almost 300% and you would certainly see why looking for a new production source should be at the top of your priority list in 2008.
Still feeling confident? There’s more. The US dollar which used to be the business monetary system of the world has suffered huge blows by virtually ALL major currencies. It is as expected, the RMB appreciation throughout the last two years, which has resulted in further increases of cost. There are no signs that the US dollar will make a comeback against the very strong RMB anytime soon, which has appreciated almost 10% compared to the dollar in the last 24 months.
Before you call your Operations Manager and ask him to begin looking for production facilities in Indonesia or in Vietnam, there is more that you need to know and be fully aware of. As if the increase in labor costs, utilities skyrocketing and depreciation of the US dollar were not enough, China’s latest move to further reduce the export VAT rebates is the punch that yields the knockout. Earlier in the year China did away with the rebate issued to certain industries and now has announced that another one, even more considerable, is to be expected in the next few months. That is a total of 3 reductions in less than 24 months.
Ok, so you are already on the phone with your VP of Operations but he/she is already aware of all of this. Your VP is now telling you that there is yet another factor to consider: a very important one. The soaring prices of raw materials have hit China and Hong Kong manufacturers HARD. Metal prices have almost double in the last 24 months, while some key metals such as copper and zinc have surged to 130% and 190% respectively.
The Chinese province of Guangdong faces the largest shortage of workers ever. In 2006, a record 2.5 million workers were needed and simply were not found. This year was not any better as the numbers provided were not promising: an additional 10% in workers and almost 30% in technicians. Several provinces have been obligated to raise their minimum wages and salaries in order to attract more workers. The increase of the minimum wage in several provinces (mainly the ones with highest concentration of workers) has increased from 12% to a frightening 22%.
It is said that you should not kick a person while they are down but the Chinese government obviously does not consider a factory a person, so to prove it, local governments in China have reported to be pushing ahead to expand the welfare offerings such as implementing housing funds under which enterprises are required to contribute no less than 5% of the worker’s wages.
So, what did you tell your Operations team? Don’t put Mr. Leoneli or Ms. Martinie on tomorrow’s flight to Vietnam to explore new factories (even though Mc. Donald’s is already doing so). You certainly need to look at other Asian countries and even Latin America, which seems to offer promising quality and pricing for future production of garments, ceramics, toys, candles, etc, BUT one thing is for sure, this transition will take some time. There will be no choice but to sustain a first round increase of pricing from China, and a second one and maybe even third one. Expect a minimum of 3 major increases in 2008.
While there is no tell how much of an increase you should expect, you should not be surprised if you see increases ranging from 10-15%. While this is not enough to cover all the changes and increases outlined above, it would be unrealistic for companies in China and enterprises around the world to pass on 100% of the increases to their end users. You might have some companies that might try to do exactly that and they will quickly leave the marketplace as consumers will simply not welcome companies that try, not only compensate for the increases, but try to make additional margins of it.
This is the time to strengthen your relationships with your vendors and partners. Shop smart and work with companies that are open about their strategies of cost increases. Educate yourself about the changes to come but most importantly, educate yourself and your team about WHY the changes will occur. Don’t forget to wear a seatbelt as the ride might be a bit shaky.
