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In China, outsourcing is no longer cheap

Discussion in 'Political Zone' started by Doomsday101, Aug 11, 2008.

  1. Doomsday101

    Doomsday101 Well-Known Member

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    As China makes big moves to improve its environmental and labor conditions, U.S. companies that manufacture there face soaring costs.

    Fortune Small Business) -- Jason and Rodney Carr hate to raise their prices. Their Gardena, Calif.-based distributor of curtains and home fabrics, Softline Home Fashions, usually keeps its costs low by sourcing materials overseas: 100% of their raw goods and 80% of their finished products come from China. But recently, China hasn't paid off the way it used to. In the past five months, the Carrs have seen their manufacturing expenses rise 20%.

    "It's a battle every day," says Rodney Carr. "We are not going to cut salaries, staff or any other assets that are important to the company. Sometimes we compensate by raising prices, but mostly we're just eating the additional costs."

    Once the epicenter of low-cost manufacturing, China is becoming an increasingly expensive place to do business, thanks to a series of sweeping mandates introduced to pacify discontented Chinese citizens and global critics. This month's Olympics will be a coming out party 10 years in the making. Aware that the world is watching, China has intensified its efforts to clean up its domestic affairs by enacting stricter environmental and labor controls, increasing its land and commodity prices, and slashing the export-tax rebates that helped create the country's giant trade surplus.

    Environmentalists, economists and labor watchdogs praise these initiatives as critical steps in the right direction for both China and the global economy. But coupled with the falling dollar and the rising yuan, these movements have put the pinch on many small U.S. outsourcers struggling to keep up with China's rapid changes.

    Melanie Corpstein, CEO of Adorable Originals, a Phoenix firm that manufactures toys and clothing, has seen the profit margins for her line of dolls shrink since she began manufacturing them in China in 2003.

    "In this economy we are in no position to ask the customer to pay more," she says. "Though my company continues to grow, China's shift has made me closely monitor other expenses, such as how many hours my team works and how much our office supplies cost."

    What's driving the cost spike? No one change bears primary responsibility for the sharp increase, but added together, a complex web of adjustments have altered the economics of doing business in China.

    Green initiatives

    China's fledgling efforts at environmental reforms, particularly in its most industrialized and developed regions along the east coast, gained steam in 2001, when the country triumphed in its bid to host this summer's Olympic Games. As this week's opening ceremonies crept closer, other events added to the sense of environmental urgency.

    "The SARS outbreak in 2003, along with the Songhua River spill in 2005, were catalysts for a great national movement to improve the health system and to clean up the environment," says Deborah Seligsohn, a Beijing-based delegate for the World Resources Institute. Other catalysts included growing awareness of China's emissions on the world's climate and Beijing's desire for energy independence.

    The government kicked off a 5-year plan to increase the country's energy efficiency by 20% between 2006 and 2010, in part by relying more heavily on renewable energy sources: By 2020, China expects renewable energy to account for 15% of its national consumption. The plan also called for the closure of inefficient factories, particularly steel, aluminum and cement plants.

    Progress was steady, but the results were not significant enough to improve air quality sufficiently for Olympics conditions. Therefore, in addition to its long-term plan, Beijing implemented emergency measures this summer to address air pollution. Dozens of factories around Beijing were abruptly forced to halt or slow production. Some of those factories will reopen after the Olympic Games, but others are shuttered for good.

    Talk back: What do you think of China's rising costs?
    After the litany of recalls last year of flawed Chinese goods, U.S. retailers began to crack down on their suppliers' quality controls (see "The New China Price"). That pressure led to greater enforcement of safety and cleanliness rules that had been on China's books for some time.

    "Pollution was a major source of discontent among the population, but U.S. retailers were pushing for low costs. Local officials were bribed to turn a blind eye," says Andy Rothman, a Shanghai-based China strategist at brokerage house CLSA. "But now, Beijing has its eye on local authorities. Manufacturers are being more careful about obeying rules that were previously ignored."

    The Carrs know this all too well. "It's the responsibility of the importer to ensure that the product is safe, and hence, the manufacturing facility has to be up to U.S. standards," says Jason Carr. "We've had to implement improved processes for dying the fabric and disposing of the water that is emitted from the machines. We also have to carefully control the lead content in the dye solutions."

    The Carrs want to deliver clean, crisp, environmentally friendly products and packaging. During their five annual trips to China, they ensure that the factories they work with are complying with the new standards. But the new regulations come at a cost that is higher than the average consumer likes to pay.

    Adorable Originals' Corpstein oversees some production herself, making trips to China to direct 50 factory workers as they stuff and sew her company's dolls. But that isn't enough to satisfy the retailers Corpstein works with, many of whom require documented quality-control data.

    "We get certificates of compliance, which make the retailer and consumer feel comfortable about the product," she says. "But the lab tests cost thousands of dollars."

    Labor controls

    A tough, new Chinese labor law went into effect on Jan. 1, making it compulsory for employers to offer employment contracts, a social security program and overtime pay.

    The labor law was driven by internal political dynamics, such as rising public discontent over low wages, lackluster labor rights and rising economic inequality, says MinXin Pei, senior associate in the China Program at the Carnegie Endowment for International Peace. Its effects are already being felt: Numerous studies, including two recent ones by the Economist Intelligence Unit report and Booz Allen Hamilton, indicate that wages in China are rising by 10% to 15% annually.

    That figure, together with the new restrictions imposed by the labor law, has kept businessmen like Ted Hornbein on their toes.

    Hornbein is managing director of Asia operations for Richco, a Chicago firm that manufactures plastic fasteners, wire management devices and circuit-board hardware. Six months before the law was passed, Hornbein visited a Chinese labor bureau to learn about the new regulations and get advice on how to set up a labor union for his workers. But after running the numbers, Hornbein realized that complying with the labor rules would send his costs soaring out of control.

    "We were running two, 12-hour shifts every day, but the new labor law restricted how long the temp workers could be on the job," he says. "It was difficult to find enough workers to cover six, four-hour shifts. As an alternative, I replaced 20 workers who cut excess metal off the components after casting with an $85,000 machine, which has increased my capital expenditure."

    That price tag will keep going up: Hornbein has to replace the machine several times a year.

    Such incidents have Chinese authorities already reconsidering the full sweep of the changes they've mandated.

    "There's a feeling that this law might be too much, too soon," says Auret van Heerden, President of the Fair Labor Association, a worldwide worker advocacy organization. "HR is a recent discipline and the courts are starting to get overwhelmed."

    Inconsistent implementation of the law is also a problem. "Enforcement is spotty, uneven and unreliable, especially across regions," analyst Pei says. The cost of implementing the new policies is high for government agencies as well as businesses, and local governments have no incentive to enforce the policies when they can instead extort cover-up payments from non-complying local businesses.

    But even if Beijing modifies the labor law, business owners aren't off the hook. The Chinese government is currently pushing for insurance for all workers and is making more of an effort to prevent worker abuse by staging unannounced spot checks at factories. And one way or another, experts expect Chinese workers to continue escalating their expectations of better wages and working conditions.

    "The recent labor reforms are a good starting point, because workers know their rights and can sue if they are being abused," Van Heerden says.

    Commodity, oil and land prices

    Perfect Pushup founder Alden Mills manufactures his Tiburon, Calif., company's fitness equipment in two Guangdong province factories. Since moving his manufacturing overseas in 2004, Mills has seen a 20% to 30% cost jump. Perfect Pushup specializes in ergonomically correct workout-equipment handles made of metal and rubber; the rise in oil and steel prices has taken a direct toll on the company's bottom line.

    "We go through exhaustive design analysis and limit the need for costly materials, while also maintaining functionality," Mills says. "Everyone has to get creative to keep costs in line."

    While steel and iron prices have surged more than 30% since 2007, oil and natural gas prices have nearly doubled, and are hurting small businesses that now pay more for both the raw manufacturing materials of their products and to transport the finished goods back to the U.S.

    "We're being hit hard, seeing price rise every few months," says Richco's Hornbein. "To offset the price of the rubber and plastics we use, we have to make our manufacturing processes very lean and ship our inventory on an LCL [less-than-container load] basis to save on shipping and handling costs. Also, we have to investigate whether it's cheaper to import the materials on a duty-free basis instead of sourcing them locally."

    Mills takes a different approach to curbing costs. "I've come to expect steel prices to change every 90 days," he says. "So I look to buy in bulk for six months out."

    The price of land on China's east coast is also on the rise. Rents are increasing in Shanghai, Beijing, Guangzhou and Shenzhen.

    "There's less land available now on the coast," says CLSA strategist Rothman. "Beijing has set up an infrastructure with roads and transportation inland to encourage heavy industry to develop there. Inland regions have cheaper land and power - but keep in mind that the labor force is moving against that trend, migrating to the east coast."

    While rising costs for raw materials and land prices impact all business, the companies hit the hardest are those that conduct their transactions in U.S. dollars, thanks to the Chinese currency's rapid appreciation against the dollar.

    Cutting tax rebates

    Since 1985, tax rebates given to exporters have allowed Chinese products to be fiercely competitive on the international market. But over the past few years, and particularly in the past 12 months, Beijing has been axing rebates for thousands of goods across a wide variety of industries in an attempt to reduce China's trade surplus.

    China levies a 17% value-added tax (VAT), a tax on the added value of goods and services that is incurred in any exchange. The country traditionally grated exporters a full rebate on the tax. But to curb its trade surplus, China has begun reducing the VAT refunds on most items from 17% to 5%. For some goods, especially those whose manufacture is highly polluting, the refund has been eliminated entirely. Batteries, for example, first had their refund slashed to 5%, and then, just weeks ago, were eliminated completely from the rebate list because they contain cadmium - a toxic chemical that harms the environment and workers' health.

    Analysts expect China to continue using VAT adjustments as a tool for trade rebalancing - which means exporters in most industries shouldn't expect a return to the full-refund days any time soon.

    "[China] is in image-building mode," says Ron Haddock, Shanghai-based vice president of consulting firm Booz Allen Hamilton. "These efforts promote high-quality goods."

    Such moves are ultimately good for the global economy and for Chinese workers, but they're still painful for businesses accustomed to the old rules. "We feel the Chinese government's rebate slashes every time our goods leave the country," says Jason Carr. "It really impacts international distribution."

    Now what?

    The trends that are shaping China's evolution won't revert, but will progress slow after the Olympics are over? And for business owners seeking lower-cost locales, where is next? Will India and Vietnam become the new manufacturing epicenters? On Thursday, Fortune Small Business will check in with part 2 of our look at China's changing business conditions.
  2. yeahyeah

    yeahyeah New Member

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    So now they are gonna have to pay the workers a dollar an hour instead of .55 cents. :cry2:
    Please...China has gotten away with FAR too much for FAR too long. Its about time there was pressure. American corporations and their greed have only enabled it.
  3. Doomsday101

    Doomsday101 Well-Known Member

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    And consumers who buy it. Before pointing the finger at everyone else try pointing at the people themselves for a change. When there was a big movement of buy American most consumers continued to buy products where they were able to get the most for their dollar without being concerned where it came from. As for China I do think things will continue to change and things will be less cost effective for companies to continue using Chinese labor.
  4. joseephuss

    joseephuss Well-Known Member

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    Sometimes even if you are trying to buy American, you can't be entirely sure that it was a product that is solely American.
  5. Doomsday101

    Doomsday101 Well-Known Member

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    I would say the vast majority do not even bother to look, I think most people are trying to get the most bang for the buck and if that means buying something that was assembled in China, Mexico or India they still buy because people will look for the best barging they can
  6. Phrozen Phil

    Phrozen Phil Active Member

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    My 17 year old son informed me that he would not be purchasing certain clothing items, as he could not be sure of the working conditions of the people who put them together. Funnily enough, we found a suitable pair of jeans manuafactured in the country next door. Yes folks, we found Carhartt Blue jeans actually manufactured in the United States of America. In the same store, a knock-off brand at a slightly lower cost ($4.00 less)- same style, were jeans made in China, Vietnam, and the Phillipines. I was actually surprised at the relatively small difference in cost. I am pleased that he took the time to research his purchase. I am more impressed with the fact that he cared enough to think it through. Part of his education this past year was to look at "shopping ethics" and the impact of a dollar spent vs a dollar spent in the wrong place. Food for thought.
  7. BrAinPaiNt

    BrAinPaiNt Bad Santa Staff Member

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    I have a side business of selling lead to china.
  8. Phrozen Phil

    Phrozen Phil Active Member

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    Do you ship it there via .50 calibre express? :rolleyes:
  9. Doomsday101

    Doomsday101 Well-Known Member

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    Good going evidently he was willing to take the time and make a choice but I seriously doubt most people would do as your son did.
  10. Phrozen Phil

    Phrozen Phil Active Member

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    I do know that many of the teens I've met recently have been more "up" on some of the social issues and that child labour is getting some "face time" in public schools. You may be right in the view of the "average" consumer, but maybe more kids want to be better than "average".

    Personally, I look for Cotton goods that are processed in Canada or the U.S.. I find that American Cotton is generally better quality than the stuff form overseas. I'm surprised that they don't market the difference more aggressively.
  11. Doomsday101

    Doomsday101 Well-Known Member

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    I try and buy American as well. I do have a question why is Canada alright hell they own more US business than any other country in the world yet we jumped Japan when they did it but Canada gets a free ride from many Americans? It is like people who scream about getting oil from Saudi Arabia or other Middle East countries yet we buy more Oil from Canada than any other country in the world.
  12. joseephuss

    joseephuss Well-Known Member

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    Well, maybe because 15 of the 19 9/11 hijackers were from Saudi Arabia and not Canada. ;)
  13. Doomsday101

    Doomsday101 Well-Known Member

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    But they were not from China or Japan yet many American had fits over the Japanese and now with China but do not say boo about Canada.

    Also Tim McVay and his flunkies came from Mich. I don't think we stop doing business with Mich because a group of thugs killed people in the explosion in Oklahoma
  14. joseephuss

    joseephuss Well-Known Member

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    I dunno about that. More and more people keep moving out of Detroit and buying few American cars manufactured in Detroit.

    You know I am kidding around. I don't know the answer to that question. Similar to why the U.S. is willing to work with China, but keeps Cuba on the no trade list. Questions that bring up more questions and answers that are difficult to find.
  15. Phrozen Phil

    Phrozen Phil Active Member

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    The simple answer is about proximity. We occupy the same continent and have essentially the same market. In terms of Oil, you may want to consider the source of that particular commodity. Do you want it from a politically stable source that's in close proximity or do you want it from the fun zone that's the Middle East? (BTW, the correct answer is both!)
  16. burmafrd

    burmafrd Well-Known Member

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    China got a free ride from the wackos for a long time- they have been the #1 polluter since 2006 (this from the UN) and do you hear anything much about it? I would love for the wacko's to try and protest in Beijing and pull those other stunts there that they do here. Handcuff yourself outside an official building? Watch the police chop off the wrist. Throw garbage at an official? Watch the police shoot the guy. After they have beaten him to death with clubs. Stand up in a meeting and shout slogans? Spend 10 years in a really NASTY prison.
  17. Phrozen Phil

    Phrozen Phil Active Member

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    Actually, there have been a number of protests, and people have been taken away, only to re-surface later the same day. The Chinese are being painfully polite for the Olympics and are not willing to get real nasty, at least until the Games are over.
  18. burmafrd

    burmafrd Well-Known Member

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    Yeah, only while the Games are on. Watch what happens as soon as they are over.
  19. Doomsday101

    Doomsday101 Well-Known Member

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    Neither, Canada is not doing the US any favors because we are close. We have a big trade deficit with them and they are laughing all the way to the bank because no one says a word. When it comes to matter of oil I want to do exactly what Canada is doing and that the Middle East is doing and what China and India is doing Drill for our own oil!!!!

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