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China's Not Cheap

China’s not Cheap
September 2008


Nancy Faraday runs a lamps business based in San Francisco. This has, over the years, established itself on a firm footing and has become a preferred supplier to numerous retail outlets on the west coast. These include large chains together with smaller, more specialised stores. Years of strong economic growth in the United States helped a small start-up grow into a sizable enterprise over a fifteen year period. Ms Faraday’s model was simple. She identified a string of suppliers based in China who could manufacture CFL and halogen lamps to the specifications sought by important retailers. The business was strong on cash flows as suppliers were content to offer generous credit terms and retail demand generally exceeded what she was able source from her vendors. Her challenge until a year ago was to find enough supply capacity that was capable of meeting her considerably stringent quality standards.

But now things are abruptly different. The demand for her products has, with the collapse of the American housing market, fallen. To add a double whammy, her Chinese suppliers too are resorting to the most awkward behaviour. They are unwilling to quote prices that are valid for more than a month and, in some instances, no more than two weeks. Inflation in China has changed everything. The Producer’s Price Index climbed to 8.2% in May 2008 and the raw materials index touched 11.9% yoy. This is bad news for Chinese manufacturers but even worse for global consumers. A survey[1] undertaken by Global Sources suggested that 80% of Chinese suppliers plan to raise export prices in the next six months, up from 59% six months ago. The reasons are mainly higher raw material costs but to a lesser extent labour shortages and higher wages bills.

Manufacturers complain that surging operating costs coupled with the strengthening Yuan and unfavourable export rebate cuts have left them with little option but to lift prices. They worked on thin margins anyway – where the basic premise of their operations comprised of very high volumes and low returns. The alternative would be to close shop. For Ms Faraday’s business it’s really a choice between a rock and a hard place. Her customers are not prepared to offer better terms as their own markets have suddenly shrunk. Retailers cannot reduce fixed costs and with falling off-take their overheads pinch a lot harder.

Ms Faraday’s dilemma is not unique. Grundfos Pumps imports cast iron from foundries in China. Its Managing Director, NK Ranganath, has observed that prices of these imports have gone up by about 15% in recent times possibly due to higher electricity prices, and Grundfos’ suppliers are unwilling to hold them for more than three months. Other importers of engineering goods express a similar sentiment. Large global corporations who have, over the years, become completely China-dependent on supplies, having shut or downsized operations in other locations, share similar complaints. Siemens, Haier and other white-good producers have increased prices by 10-15% which, actually, is a stunning development, as the consumer appliance industry was abundantly oversupplied for the past twenty years.

There really is not much of a response strategy that importers can adopt in the short term. Having focused their complete attention on China, other supply sources that may have previously existed have withered away. Countries in South East Asia who once proudly claimed a strong manufacturing base, can no longer do so. The global supply chain in recent years seems to have bypassed them in a northerly direction. In the longer term, the lesson would be to develop alternatives to the great China factory, as history has a strange way of repeating itself. Ms Faraday is on the road looking to build other partners into her supply chain. But this time her efforts will be outside of China.

[1] The survey interviewed 711 manufacturers of high demand export category goods ranging from eye-ware to hand bags to furniture

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