In an earlier blog (What do Google, Coke, China and Katrina Have in Common? 3/25/10), I emphasized that the typical Supply Chain risks are the tip of the iceberg when looking to do business in “low cost” countries. A recent AP article (Companies brace for end of cheap made-in-China era, 6/7/10) re-emphasized the point. AP reported on the number of companies that are finding it increasingly advantageous to shift production of everything from Frisbees to books to iPads from their traditional Chinese bases to lower cost locales. One of the major reasons cited is that workers in China are growing more aware of their power and, as a result, strikes and other actions are forcing companies to increase wages dramatically. The impact of China’s “revolution of rising expectations” is particularly strong when combined with the growing cost of shipping and fuel.
The article cited three responses to the challenges companies are facing:
- Move to less developed areas of China
- Move to other low cost countries
- Bring operations back to the States
One of the key factors that any company reevaluating its “China strategy” should consider is that the issues being raised in China are predictable and inevitable. One of the most frequently overlooked risks in low-cost country sourcing is the risk that wages will rise with the expectations of workers. As the AP article detailed, workers in the most developed areas of China no longer share the same values as their parents. Their goal is not to create a nest egg that will allow them to return to a rural village and live in comfort when they reach retirement. Today’s workers want more now and they want to continue their more varied and expensive life style when they retire.
Guess what? The only way for that to happen is for wages to go up and for such “Western” benefits as company-provided retirement, health insurance, shorter hours, and longer vacations to become available. How does that impact the three potential responses listed above?
Moving to other, less developed areas of China seems attractive in the short run but is likely to provide no more than temporary relief. It doesn’t take a crystal ball to see that the window of opportunity there will not remain open long. The workers in Western China are no more likely to retain their current level of expectations than workers in the current hot beds for foreign manufacturing. Expectations always rise and companies always find that they have to meet those expectations in order to avoid major disruptions in their operations.
What about moving to other low cost countries that currently have a better (lower) wage structure? While there is, again, the opportunity for short term cost reductions, the revolution of rising expectations is, as mentioned, inevitable and predictable. It can only be delayed and then not for long. In the past, the length of time from tapping a low-cost labor force until the workers sought a bigger piece of the pie was measured in generations. (Think of America’s Industrial Revolution and how long it was fueled by low cost immigrant labor before unionization took hold and changed the balance of power.) Today, the combination of global information flow and the numerous examples of what can constitute the “good life” for wage earners have significantly reduced the time lag between industrialization and the emergence of a new level of expectations. It doesn’t much matter which low-cost area you go to because the revolution will hit sooner rather than later. Does that mean that bringing operations back to the U.S. is the best option? Maybe, “Yes”; maybe, “No”.
The revolution of rising expectations is not the only issue eroding margins in China. As I detailed in another blog, (Does it matter if a 600 lb. Gorilla is Chinese or American? 4/15/10) one of the most often overlooked risks is that of shifting government policy. In China, the end of tax incentives is combining with rising expectations and emerging monetary policy to create a “perfect storm” that may swamp many companies’ profits in a sea of unanticipated cost. What happens to the cost analyses if, for example, the U.S. undertakes significant immigration reform and actually puts teeth into the rules that prohibit hiring undocumented aliens? In that scenario, minimum wages could well become an anachronism as the power of workers in the market-place supplants the power of the government to establish the least a company can pay in order to fill its less desirable positions. Similar impacts to the cost equation could result from implementation of Cap and Trade, Pay as You Go spending, or any of a number of other proposals that rise and fall in favor in response to the ever-shifting political landscape.
The bottom line? Companies need to take much more proactive, critical and detailed looks at their options. They also need to continuously monitor and attempt to anticipate changes in social, political, and cultural variables that impact cost directly or indirectly. As I have suggested before, Scenario Planning, Value Analysis, and other such tools are critical. Most importantly, leaders have to realize that they can no longer make decisions based on traditional cost analyses. Indeed, the items that typically show up in an analysis of Cost of Goods Sold may be the least important factors to consider because they are often reflections of decisions made in areas that are far beyond those that impact COGS. The challenge is that most of the decision factors that will make the difference in the future are neither well-understood by businesses nor are they easily quantifiable. The winning companies in the coming decade will be those that come closest to developing that understanding and learning how to deal with ambiguity without turning decision-making over to a roulette wheel.