Sunday, February 17, 2008

Global Supply Chain News: Are a Confluence of Factors Going to Bring an End to the China Sourcing Party?

Global Supply Chain News: Are a Confluence of Factors Going to Bring an End to the China Sourcing Party?
(Supply Chain Digest)

Rising labor costs, inflation, oil, are causing rapid increases in imports from China, with more increases expected

As Western manufacturers, retailers and wholesalers continue to flock to China for sourcing of a wide range of manufactured goods, a variety of trends are driving the cost of China’s exports much higher, threatening to end the China sourcing party that exploded in the past few years.

A growing economy has led to significant overall inflation in China, from wages to raw materials. A weak U.S. dollar puts pressure on Chinese companies to raise prices to maintain profit margins. Rising energy prices make the extra costs of getting goods from across the globe even more expensive than before. An increasing focus on safety and the environment, driven by pressure groups in the West, is increasing regulation and manufacturing costs for Chinese companies as well.

In short, the competitive advantage is shrinking.

The trends have some Western companies rethinking China sourcing strategies. Whether that means a return of some domestic production, or simply a switch to other lower cost countries such as Vietnam or Cambodia, remains to be seen.

The Washington Post reported this week, for example, that a Chinese toy manufacturer has raised the prices of stuffed teddy bears from $1.30 each to $2.00 – a more than 50% increase – and the company says it may lift prices even more.

The prices on many Chinese goods have increased by 10-50% in the last half year – a significant increase. After falling for years, the price index of goods from China rose 2.4 percent in 2007, according to the U.S. Bureau of Labor, the largest annual increase since the index was first published four years ago.

Price increases were in part muted for awhile, as China maintained a constant currency valuation against the U.S. dollar even as the dollar fell hard against other major currencies. But while that strategy protects U.S. buyers against price changes based on currency swings, it can hammer the profitability of Chinese manufacturers – forcing them to raise prices just to stay even. In some cases, contracts also kept a lid on prices even with rising costs, but many Chinese suppliers are demanding double-digit price increases for new contracts in 2008.

Reaching the Break Even Point

Companies have different thresholds in reaching “make versus buy” decisions, or in deciding to go with a China sourcing option versus a domestic one.

A manager at Abbott Labs, for example, said last year that given all the other costs and risks associated with offshoring, Abbott looked for a per unit cost reduction of about 30% before they would decide to go to Asian sourcing.

Whatever the particular threshold or savings expectations, double-digit increases in per unit costs, plus potentially greater transportation costs as well, obviously have the potential to dramatically change the cost-benefit equation for sourcing Chinese goods.

The Washington Post story says China’s Nantong Eurofield Art's Toys, who has customers such as Target, Wal-Mart and Toys R Us, had to raise the prices of some products by more than 50 percent. A little more than half of its customers accepted the new prices, and just under half did not renew their contracts.

In some cases, if a Western buyer is working through an Import-Export company, that middleman may absorb some of the price increase so that the full hit is not passed immediately on to buyers.

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