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Chinas Shifting Competitive Equation


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Booz | Allen | Hamilton surveyed 66 companies belonging to AmCham Shanghai's Manufacturing Business Council and reports the interesting results in this report. It found that, due to low labor costs and high expectations regarding a market of 1.3 billion people, multinationals have tended to build export oriented factories with operating strategies based on abundant, cheap labor and distribution channels aimed at rapid increases in annual sales. The piece discusses the current state of China and its industry and looks at what is needed to build a strong platform for growth going forward.

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Chinas Shifting Competitive Equation

  1. 1. by Christoph Bliss Ronald Haddock Conrad Winkler Kaj Grichnik grichnik_kaj@bah.comChina’s Shifting CompetitiveEquationHow Multinational Manufacturers Must Respond
  2. 2. 1 China’s Shifting Competitive Equation How Multinational Manufacturers Must Respond By now, the world’s largest corporations have poured billions of dollars, yen, and euros into About the Survey China in pursuit of two basic objectives. One Of the 66 companies belonging to AmCham has been to create a low-cost manufacturing Shanghai’s Manufacturing Business Council platform that could make and export products to that were surveyed in October and November other markets. The second objective has been 2007, 81 percent were wholly owned by to create sales and distribution networks that foreigners, 10 percent were joint ventures can reach China’s 1.3 billion people, sometimes between multinationals and Chinese partners, and 9 percent were categorized as “other.” with products that are made in China but also The manufacturers’ industries included con- with goods imported into the country. In the sumer, industrial, healthcare, and materials, mind of far too many corporate strategists at with countries of origin including the United headquarters, China should be treated much like States, Japan, and several in Western Europe. any other emerging market. About one-third of the respondents had an additional major presence in China beyond But these old sourcing and sales models are coming their manufacturing footprints: More than under pressure, according to a study conducted by 50 percent had representative offices, while the American Chamber of Commerce (AmCham) roughly one-third had regional or global head- in Shanghai and Booz Allen Hamilton. The “China quarters in China (because some companies Manufacturing Competitiveness 2007−2008” study, surveyed were joint ventures with Chinese enti- conducted for the first time in 2007 and planned ties, their headquarters were considered to be annually thereafter, surveyed 66 manufacturers among in China). Other companies also maintained the members of AmCham Shanghai’s Manufacturing regional or global procurement centers, or Business Council (see “About the Survey”). It found research and development centers, in China. that, due to low labor costs and high expectations regarding a market of 1.3 billion people, multinationals have tended to build export-oriented factories with operations elsewhere in the world. Nor have most of operating strategies based on abundant, cheap labor them managed to integrate the dual functions of export and distribution channels aimed at rapid increases in platforms and domestic market penetration. The study annual sales. In neither case have multinationals, as showed that three out of four companies today lack a whole, imported the very best practices from their fundamental best practices in their China operations.
  3. 3. 2Companies that do rise to the next management we will discuss the research results in some depthlevel by integrating their export-oriented activities for before offering our own conclusions about the strategicglobal markets with their domestic market operations implications of this research for chief executive officersare achieving higher levels of profitability. The study and other corporate decision makers.showed that companies that successfully integratetheir China operations enjoy profitability of 29.6 The State of China and Its Industrypercent, on average, compared with 17.8 percent It is clear that China’s manufacturing competitivenessprofitability for those that do not. But only one out of is coming under fire: More than half of the surveyedfour companies is able to integrate the dual halves of companies—54 percent—either strongly agree or agreetheir China operations this way. with the statement “China is losing its competitive edge to other low-cost countries in manufacturing.”Multinationals will need to bring their best operationsto China and fully integrate their sales and sourc- Fortunately, the survey also revealed good news:ing functions if they hope to retain an advantage as Even if China has lost some of its edge, it is stillChina’s operating environment becomes more competi- very much in the game. Operating in China stilltive and costs increase. One of every two multination- offers huge advantages, which is why 83 percent ofals surveyed agrees that India, Thailand, and Vietnam the respondents say they have no concrete plans toare challenging China’s position because, among other move capacity from China, compared with 17 percentfactors, the Middle Kingdom’s wages and other costs who say they do. Reflecting changing perceptions,are rising and the increasing value of China’s currency manufacturers say the biggest reason to remain inis eroding its cost advantage. Nearly one in five (17 China is access to its vast domestic market (seepercent) of these companies already has made the Exhibit 1). Manufacturers also say they are reluctant todecision to move at least some China-based opera- spend the money to build new supply chains or othertions to other low-cost countries in Asia and elsewhere. infrastructure in other countries.Because we believe this is the first study to produce In fact, access to the Chinese market is now a keya statistical portrait of how manufacturers perceive reason why many companies are coming to China intheir China operations and how they are structured, the first place: Access to the local market is importantExhibit 1Respondents’ Top Reasons for Not Relocating Out of China 80% 78 14 60% 13 Percent of Votes 39 40 40% 14 29 29 3 22 51 21 14 20% 13 16 6 16 14 13 13 3 5 6 8 16 13 6 8 12 10 10 10 3 55 0% 5 5 2 2 2 5 Vast Unwilling to Constraint Unfamiliar Country- Ongoing Better Better labor Ongoing Stable domestic establish a on capital with new speci c favorable infrastructure productivity attractive tax political market in new supply expenditure business risks government bene ts situation China chain environment policy Third Most Important Factor Second Most Important Factor Most Important FactorSources: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton
  4. 4. 3 Exhibit 2 most prominent in this shift are the appreciation of the Respondents’ Key Motives for Establishing a Manufacturing Base renminbi (RMB) and inflation in prices of components in China and materials (see Exhibit 3). Other factors they cite 80% 70.8 are wage increases and poor employee retention. Percent of Respondents 70% 64.0 60% 51.7 Companies are feeling much of the cost pressure 50% 42.7 40.4 in the realm of white-collar managerial staff. The 40% 30% respondents report that they are paying management 20% staff 9.1 percent more every year and paying white- 7.9 6.7 10% collar support staff 10.3 percent more. In contrast, 0% Access Labor Access Strategic Material Access Utility blue-collar staff costs increased by 7.6 percent and to local cost to Asian move cost to cost Chinese savings markets against savings talents/ savings raw material costs by 7.1 percent. On balance, most market key global quality competitors labor companies are facing annual cost increases of more than 5 percent in wages and more than 3 percent in Source: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton materials (see Exhibit 4). At the same time that costs are increasing, China is to more respondents (70.8 percent) than is the mere lagging behind global standards in many operational use of China as an export platform, whether for world dimensions. Compared with companies’ existing or Asian markets. This contrasts with 64 percent of global operations, China scored below standards on respondents who cite labor cost savings as their major such important measures as logistics infrastructure, motive for locating operations in China and 51.7 per- trade environment, access to technology, management cent who cite access to Asian markets (see Exhibit 2). capabilities, and protection of intellectual property (see To the degree that some executives believe China is Exhibit 5). losing some competitive edge, the two factors that are Exhibit 3 Top Concerns of Companies that Believe China is Losing Manufacturing Competitiveness 75% 70.3 70.3 60% 18.5 25.9 51.8 11.1 Percent of Votes 45% 25.9 14.8 33.3 30% 3.7 25.9 11.1 18.5 18.5 15% 29.6 11.1 7.4 11.1 25.9 11.1 18.5 7.4 14.8 3.7 3.7 7.4 11.1 7.4 3.7 3.7 3.7 3.7 3.7 3.7 0% RMB In ation/ Poor Wage Sluggish Recall of Hostile trade Ongoing Poor delivery Potential Social appreciation price employee increases product Chinese policies of the concerns reliability of nancial compliance increases retention launch products U.S. and E.U. over local supply market (e.g., child readiness due to quality against intellectual base instability labor) problem China property rights Issue with Third Highest Impact Issue with Second Highest Impact Issue with Highest Impact Sources: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton
  5. 5. 4Exhibit 4 China is slightly closer to global standards when itRange of Cost CAGR Experienced by Survey Respondents comes to logistics capabilities but is still behind in 70% 67 most industries. The sector where it is most behind appears to be energy equipment. When it comes to 60%Percent of Respondents 54 electrical equipment, however, China is on par with 50 50% 45 more advanced economies (see Exhibit 7, page 5). 44 40% 37 When respondents were asked to compare China with 30% 27 other countries as a venue for relocation, it was highly 20% 18 17 significant that they cited lower labor costs in those 9 11 other countries as the largest differentiator, at 3.7 10% 6 6 6 on a scale of 1 to 5 (see Exhibit 8, page 6). 3 0 0% White-collar White-collar Blue-collar Raw material Clearly, the days of China’s being considered a management supporting staff unit cost cheap labor manufacturing platform are numbered. staff staff compensation compensation compensation Other major factors in the attractiveness of those CAGR = 0% – <5% CAGR = 5% – <9% other countries were tax benefits, the competitive CAGR = 9% – 12% CAGR = >12% landscape, intellectual property protection, and utility costs. However, there were a number of areas in whichSource: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton China was superior to the alternatives, including the size of the market, availability of supply base, andThe supply base is a crucial issue, and it’s clear that IT infrastructure. The countries most often cited asChinese suppliers are significantly less well developed possible alternatives to China were India, Vietnam,than suppliers in the United States, Europe, and other Thailand, Malaysia, and Brazil, in that of developed Asia. That’s especially true in theautomotive and energy equipment industries, and If companies have failed to thrive in China, however,slightly less so in electrical equipment (see Exhibit 6, the competitive environment is not solely to 5).Exhibit 5China’s Scores on Various Parameters Compared to Companies’ Existing Global Footprints Intellectual property protection 2.05 5 = Significantly Above Standards Government efficiency 2.46 4 = Above Standards Logistics infrastructure 2.49 3 = Neutral 2 = Below Standards Legal compliance 2.54 1 = Significantly Below Standards Environment sustainability 2.56 Trade environment 2.58 Access to technology 2.63 International logistics Infrastructure 2.71 IT infrastructure 2.71 Currency stability 2.74 Management capabilities 2.74 Ease of financing 2.78 Labor quality 2.84 Availability of supply base 2.93 Readiness to best practice 3.00 Below Neutral Above Standards Standards Average ScoreSource: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton
  6. 6. 5 Exhibit 6 Comparison of Supply Base Quality across Geographies 5.0 5 = Strongly Positive 4 = Positive 3 = Neutral 2 = Negative 4.5 1 = Strongly Negative Average Score 4.1 4.0 4.0 4.0 3.9 3.9 3.9 3.8 3.8 3.8 3.7 3.6 3.5 3.5 3.5 3.5 3.4 3.4 3.4 3.4 3.3 3.1 3.1 3.0 3.0 2.9 2.9 0.0 Overall Automotive Computer & peripheral Electrical equipment Energy equipment Industrial machinery China Asia except China Europe U.S. Source: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton Exhibit 7 Comparison of Logistics Capability across Geographies 5.0 5 = Strongly Positive 4 = Positive 3 = Neutral 4.5 2 = Negative 1 = Strongly Negative 4.0 4.0 Average Score 4.0 3.8 3.7 3.7 3.7 3.7 3.7 3.7 3.6 3.6 3.6 3.6 3.5 3.5 3.5 3.4 3.4 3.4 3.4 3.3 3.1 3.0 2.9 2.8 2.6 0.0 Overall Automotive Computer & peripheral Electrical equipment Energy equipment Industrial machinery China Asia except China Europe U.S. Source: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton We asked respondents about how they are deploying product flows. But they are significantly behind in best practices in their manufacturing, supply chain, network modeling and optimization, postponement and logistics operations—and found that none of the of assembly, segmenting and tailoring supply chains best practices, whether supply chain risk management by product characteristics, and statistical forecasting or lean Six Sigma, was being applied by more than 50 (see Exhibit 9). There does not appear to be a wide percent of the respondents. Their Chinese operations variation across industries in this regard: The computer, have done best in integrating their enterprise resource automotive, electrical equipment, industrial machinery, planning or manufacturing resource planning (ERP/MRP) and chemical sectors are roughly equivalent. systems, calculating their inventories, and optimizing
  7. 7. 6 Exhibit 8 Comparison of China with Respondents’ Most Favorable Candidates for Foreign Relocation Average Score of Top Five and Bottom Five Parameters Significantly Better 5 than China Five factors in which alternatives are superior to China Somewhat Better 4 3.74 Five factors in which China are superior to alternatives than China 3.48 3.36 3.32 3.26 Similar to China 3 2.70 2.68 2.65 2.45 Somewhat Worse 1.96 2 than China Significantly Worse 1 than China 0 Labor Tax Competitive Intellectual Utility Availability IT Market Logistics Size of costs benefits landscape property costs of supply infrastructure growth infrastructure market protection base Source: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton Exhibit 9 Extent to Which Respondents Apply Best Practice Levers to Existing Operations in China 100% 11 11 9 11 12 13 12 90% 20 18 27 30 27 15 33 80% 22 18 20 40 30 22 26Percent of Respondents 70% 23 25 18 60% 18 35 30 19 27 11 22 50% 33 28 40 40 40% 34 34 20 28 35 40 30% 38 31 36 35 20% 29 28 20 16 16 16 18 10% 21 16 11 16 11 7 7 7 2 4 7 5 7 7 2 0% Integrated Analytical Optimized Advanced Push vs. Supply Optimized Supplier Lean Six Design for Network Postpone- Segmented Statistical ERP/MRP inventory product demand & pull chain risk cycle integration Sigma manufacturing modeling ment production forecast calculation ows capacity balance management on shop & logistics planning oor Not Applied Yet Minimally Applied Somewhat Applied Applied Fully Applied Source: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton A large percentage of the companies surveyed—43 The survey paints a complex portrait: These percent—are consciously pursuing the dual objectives manufacturers have a large presence but either have of selling products in China and taking advantage of not been able to or have not chosen to implement labor cost savings, presumably for goods for export global best practices across their operations, and (see Exhibit 10, page 7). Indeed, that appears to they are concerned about the changing cost structure be the path toward greater profitability in China. they see unfolding around them. It is clearly a critical Companies that report pursuing dual objectives enjoy moment for manufacturers who want to make the most profit margins of 29.6 percent while others report only of their existing investments in China as well as those 17.8 percent margins.
  8. 8. 7 Exhibit 10 web of capabilities, including manufacturing, Respondents’ Perspectives on Whether Local Market Access or innovation, new business model incubation, and Labor Cost Savings is the Primary Motive for Operating in China talent development. It’s not just another emerging Neither motive market. Because of its size and its dynamism, these companies recognize that China must be a core part of their global strategies. They integrate their sourcing 10% and sales operations in China, rather than focusing Both on developing some operations aimed at the world Local market motives access as 27% 43% while other systems concentrate on China. That’s why major motive we call the companies operating in this zone “global supply chain integrators”: They integrate their sourcing- 20% centric models and their sales-centric models in China and deeply embed their Chinese operations in their Labor cost savings planning and thinking about global markets. They treat as major motive China as a linchpin of their global operations, rather Source: China Manufacturing Competitiveness 2007−2008; Booz Allen Hamilton than as just another market. Postponement/Late Customization. One of the keys to who are just beginning to recognize the possibilities making an integrated presence work, and the next level inherent in one of the world’s largest markets. of the pyramid, is the ability to create manufacturing systems that produce large volumes of products, but Building a Strong Platform for Growth in China postpone the moment at which those products have to We believe that the manufacturing philosophy employed be customized for specific Chinese and non-Chinese in recent decades by foreign multinationals in China is markets. (This is an area where the research showed in need of an overhaul. Far too many companies built that Chinese operations are particularly weak.) There factories and distribution systems with low levels of may be an infinite number of ways to assemble a technology and without widespread adoption of best personal computer, for example, but few of them make practices from more sophisticated markets, assuming economic sense unless the company knows who the that the low costs associated with operating in China final customer is. In an export context, rather than would offset these omissions. But the changing cost and currency structure have shifted the equation. Now those pressures are beginning to force a rethink Exhibit 11 of how these companies structure their Chinese Defining and Implementing a Globally Integrated Operations Strategy operations and how they position China in their overall global strategy. Management Summary The best manufacturers are employing a thought pro- F F Streamline through Lean cess that may be likened to a pyramid (see Exhibit 11). Lean Practices Operations Levers E F Global Integration. The base of the pyramid, and S&OP therefore the starting point, is almost philosophical D Footprint & and network Modeling Network modeling in nature and poses a question to chief executive C Tailored Business business officers: What are the fundamental guiding principles streams/segmentation Streams/Segmentation Define Your Operations Strategy for organizing your Chinese operations? We have found B Postponement/ late Customization Late customization that the most global companies—IBM, General Motors, A and General Electric, for example—view China in a Global Integration/ integration/“The Zone” global context and see it as part of an international Source: Booz Allen Hamilton
  9. 9. 8building up a huge inventory of commoditized PCs in sary for rapid, last-minute configuration are available atChina, it may make more sense to use China for the the right point in its supply chain. Yet Dell has varyingearly and middle stages of assembly, but not apply approaches to its supply chain for notebooks, desktopculture-specific, customer-driven touches until the computers, servers, and other products. Although thiscomponents get near the ultimate customer, whether in innovation is not exclusive to China, it provides anthe United States or elsewhere. example of how a company can master the application of this concept in other markets.There are at least three varieties of postponement: Tailored business streams can be challenging ton Light. Hewlett-Packard, for example, postpones develop, but they can bring enormous benefits if commitment of a printer to a market by making companies embrace the best practices that are universal printers and then applying power supplies available in other markets today. Companies can and language-specific manuals at the last moment start the process by having a set of clear policies forn Medium. The National Hockey League has replica jer- managing trade-offs in these systems and by creating a seys made in bulk, but then customized in the final unified decision-making system. stage with the player names and numbers, in quanti- Footprint and Network Modeling. Manufacturers will ties depending on the popularity of specific players need to understand how postponement and tailoredn Advanced. When Motorola makes radio products, it business streams can best work for them in order places the most expensive parts in a housing set; to take the next critical step: determining how many labeling and packaging are undertaken only after a plants they should have, where they should be specific order is received in a postponement center. located, and what their focus and mission should be. Understanding China’s role in global operations is aTailored Business Streams/Segmentation. The net key element in determining how to best construct aeffect of successful postponement is what we call global manufacturing footprint.a tailored business stream1. By definition, a tailoredbusiness stream takes advantage of China’s capacity There are four key elements to designing afor large-scale, cost-efficient manufacturing yet retains manufacturing network:high levels of differentiation for both Chinese and n Let the product and the customer guide the markets. Consider market requirements, including lead times,To understand what a tailored business stream is, delivery, and services; if customers require short leadlet’s return to the example of PC assembly. It’s not times, it may rule out the construction of plants inuncommon for companies to respond to customer distant, low-cost countriesdemand by offering various levels of customization, n Identify economics and challenge constraints. Thesewhich increases operating expenses without neces- may include contractual obligations, regulatorysarily adding value. Tailored business streams allow requirements, and labor agreementsa manufacturer to identify the common elements thatunite 80 percent of its output and thus put the majority n Evaluate alternatives. In evaluating different networkof its capacity into a single stream, while reserving 15 scenarios, the total production and supply network,percent of capacity for somewhat predictable demand which is generally much broader than the manufac-conditions and 5 percent for opportunities that arise turing footprint, needs to be optimized. Take intosuddenly and therefore cannot be forecast. Dell Inc. is account the costs of complexity and the economics ofan example of a company that applies the postpone- manufacturing in-house versus outsourcingment and tailored business streams concepts to its n Develop the business case. The implementationproduct: It customizes computers in response to a plan for the new footprint should considerspecific order, ensuring that the components neces-
  10. 10. 9 organizational changes and potential risks, such To be sure, there are clearly huge opportunities to as supply interruptions, transportation delays, and use lean practices to improve existing operations and currency movements. unlock latent productivity. Too few companies are well integrated with their suppliers—and point-of-usage deliv- Sales & Operations Planning. The next level of the eries, which are commonplace in the developed world, pyramid, S&OP enables coordination and joint planning , are not widespread in China. In some cases, there have between departments, by ensuring that marketing been poor localization levels in manufacturers’ supply teams alert operations and IT when they plan a bases. Quality problems in Chinese supply chains have promotion; by increasing communication between been widely reported, and they are of obvious concern. product managers, sales executives, and processing But they are just one part of a broader problem. center leaders; and by establishing a regular forum to resolve cross-functional issues. Smart manufacturers Shop-floor operations also are not integrated enough. have found that better coordination between the sales Logistics, both inbound and outbound, are inefficient, and operations departments, as well as planned rather and information systems are not producing the right than ad-hoc decision making, can make the difference caliber of information. One problem is that companies between profit and loss. To continue the PC example, have built ERP/MRP systems for sourcing and then a strong S&OP system would allow a company to more other systems for their distribution channels. If they easily determine if a major customer wants a shipment are going to be able to integrate their complete opera- of very specific computers in two days or a more tions, the information systems also need to be linked. generic order delivered a week or 10 days later. With But the goal of achieving lean practices should not better communication between the sales force and drive the entire decision-making process in China. the manufacturing team, the S&OP system would drive Building full-fledged manufacturing and distribution decisions about where last-minute customization is capabilities on the mainland is becoming more com- performed and where inventory is held. plex than it once was, and decisions have accordingly Lean Practices. Many manufacturers start at precisely become more complicated. the wrong point in China by trying to create lean In previous decades, it seemed that virtually any operations without understanding their fundamental plant built in China could become profitable because mission and all the building blocks of the pyramid. We costs were so low. And virtually any kind of sales have found that it is wrong to tackle the challenge of channel could reap double-digit gains in growth lean practices, originally pioneered by Toyota, if the every year. But now the challenge for companies is fundamental operating philosophy is misguided or not to take a more systematic and global view of their adequately developed. We estimate that fewer than 5 Chinese operations and integrate the duality of those percent of the companies in the world are able to fully operations, thereby becoming global supply chain deploy lean practices, and the percentage is much integrators. Even more fundamental, perhaps, is lower in China. adjusting the philosophical premises that shape and guide all decision making in China. Also contributing to this article were Ken Zhong, Raymond Yeung and Ashish Ranjan.
  11. 11. 10What Booz Allen BringsBooz Allen Hamilton has been at the forefront of been recognized as a consultant and an employer ofmanagement consulting for businesses and choice. In 2007, for the third consecutive year, Fortunegovernments for more than 90 years. Providing magazine named Booz Allen one of “The 100 Bestconsulting services in strategy, operations, organization Companies to Work For,” and for the past eight years,and change, and information technology, Booz Allen Working Mother has ranked the firm among its “100is the one firm that helps clients solve their toughest Best Companies for Working Mothers.”problems, working by their side to help them achieve To learn more about the firm, visit the Booz Allen Webtheir missions. Booz Allen is committed to delivering site at To learn more about theresults that endure. best ideas in business, visit,With 19,000 employees on six continents, the firm the Web site for strategy+business, a quarterly journalgenerates annual sales of $4 billion. Booz Allen has sponsored by Booz Allen.Ronald Haddock is a vice president and director of transformations and is the lead author of ManufacturingBooz Allen Hamilton in Greater China. He has been Realities: Breaking the Boundaries of Conventional Practicewith Booz Allen since 1994 and in Asia since 1997, (strategy+business books, 2006). He can be reached atserving multinational corporations and local clients in +49 89 54525 553 or automotive and industrials sectors from Booz Allen’s Conrad Winkler is a vice president of Booz Allen Hamilton,offices in China, Korea, and India. He can be reached at based in Chicago. His expertise lies in manufacturing+8621 63406633 or strategy, manufacturing transformation, and supply chainKaj Grichnik is a vice president of Booz Allen Hamilton management. He can be reached at 312-578-4692 orbased in Munich. He specializes in manufacturing Christoph Alexander Bliss passed away prior to the final publication of this article. Booz Allen Hamiltonrecognizes with gratitude his numerous and significant contributions to the advancement of the topics ofoperations strategy and globalization.Downloadable digital versions of this article and other Booz Allen Hamilton publications are available from
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