Balancing cost competitiveness and process quality/reliability is the greatest challenge facing U.S. companies today as they set up China manufacturing facilities. Over the past 10 years, China's manufacturing landscape has changed dramatically.
Aggressive capacity expansion by both local players and major international companies has driven pricing down to very competitive levels in most industry sectors. At the same time, costs continue to rise as labor rates increase, land prices escalate and energy costs skyrocket. As U.S. firms seek to penetrate the burgeoning domestic China market, they are confronted with the need to keep manufacturing costs as competitive as possible while not compromising the integrity of their product offering.
In most cases, U.S. firms will not be able to match the low-cost structure and operations of a local Chinese manufacturer; therefore, they must offer a better solution at a premium price. But achieving this premium in the mainstream markets of China is a tough sell these days, which makes minimizing the cost gap with local competition a high priority.
Achieving the right level of China-fication in facility set up, process and equipment is the key to success here. China-fication is transplanting to China what you do well in manufacturing in the West, while exploiting the unique competitive aspects of the Chinese market. China-fication also means you have to do things differently than you do in your home market while not meaningfully compromising the integrity of the end result.
These cost pressures are sometimes so great as to cause normally sensible and well-mannered executives to froth at the mouth. The nature of the conflict is about achieving lowest cost with acceptable compromises. The primary conflict is in balancing the two issues of "what is acceptable" versus "how low can you go?"
The site factor is the comparative cost of setting up a facility in China versus an established norm, let's say the U.S. Gulf Coast. The latter site factor cost is set at an index basis of 1.0. The goal is to be as competitive as possible by getting the site factor as low as possible when setting up a facility in China. The conflict can best be portrayed as a spectrum, as shown in "The Site Factor" diagram.
It is not uncommon for a "wet behind the ears" engineer who takes his first trip to China and -- religiously applying U.S. standards, policies, processes and even equipment brands to the China situation -- to come back with an even 1-to-1 site factor. On the other end of the spectrum, we find the land of hearsay or anecdotal claims, typically voiced by local Chinese advisers or partners or even other Asian management team members who say that savings of 60% or more are possible.
It is important to quickly draw the demarcation line for these two extremes and focus on the real battle in the middle. Overly aggressive, risk-taking companies will lean to the left while conservative, less internationally experienced management will be biased to the right.
With proactive but still prudent initiatives, a China site factor can generally reach the 0.7 level by addressing such issues as localizing equipment sourcing, modifying the process to be more manual, realizing lower construction costs, aggressively negotiating on land use rights, etc. (it should be recognized that your manufacturing process type -- heavy or light industry, high tech or low tech and so on -- will directly influence your site factor spectrum).
The real challenge and source of stress for management is pushing down deeper into cost reduction, i.e., moving further left on the spectrum. Going into this level of cost reduction, by definition, will introduce some uncomfortable elements to the process, such as:
- Working with new/local/unproven (yet lower-cost) equipment manufacturers
- Using lower-cost (and locally available) materials
- Partnering with local organizations/individuals
- Compromising on safety standards (in both construction and operational phases)
- Acquiring local, low-cost assets of questionable quality.
If setting up a local facility, whether organically or via a venture/acquisition, you will be challenged by this site factor debate, or need for China-fication. (If you're not, you are either very lucky or you are missing tangible opportunities to lower your costs).
In determining the appropriate level of China-fication that is right for your company, it is important to consider the following:
- Validate what cost level you need to achieve in order to compete -- not only in today's market landscape, but in the future market environment.
- Bring in the right departmental staff early in the process, generally at the beginning. Too often the design and engineering team is brought in with full force only after the commercial deal is done. Their role then becomes to fix the problems instead of optimizing the approach.
- Implement an objective and aggressive due-diligence process utilizing experienced third parties when appropriate (remember the 6 Ds: due diligence, due diligence, due diligence).
- Achieve consensus on the "rules of the game." In other words, where are you willing to compromise? Often, getting top management involved here is critical as a major safety or quality problem down the road could severely hurt the company's overall reputation.
- Be open-minded -- consider new ways of doing things, not simply transplanting your existing business model.
To be cost competitive, China-fying your operation is mandatory. For those companies willing to do the work and consider new approaches, an effective and workable balance can be achieved.
Steven H. Ganster is CEO of Technomic Asia, a strategic consultancy with more than 20 years of experience helping clients plan and execute Asian growth strategies. Technomic Asia is a division of supply chain consulting firm Tompkins Associates.