chinabusinessreview.com April–June 2012 13Logistics i.docx

chinabusinessreview.com April–June 2012 13
L
ogistics is an essential component of a successful
deal anywhere in the world, but especially in China
where services offered may not be what they seem.
Global supply chains are easily disrupted when
companies do not consider critical logistics services
or blindly trust their supplier to arrange transportation and the
export of products from China.
To avoid these supply chain traps, consider these nine rules:
1. Carefully select a logistics and .transportation supplier
There are thousands of small logistics companies in China
that advertise as freight forwarders and export trade brokers.
Almost anyone will say they can do this job because they
A carefully selected logistics partner can help companies
overcome their China supply chain challenges.
Nine Rules for Logistics in China
Rosemary Coates
F O C U S : D I S T R I B U T I O N & LO G I S T I C S
Companies in China should select a logistics provider with a
global network of offices, standard procedures, and up-to-date
information technology systems.

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14 April–June 2012 chinabusinessreview.com
have connections to trade services. But so many things can
go wrong and result in supply chain disasters. If a company
cannot get goods to market in time for the season or the
sale, or to meet peak demand, the company’s logistics net-
work has failed.
Small freight forwarders can provide personalized service
when a company needs special care, but they may also add
time and frustration to your supply chain. Because they are
independent businesses, small, independent Chinese forward-
ers rely on a network of agency relationships and one-off
favors to move freight. Essentially, these small forwarders and
brokers are just cargo coordinators. They typically do not
own any of their own equipment, make no investments in
capital equipment or systems, and rely on subcontractors to
provide trucking, air, and ocean freight. Their networks are
only as strong as the weakest link. It is common to see small
forwarders like this in tier-two or tier-three cities, moving
cargo in tricycle carts from manufacturing sites to airports.

Some of these companies also subcontract the preparation of
export documentation, including US Customs’ 10+2 report-
ing—the information now required to be processed before an
ocean shipment, bound for the United States, can leave a for-
eign country—which can cause delays in China if documents
are not properly prepared. Companies should select a freight
forwarder or broker with a global network of company-
owned offices, standard procedures, and information technol-
ogy (IT) systems capabilities that comply with the complicat-
ed export and import regulations.
Global logistics providers that have established offices across
China, such as Expeditors International of Washington, Inc.,
CEVA Logistics, DB Schenker, Kuehne & Nagel International
AG, among others, offer advantages, including:
■ Standardization and consistency of procedures worldwide;
■ Up-to-date information about export/import regulations;
■ Communications standards and protocols;
■ Global IT systems to track the many documents required
for global trade shipment progression and compliance with
trade regulations;
■ Negotiated rates and schedules with air and ocean carriers;
■ Standard documents and assistance with completing them;
■ Landed cost and total cost estimations; and
■ Familiarity with International Commerce Terms of Sale
(Incoterms).
Keep in mind that just because these forwarders are larger
does not mean they are more expensive. Very often, the size
of the forwarder allows them to negotiate for better volume
rates from ocean and air carriers.
2. Make sure logistics providers havesystems capabilities
In the past, logistics was all about moving boxes and get-

ting space on aircraft and ocean vessels. In the early 1990s,
with the wide implementation of enterprise resource plan-
ning (ERP) systems at most companies, visibility and syn-
chronization became king. Companies could then truly see
the impact of disruptions in scheduling caused by delays in
transit. As a result, logistics progressed from moving boxes
to moving information.
Now, it is extremely important to know where freight is in
the supply chain, inventory levels by location, and what is
expected to move from your suppliers. This is because manu-
facturers and retailers need to plan for arrivals or delays using
their own ERP or other systems. Without accurate logistics
information about shipments from China, entire supply
chains can be disrupted—or worse, shut down.
Logistics providers should be partners in gathering and
reporting information to help manage a company’s supply
chain. To accomplish this, logistics providers have to make
large
investments in their own systems. The ability to provide infor-
mation is no longer an option, but a basic service offering.
Companies should be able to search and schedule online, trans-
mit information electronically (such as Advance Shipment
Notices and trade compliance information), and receive auto-
mated notices when there are delays or disruptions. Logistics
providers should have sufficient IT staff to integrate or
interface
their systems with any company’s systems.
Closely tying IT systems creates a deeper level of partner-
ship that must be monitored and managed. Importers should
plan to go to China on a regular basis to review the logistics
operations and the associated IT systems. Start with a written
audit plan and review sample transactions every time you visit.

Background on Incoterms
International Commerce Terms of Sale
(Incoterms) apply to delivery of goods
sold, and exclude intangibles like
computer software. Use of Incoterms
reduces or eliminates uncertainties from
differing interpretations in contracts. The
Incoterms are updated to reflect new
usage about every 10 years. Among the
most commonly used Incoterms are EXW
(Ex works), FOB (Free on Board), CIF (Cost,
Insurance, and Freight), DDP (Delivered
Duty Paid), and FCA (Free Carrier). The
International Chamber of Commerce (ICC)
introduced Incoterms in 1936.
Since then, the ICC has updated them
seven times to keep pace with the
development of international trade. The
latest edition of Incoterms is Incoterms
2010, which took effect in January 2011.
The ICC publishes a brief introduction to
Incoterms as well as a fact sheet on its
website. The section does not provide
every answer, but will help companies
understand how Incoterms are organized.
For more information, visit www.iccwbo.
org/incoterms.
—Rosemary Coates

3. Compare rates and services Business conditions in China
change rapidly.
Companies need to be aware of pricing in the market and
service offerings. One of my clients was very surprised to
find out that while their logistics provider seemed to have
competitive pricing, they were five years behind in systems
capabilities and had not made other process or productivity
improvements for several years.
I recommend that companies forge a long-term relation-
ship with their logistics providers and encourage and moni-
tor productivity improvements through IT systems, shared
forecasts, and strong quarterly evaluations. But it is also very
important that companies stay current with the market-
place. On trips to China, visit other facilities and talk to
other providers to make sure service offerings are competi-
tive and up-to-date.
It is also prudent to go through a bidding
or request-for-proposals (RFP) process every
two to three years. Even if a company does
not want to change providers, this process
will at least provide an opportunity to review
the business in depth and determine where
improvements can be made.
A company’s purchasing department can
help write an RFP that stays within company
guidelines and includes all of the questions
required to attain comparative information.
Companies can also engage a consultant if
assistance is needed in the RFP process for
logistics providers. Consultants will bring
marketplace information and objective rigor

to the process.
4. Consider central China I spoke at a logistics conference in
Chengdu, Sichuan
last year and was surprised by the rivalry for logistics business
between Chengdu and Chongqing. Both cities have experi-
enced better-than-average economic growth and attracted
high-tech and automotive manufacturing. The two cities are
rapidly building logistics capabilities to support the manufac-
turers that are moving there, and vying for new business. The
PRC government is also moving quickly to construct addi-
tional high-speed rail links and new superhighways from this
area to the eastern coastal export cities. Local governments are
offering attractive financial benefits, such as tax breaks and
other financial incentives.
Consider locating manufacturing in one of these cities
where wages are one-quarter of those in the eastern cities.
In western and central cities, many experienced migrant
workers are closer to home, the workforce is plentiful, and
vertical integration of vendors in the supply chain is spawn-
ing many alternative local suppliers.
Recently built super highways and rail lines to the interior
of China allow for fast movement of cargo. Adding a day or
two to the transit time from the interior to the coast will not
make much difference in costs or time to market. The logis-
tics infrastructure of warehousing and distribution centers is
newly built and readily available.
5. Rigorously review logistics providers Too often my clients
will tell me that they hold quar-
terly business reviews (QBRs) with their logistics providers,
but when I dig deeper, I find that the QBRs are nothing
more than activity reviews. These meetings focus on how

many shipments, containers, or millions of pounds were
moved, hours worked, and other countable topics. However,
a QBR should be multi-dimensional and include quality
and productivity measures in addition to activity measures.
Further, the quarterly evaluation process should be complet-
ed by both the company and the logistics provider, to give
two-way feedback.
QBRs should include a review of topics
such as:
■ On-time service;
■ Errors by category;
■ Response time;
■ Specific problems or challenges during
the past period;
■ Potential ways to automate the commu-
nications between companies;
■ Improvement in automation and pro-
cesses to increase productivity;
■ Revenue generated per quarter and quar-
ter-over-quarter revenue comparison; and
■ Training and education. (For example, a
company should educate a logistics provider
on its products and business, and the logis-
tics provider should educate the company on services and
new trade compliance regulations and procedures.)
Regardless of what a company chooses to measure, all cat-
egories and key performance indicators (KPIs) should align
with corporate goals. Managers should ask themselves the
following questions: Have I read my own company’s annual
report? Do I clearly understand this year’s goals and objec-
tives? Do all of the company’s logistics performance indica-
tors support these goals? If the answer is no, the company is
measuring the wrong things.

A logistics provider should also measure the company it
serves. The logistics provider should give feedback on things
like their customers’ response times, productivity improve-
ments, issue resolution, and training. Two-way communica-
tions between the logistics provider and their customers will
provide valuable input regarding areas where improvements
need to be made.
6. Know your Incoterms Incoterms, or International
Commerce Terms of Sale,
were developed by the International Chamber of Commerce
(ICC), and they are recognized by most countries. The latest
versions, Incoterms 2010, are commonly used, standardized
■ A logistics supplier should
gather and report information
to help manage a company’s
supply chain.
■ Companies should develop
indicators and review logistics
providers’ performance every
quarter.
■ Companies should visit their
China operations quarterly to
audit and observe their
operations on the ground.
Quick Glance
16 April–June 2012 chinabusinessreview.com

terms that stipulate who pays for what in international ship-
ping and who assumes risk (see p.14).
Correct use of Incoterms helps to provide legal certainty
between buyers and sellers. To be sure of using Incoterms
correctly, companies should consult the full ICC texts or
use a consultant. A company needs to understand the
financial and risk responsibilities for the Incoterms in its
contracts with Chinese suppliers.
7. Export/import compliance is required Before 9/11, the
United States maintained a list of
“denied parties” with whom US companies could not legally
do business. After 9/11, the restricted parties list (RPL) bal-
looned to more than one million names. To comply with
the law, every order from every customer must be checked
against the RPL. With so many names on the list, it is near-
ly impossible to do this manually. As a result, many compa-
nies rely on logistics providers to check the list for them.
The Chinese office of a logistics provider should have tech-
nology that performs this task in seconds online. In addi-
tion, a company and its logistics provider should have writ-
ten procedures for handling matches to names on the list.
On the import side, a Chinese logistics provider should
be able to prepare standard and non-standard documents
that will allow a company to clear US Customs easily and
legally. This means that for imports into the United States,
the documents need to be in English, and completed quick-
ly with all information required so as not to delay any ship-
ments. In addition, for ocean shipments, the freight for-
warder must submit 10+2 information electronically to US
Customs before the container is loaded onto the vessel in
China. This is yet another reason to use a global logistics
company with IT capability.

Add a review of compliance systems and procedures to
your checklist for every visit to China. A company’s internal
audit and trade compliance staff can assist with developing
Overall, logistics and transportation capabilities are maturing
across China, and in some areas logistics capabilities are
considered world class.
China Foto Press
this checklist. I recommend that companies visit their
China logistics provider two to four times per year and on
each visit, review the procedures, validate that these proce-
dures are being followed, and provide training if necessary.
8. Determine the best approach for serving the burgeoning
Chinese domestic market
Most of my clients have started to develop robust approaches
to selling inside of China. With the rise of the Chinese middle
class and the enormous PRC government market, foreign com-
panies see a huge new market opportunity to sell goods.
Factories producing goods for export may also be licensed to
produce goods for the growing Chinese market. But beware,
logistics and distribution within China to support domestic
sales are very different from exporting from China.
Chinese distribution channels may be somewhat longer

and more complex than the United States. For example,
luxury goods retailers have found a robust market in China’s
big cities, but these retailers are also opening stores in the
tier-two cities. Logistics for tier-two and tier-three cities
may not be as sophisticated and may require unique delivery
solutions. In large cities, multi-stop deliveries to several
retail stores are coordinated by a retail logistics company.
In a tier-three city, the retailer may have to wait a week or
more for a single store delivery from the airport that is
passed from trucker to delivery cart.
Setting up an effective and efficient domestic Chinese dis-
tribution system will take time. Companies need to consider
and vet logistics providers, resellers, and wholesalers. China
is a new and diverse market for delivery of goods so the pro-
cess may be uneven for a few years. As a result, companies
should consider where to locate inventories and distribution
centers. Further, if a company produces and plans to market
industrial products, it will need to consider delivery sites
and capabilities before shipping goods. Older buildings and
factories may not have adequate facilities such as truck
docks and fork lift equipment.
Overall, logistics and transportation capabilities are
maturing across China, and in some areas logistics capabili-
ties are considered world class. Be sure to select logistics
providers and partners with global networks and standards,
and measure them regularly and rigorously. For distribution
within China, verify the capabilities of partners and under-
stand the delivery points. Companies should not assume
that every delivery place can accept trucks, has fork lifts, or
other equipment. Verify where you plan to deliver—dock,
warehouse, or other location—and the equipment available.

9. Visit China oftenThere is no substitute for regular,
structured visits to
vendors and logistics providers in China. Companies should
never assume that just because policies and procedures are
stated in a contract that any of them will be followed. In the
Western world, we view a contract and written procedures
as the end product to be executed. In China, the contract is
just the beginning of doing business together. Contracts and
written procedures are often viewed as guidelines and are
subject to interpretation. If companies want procedures to
be followed precisely, they must monitor and audit the
Chinese operations regularly.
I typically recommend that companies visit their China
operations quarterly. During these visits, companies should
audit the processes through observation and by using a valida-
tion checklist. Ask to see the operations while people are work-
ing, then return for a surprise visit later that day or evening.
When companies cannot employ a full-time person in
China to watch over and manage operations, it is important
to hire a trusted agent who resides in China to work on
behalf of the company. (Some consulting companies provide
these services for a fee.) Even with the addition of local ser-
vices to oversee operations, companies still need to make an
effort to visit China quarterly.
Rosemary Coates ([email protected]) is the president of Blue
Silk Consulting, a global supply chain consulting firm and the
author of 42
Rules for Sourcing and Manufacturing in China, a top seller on
Amazon.
She is currently working on her second book, 42 Rules for
Superior Field
Service, which will be published in the summer of 2012.

In western and central cities, many experienced migrant workers
are
closer to home, the workforce is plentiful, and vertical
integration of
vendors in the supply chain is spawning many alternative local
suppliers.
Reproducedwithpermissionofthecopyrightowner.Furtherreproduc
tionprohibitedwithoutpermission.
Sourcing & Manufacturing
in China
DVD Program 3: Chapter 2 Labor and Logistics 18:00 – 26:00
or so RiverEdge Furniture
Discussion Q Number 1
Dicussion Q No. 2-4 (40mins)
/Students discussion of the short articles and slides
Optional: DVD Program 3, Chapter 1
1
Discussion Questions
Why has China become the world factory?
The cost of manufacturing in China has increased significantly
in the past decade. What are the reasons for this rise? Should
companies look to locate their manufacturing facilities

elsewhere? Why or why not? How should companies respond to
the rising costs?
What kind of logistics partners should a company work with in
China? Why? What other issues do you need to consider to have
an effective logistics for a company’s domestic and export
business in China?
What are the challenges manufacturing/outsourcing in China?
2
Q1. Why World Factory
Cheap and skilled labor with high productivity
Compound annual growth rate for productivity was 16.5%
during 2004 – 2010.
Developed infrastructure in logistics and shipping
High quality supplier network
Large local market to exploit, especially when China is shifting
to domestic consumption economy
Reliability and flexibility of production
DVD Program 3: Chapter 2 Labor and Logistics 18:00 – 26:00
or so RiverEdge Furniture
Discussion Q Number 1
3
Q2: Why is the cost of manufacturing increasing?
Shortage of labor
Elderly population will increase 60% by 2020 and working-age
population decreases by 35%
Land and raw material costs rose rapidly
Currency appreciation

Chinese government incentives for westward expansion and
minimum wage increase in rich areas
Rise of urban middle class demanding higher wages to
compensate for inflation
In addition to higher land and raw material costs, urban
manufacturing wages in China have more than doubled from
2003 to 2010.
Rising cost of manufacturing
The discussion article: China’s rising cost
Ask students to discuss the article.
Show the video
Summarize with slides
4
US$ has been depreciating against Chinese RMB until 2014
Optional: Show DVD program4, Chapter 1
6
Re-shore or change strategy in China?
Instead of leaving China, perhaps move to inland China
The labor costs in inland is growing rapidly too.
Increase productivity by automation
Export-oriented companies could focus more on China market
At the same time, it might make sense to diversify the
production bases and move some of the facilities to other low-
cost countries

Re-Shoring
Research at Wharton
Should everyone re-shore?
Show the videos
7
Q3: 9 Rules for Logistics
Carefully select a logistics and transportation suppliers – larger
ones might be better and more reliable but small ones may
provide customized services
Make sure logistics providers have IT systems capabilities –
ERP systems are essential
Compare rates and services
long term relationships are valuable
Bidding every 2-3 years
Consider central China for manufacturing
Rigorously review logistics providers and two-way feedback
communication – activities, quality, and productivity should all
be measured
Know your Incoterms (International Commerce Terms of Sale) –
who pays for shipping and who assumes risks.
Export/import compliance is required – use a partner that can
check the compliance and prepare the documents and review
with them these procedures regularly
Determine the best approach to serve Chinese market – the
logistics and distribution are different
Visit China often – monitoring and auditing are important
The discussion article: 9 rules of logistics in China
Ask students to share the article

8
9
Q4. Managing Off-shored & Outsourced Operations: Challenges
Design-manufacturing separation and coordination
The complexity of management and control of supply chain
Training and development of suppliers and managing the
relationships with the suppliers
Ethics related issues (product safety; working conditions,
environment, etc.)
Quality control
Intellectual property theft
9
There are costs associated managing outsourced or off-shored
operations:
In an outsourced relationship, the design and manufacturing
functions are separated. The design function is handled by the
corporate headquarters whereas manufacturing is handled in
foreign country by either the company itself or vendors
contracted by the company. The separate is more severe in
vendor relationship.
Coordination between design and manufacturing is essential not
only to ensure the product is manufactured as design
specifications, but also to ensure the lessons learned during the
manufacturing process are fed back to the design function.
OPTIONAL: DVD Program 3: Chapter 1

30 CHINA BUSINESS REVIEW July–September 2012
China’s Rising Costs
FOCUS: TRADE AND INVESTMENT
BY SIMON ZHANG
Companies that reevaluate their China-based manufacturing
operations can remain competitive despite inflation.
LI
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WORKERS INSTALL A MOTOR GRADER
at Caterpillar’s production facility
in Suzhou, Jiangsu. Despite cost
inflation, many foreign companies
choose to stay in China to serve
the Chinese market.
July–September 2012 CHINA BUSINESS REVIEW 31
Executives across China have been quick
to mention rapidly increasing labor costs in
recent years as one of their top concerns for
their China operations. China’s labor costs in
the urban manufacturing sector reached
¥31,000 ($4,579) per employee per year in
2010, more than doubling from just ¥12,700
($1,534) in 2003. This represents a com-
pound growth rate of 13.8 percent in ren-
minbi (RMB), or 17 percent in dollars after
taking RMB appreciation into account.
China’s costs are growing at a faster rate than
many other countries with low overall manu-
facturing costs, such as Vietnam, India, and
Mexico. But this represents just the tip of the
iceberg for foreign companies’ investment
prospects in China.
According to analysis by InterChina

Consulting, China has reached the turning
point at which it can no longer be considered
a low labor cost production base, and it will
likely never return to that status. However,
the negative implications of this trend have
been exaggerated and distorted in many
cases. Foreign companies should consider
factors other than costs and adopt strategies
to deal with the cost issue in a strategic and
sustainable way.
For enterprises in China, there are critical
decision-making factors to consider other
than cost alone. These include productivity
in China, proximity to the local market,
proximity to a high-quality supplier network,
and the availability of quality labor.
COST INFLATION IS EVIDENT ABOVE THE
ICEBERG, BUT WHAT LIES BENEATH?
High labor costs is just one element in a
series of factors that have led to cost inflation
in China. Many other costs that affect the
bottom line of business operations have also
spiked in China recently. For example, the
purchasing price indices for raw materials
and other manufactured goods as inputs
increased by an average of 4.3 percent from
2000 to 2010, even accounting for a heavy
dip during the 2009 economic downturn. In
most of those years, price indices increased
by 5 to 10 percent. Utility prices for indus-
trial usage in many of the 15 provincial
capitals InterChina monitored also increased

at a compound annual growth rate of 5 to10
percent after 2005. Increases in land rental
prices have made regular headlines in recent
months as well.
Despite these cost increases, many foreign
companies still consider China an important
market. For the past 10 years, roughly 80
percent of executives have said that China is
one of their companies’ top three global
investment destinations, according to annual
surveys by the American Chamber of
Commerce in China. Over the same time
period, approximately 70
percent of executives
reported that their firms’
operations in China are
profitable or very profitable.
Proximity to the market has
been a key determinant in
Chinese investment deci-
sions. Many people assume
that companies that invest in China do so to
export goods—but for the past 10 or more
years this has been the exception rather than
the rule. In fact, foreign manufacturing com-
panies in China export less than 25 percent
of their gross industrial output, even after
including the companies in Hong Kong and
Taiwan, which generally post high levels of
exports.
Given this steady interest in China as a
global investment destination, it is important

to understand the rising labor costs against
the larger context of China as a maturing, yet
robust market. China’s market is one of the
world’s largest and continues to grow at an
enviable pace. Many observers also overlook
the fact that China’s manufacturing sector
productivity, which achieved a compound
annual growth rate of 16.5 percent from
2004 to 2010, has increased rapidly in recent
years. Productivity gains, which were achieved
largely through investment, have successfully
offset the impact of the fast-growing labor
costs in the past. China is now, however, tak-
ing steps toward shifting to an economy
driven by technology upgrades, innovation,
and revamping of business models. This
trend is likely to continue to offset, at least
partially, the impact of rising labor costs in
QUICK GLANCE
» In addition to
higher land and raw
material costs, urban
manufacturing wages
in China have more
than doubled from
2003 to 2010.
» Capital- and
labor-intensive

manufacturing
operations should
consider new
strategies to deal
effectively with cost
inflation and remain
competitive in China.
» Some companies have
moved operations
to inland provinces
or have automated
production processes
to mitigate rising costs.
Many people assume that companies that invest in
China do so to export goods—but for the past 10
or more years this has been the exception rather
than the rule.
coming years. Though labor costs in

Vietnam and other low-cost countries
are approximately one-half to one-
third less than Chinese labor, productiv-
ity in many low-cost countries is consid-
erably lower than in China.
Consumption will become one of
the key drivers for business as China
shifts from investment and export-driv-
en gross domestic product (GDP)
growth. The size of China’s middle
class is likely to triple in the next 10
years. But China’s market is becoming
more complex, and will require a high-
er degree of localization to be success-
ful. In the future, firms that manufac-
ture or design products in China for the
domestic market will become more
competitive. Highlighting this trend,
many Fortune 100 companies have
designated China as their second home
country or second global headquarters.
China’s relatively mature supply
chain has also persuaded foreign com-
panies to stay in China rather than
move away. In fact, companies fre-
quently cite less developed supply
chains in many low-cost countries as a
barrier to investment. Even in the well-
publicized case of Nike, Inc., it has
taken more than 16 years to lower the
amount of raw materials the company
imports to Vietnam from 98 percent to
56 percent, even with significant sup-
port from the Vietnamese government.

RUSHING TO “RESHORE”?
The issue of relocating away from
China—or what some are calling the
“reshoring” of manufacturing—has
become a hot topic. Sleek Audio (with
an estimated global revenue of
$790,000) moved production back to
the United States in early 2010, citing
cost issues and quality control. The
Outdoor Greatroom Co. (with global
revenue of $5 million) also moved pro-
duction back to the United States, cit-
ing a need for proximity to other facili-
ties, shipping delays, and a need for
greater quality control.
Companies that have so far chosen
to reshore their manufacturing facilities
have been export-oriented companies
with little to no customer base in China
and limited prospects for establishing
such a base. In the past, these compa-
nies only manufactured in China
because of the cheap labor costs, and
the nature of their business in China
has been considerably labor-intensive.
Factors such as concerns over quality,
high shipping costs, and delays are
likely to outweigh the diminishing
labor-cost advantage.
However, many companies in the past
and likely most in the future will be tar-

geting China’s large domestic market. In
the US-China Business Council’s annu-
al survey of member company priori-
ties, 93 percent of respondents in the
2011 survey said their companies were
in China to reach the China market.
Forty-three percent of respondents said
their companies used China as an export
platform to non-US markets, and 27
percent used
China as an
export platform
to serve the
United States.
C o m p a n i e s
with a focus on
China’s domes-
tic market are likely to stay in China in
the medium term, including the lead-
ers in the value chain of the electron-
ics, food and beverage, energy, chemi-
cals, auto, pharmaceuticals, machinery
and industrial goods sectors, in addi-
tion to the component and material
suppliers involved in the value chain.
Some export-oriented companies have
started to balance their strategic focus
in China for both export and for
China’s market to respond to the mar-
ket trend.
Some companies, such as Nike, have
chosen to diversify their production
locations to other low-cost countries,
rather than drastically reduce the pro-

duction base in China (see p.33). Media
reports have cited labor costs as playing
a large role in Nike’s move to Vietnam.
But Nick Athanasakos, Nike’s vice pres-
ident in charge of global sourcing and
manufacturing, pointed out in late 2011
that Nike is looking ahead to Vietnam
joining negotiations on the Trans-
Pacific Strategic Economic Partnership
Agreement (TPP) and Vietnam-EU
Free Trade Agreement (FTA), which
would lead to more favorable trade
policies between Vietnam and the
United States and European Union.
The share of Nike’s shoes produced in
Vietnam increased from 15 percent to
39 percent in the past 10 years mostly
because of decreases in production in
Indonesia and Thailand, according to
its annual reports.
ADAPTING TO A NEW REALITY
While it will be easy for manufactur-
ers to remain in China in theory, it will
become difficult to stay competitive in
China in practice. Both capital- and
labor-intensive operations will need
new strategies to deal effectively with
cost inflation and remain competitive
in China.
Relocating operations to inland
provinces and cities is possibly the most
frequently mentioned approach to cost

inflation in China. Hewlett-Packard
Co. began this process in the mid-
2000s with a facility in Chongqing
responsible for applications, infrastruc-
ture technology, and business process
outsourcing for HP’s enterprise cus-
tomers in China and globally. HP
opened in 2008 its second personal
computer manufacturing facility in
China in Chongqing with an invest-
ment of $3 billion, and set up a call
center in Chongqing that serves cus-
tomers in China and globally.
However, HP’s decision was not
purely driven by the labor costs in west-
ern China. Labor costs in inland cities
are increasing at a faster pace (typically
15 to 20 percent) than in coastal cities
(typically 10 to 15 percent), which
means the current labor cost advantage
in inland cities is temporary. For HP,
Chongqing provides a chance to better
target China’s inland market and
FOCUS: TRADE AND INVESTMENT
Both capital- and labor-intensive operations will
need new strategies to deal effectively with cost
inflation and remain competitive in China.
July–September 2012 CHINA BUSINESS REVIEW 33
Europe. HP’s plant in Chongqing will

be capable of producing 20 million
laptops a year once the plant is fully
operational. Much of the facility’s
products will be exported to the
European market. The Eurasia Land
Bridge railway line allows companies to
export products to Europe in roughly
13 days, dropping from 36 or 37 days
by container ship.
Some companies will be able to fur-
ther increase productivity to offset cost
inflation, especially companies that
could further automate assembly lines
in their China operations. For example,
in sectors such as home appliance com-
ponents, many companies’ production
setup is still heavily labor-intensive or
only partially automated in China. In
their home countries in Europe or the
United States, facilities are equipped
with state-of-the-art assembly lines
worth several million dollars. However,
facing high cost inflation in China,
many companies have decided to grad-
ually shift their production setup to a
higher degree of automation. This is
not only a defensive strategy to deal
with labor costs, but also a proactive
action to manage high labor turnover in
China, and deal with shortages of
skilled workers and operators. One of
InterChina’s clients plans to automate
two of its assembly lines to replace 18
semi-skilled workers. In this case, the
company will save money even when

taking into account the annual depre-
ciation of the expensive machinery.
For export-oriented companies,
especially those with relatively high
value-added—such as technology,
consumer electronics, fine chemicals,
pharmaceuticals, and software sec-
tors—refocusing on China or adding
more weight to domestic sales in
China may be a good choice. Some
companies may also need to take steps
to move their export business to other
low-cost countries, especially to those
near the target market. According to
InterChina’s analysis, China will likely
lose its cost competitiveness between
2015 and 2020 when compared to
other low-cost countries with similar
supply chains, such as Mexico and the
Czech Republic. Companies should
consider long-term goals, such as
global resource optimization. In one
case InterChina handled, the client
agreed to make the necessary optimi-
zation of capacity in North America
and China, which had significant
impact on future investment decisions.
This export-oriented client will move
its export business back to North
America in the medium term, but it
will develop the dedicated sales focus
in China to contribute to the global
top-line growth with reasonable mar-
gins in China.

Foreign companies can also offer
higher value products and services. For
example, Caterpillar China plans to
invest $1 billion over the next few years
to add more local dealerships and
increase research and development,
distribution, used equipment sales, and
manufacturing and leasing activities.
The firm also plans to improve after-
sales service. These actions aim to
address the challenge from increasingly
competitive Chinese players and the
rapid rise of cost inflation.
Cost inflation is a reality in China,
but China’s domestic market will
remain attractive enough to bring con-
tinued rewards to those companies able
to stay and localize to beat the competi-
tion. Luckily, new tools are available for
foreign companies in China, though
each solution has to be tailor-made for
each company’s individual situation and
must strike a balance between the cost
issue and other critical strategic issues.
SIMON ZHANG ([email protected]
com) is InterChina Consulting’s managing
director of strategy practice based in the com-
pany’s Shanghai office.
Vietnam
China

Other
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Nike annual reports
NIKE’S PRODUCTION SHARES IN MAJOR COUNTRIES fig.
1
15% 18% 22% 26% 29% 31% 33% 36% 37% 39%
38% 38% 36% 36% 35% 35% 36% 36% 34% 33%
47% 44% 42% 38% 36% 34% 31% 28% 29% 28%
Though Nike has diversified its production locations to other
low-cost countries, such as
Vietnam, the company has not drastically reduced production in
China.
Reproducedwithpermissionofthecopyrightowner.Furtherreproduc
tionprohibitedwithoutpermission.
Special report:
Business in China
Manufacturing
Still made in China
Chinese manufacturing remains second to none

Sep 12th 2015 | From the print edition
AMID ALL THE excitement about high tech and the
push into services, it is easy to forget that China’s
modern economy was built on the strength of a solid
and often low-tech manufacturing sector. Now
manufacturing is widely thought to be in trouble.
Factories are squeezed, labour costs are rising and
jobs are being reshored to America. Competitors such
as Germany are said to be leaving China behind by
using robotics.
Chinese officials have responded in the only way they know. In
May the State Council, China’s ruling
body, approved “Made in China 2025”, a costly scheme that will
use mandates, subsidies and other
methods to persuade manufacturers to upgrade their factories.
The plan is for China to become a
green and innovative “world manufacturing power” by 2025.
China is already the world’s largest manufacturer, accounting
for nearly a quarter of global value
added in this sector. Research by Morris Cohen of the Wharton
Business School finds that the
country leads in many industries and that “reshoring to the
developed economies is not happening
on a large scale.” Even though some production is moving to
countries nearer its consumers, China
remains at the heart of a network known as Factory Asia. It has
an excellent infrastructure and an
enormous, hard-working and skilled workforce. Though wages
are rising, its labour productivity is
far higher than that of India, Vietnam and other rivals, and is
forecast to keep growing at 6-7% a
year to 2025.

Manufacturing is almost entirely controlled by private firms,
both Chinese and foreign, which unlike
SOEs will not be pushed by bureaucrats into making
unprofitable investments. Marjorie Yang,
Esquel’s boss, says that subsidies may feel good but distort
investment decisions: “The government
loves to fund flashy hardware and robotics, but there’s no
money for the software and data analytics
needed to make proper use of it.” And in any case most of these
private firms are already innovating
at a cracking pace without prompting from government.
Manufacturing is almost entirely controlled by private firms,
both Chinese and foreign
Michael McNamara, the boss of Flex, a big American contract
manufacturer, says product cycles
have become much faster. Factories in China used to serve
export markets, but are now reorganising
to concentrate on the booming local market. They are sensibly
investing in automation, worker
training and new methods. In the process, he says, China is
“moving from work engine of the world
to genuine innovator”.
Liam Casey, an Irish entrepreneur who has worked in Chinese
manufacturing for two decades,
believes that “a huge amount of innovation” is happening
around manufacturing supply chains.
PCH, his firm in Shenzhen, is a supply-chain manager that now
helps foreign manufacturers with
design and mass customisation. A private firm with revenues of
over $1 billion last year, it moves up

to 10m components a day and ships merchandise worth $10
billion a year.
Kirk Yang of Barclays, a bank, believes the manufacturing
sector is moving from “Made in China” to
“Made by China”. In the 1980s and 1990s most factories were
owned by firms from Taiwan (like
Foxconn) or the West (like Flex). Increasingly, he predicts, the
sector will be run by Chinese firms.
Taiwan used to dominate the market for upmarket electronics
components, but he thinks many
Chinese parts-suppliers—like BYDE, an arm of the electric-car
firm BYD—are now excellent.
China is the world’s largest market for industrial automation
and robots. Ulrich Spiesshofer, chief
executive of ABB, a Swiss engineering giant, reckons that the
latest robots “elevate the nature of
work” because they improve safety and eliminate the need for
heavy lifting. ABB’s local engineers
developed China Dragon, a robot made specifically for the
computer industry, which sells well
globally. In many industries China is still learning from the
world, say the engineers, but its
electronics manufacturing is so advanced that “the world is
learning from China.”
Mr Spiesshofer sees China pushing ahead with robots like
YuMi, which was partly developed there.
This affordable two-armed creation (pictured above) can be
deployed safely next to humans on
assembly lines and is able to do fine work like inspecting
phones for scratches. At its factory in
Shanghai, ABB is scaling up YuMi to mass production this
month.

Terry Gou, Foxconn’s boss, claims that within five years the
30% of his labour force doing the most
tedious work will be replaced by robots, releasing them to do
something more valuable. The highly
inventive firm, which holds many American patents, is building
all its automation in-house.
Staying ahead of the game allows manufacturers to keep their
best clients. Nike, a global sportswear
firm, has seen a lot of its suppliers decamp to cheaper Vietnam,
but still gets 30% of its components
from the mainland. Eric Sprunk, its chief operating officer,
looks for suppliers capable of developing
novel techniques that can inspire new products.
We have a plan
What about the government’s “Made in China 2025” plan? It
might succeed on its more modest
goals, says Stephen Dyer of Bain, a consulting firm. Its
immediate aims are to improve quality,
productivity and digitisation, and to expand the use of
numerically controlled machines. All these
things, he notes, are already in common use by world-class
manufacturers in other countries. A
push to invest might well help Chinese laggards catch up.
China’s state planners also want to help companies leapfrog to
the forefront of technology. Their
plan involves policies to encourage the adoption of robotics, 3D
printing and other advanced
techniques. But factories will invest in advanced kit only if it
makes commercial sense. “You can’t

push this onto firms,” says Mr Dyer. “They just won’t do it if
it’s irrational.”
A visit to a middling factory in a middling city illustrates the
point. The Guangneng Rongneng
Automotive Trim Company in Chongqing is not a fancy place.
Stock is piled hither and yon. Owned
by a privately held firm, the factory makes injection-moulded
and welded automotive parts, mostly
for Ford. Chen Gang, its director of operations, says wages have
gone up so much that he has to pay
itinerant workers the same as they can earn in Shenzhen.
He points to a fancy ABB robot on one side of an aisle that
makes complex parts to go on instrument
panels. Across the aisle sits a Chinese robot made by Kejie,
which lacks the range and precision of
the foreign model but is one-third the price. And plenty of the
work at his firm is, and will remain,
done by hand. “China is headed in this direction,” he says,
pointing to the robots, but the pace of
adoption will vary from factory to factory.
Thanks to Deng’s liberalisation and China’s subsequent
accession to the World Trade Organisation,
the country’s manufacturers rose to become export
powerhouses. Because exporters must compete
in the global market, the weak and inefficient—which includes
most SOEs—have been driven out.
From the print edition: Special report

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