BCG Report: Surviving China’s Rip Tide

Thursday, June 28, 2007 2:01

Following up on our post Accounting for Transportation Costs , I was forwarded a recent report by BCG entitled Surviving the China Rip Tide(PDF)

Broken into several chapters, this report highlights a number of critical issues for companies to consider when planning out their China supply chain. At foremost concern is the effect that increased delays at U.S. and E.U. ports are having on supply chains.

Running @ 90% ~95% capacity already, many U.S. and E.U. these ports are really sensitive to the infrequent and seasonal spikes (Mid July is going to be a mess.. see our post Rollin.. Rollin.. Rollin.. Get those Containers Floatin! ), and in BCG’s opinion, retailers need to start planning for a situation that will only get worse.

In their words:

We believe strongly that a firm focus on reducing time and variability in the China-anchored supply chains serving North America and Europe can help companies dramatically reduce their costs, improve their margins, and build competitive advantage

Totally agree. Many companies fail to realize that with the proper planning, a lot of money can be saved in the supply chain.


In reducing inefficiencies, BCG offers for VERY high level options.:

  • Firms should aggressively manage their supply chains in China to reduce inefficiency (Agree)
  • Firms should begin exploring their options air freight and other premium services to mitigate delays. In their opinion, opportunities are often lost, even when there is only a marginal cost different (Premium services agree… air freight – Show me the number)
  • Accept higher costs of manufacturing by diversifying the supply based and suppliers, and look at producing critical components domestically (Case by case there may be advantages, especially for highly automated items)

The rest of the white paper builds the case as to why companies should look at the above models:

– Lure of China – BCG makes the assertion that the primary source of China’s cost advantage is labor, and that many firms have been moving production to take advantage of these savings. To be fair, the 2 pages they devoted to this section is not enough space to cover this topic, and the authors left a lot of gaps…

  1. Labor is not the only cost advantage that manufacturers enjoy, and often
    the various reduced taxes, low rents, etc offer much lower fixed overheads
  2. Many companies operating in China do not yet carry the pension burden that they do in the U.S., and as such are able to pass that cost on
  3. China’s availability of lower cost raw materials is also a huge draw for many.
  4. Many firms are moving to China to be close to customers and produce gods that are localized

However, the underlying theory that they are trying to point out, that companies get fixated on labor cost rather than take into account transportation and other costs, was made and I agree wholly.

– Demand- Side Pressures in Shipping – Straight to the heart of the paper, this section highlights a number of the underlying issues surrounding the recent delay:

  • China is building 100 container berth over the next several years – North America.. 5 on the West Coast (and the these ports have seen 12% growth in container traffic
  • Many ports are unable to expand as members of the surrounding communities resist growth
  • U.S. Rail capacity is nearly maxed… with no plans to expand

to relieve this tension, BCG sees two solutions (1) Use the Port of Prince Rupert south of the Alaskan border, on Canadian side, it is currently only servicing bulk, is underutilized, and has rail. The problem is that for U.S. markets, the containers must be cleared twice, and that is on top of the additional transit time on Canada rail and (2) MEXICO!!! – Punta Colonet is expected to have a million TEU by 2010… but rail has no extension..

Overall, I agree with the underlying logic of this section. In the next 3-5 years, West coast ports are not going to be able to keep up with China’s production. Containers will begin to stack up, trucks will sit idle waiting for their loads, and the costs per container will rise. Where I diverge in my thinking is that this market dynamic will force buyers to reestablish U.S. relationships for goods rather than pay the higher prices to receive them from China.

This is a scenario we war game with one client called “best shore option”. We have cost out (to door) the final price of the assembled goods, and as components. Then we leverage that day to negotiate with suppliers in China and the U.S. At this point, China is still the best shore, but for some (steel stamping) the best shore may move.. frequently. To do this effectively though, manufacturers need to have a COMPLETE understanding of the numbers, and update those numbers as the RMB, VAT, and other items change.

– The hidden costs of supply chain and the dangers of lengthening supply chains- (picture of lockness monster) – The jist of these two section are simple. the longer your supply chain, the more pieces in the chain, the more expensive the chain is…. and often times, manufacturers are not taking into account a number of costs that can clearly linked to the supply chain: Carrying costs, stock out costs, obsolescence, etc. These are the costs that make accountants scratch their head as all the orders are sold at 40%, but effective rates are 32%

to prove their point, they have performed several simulations that highlight the above issues very well.

– wrap up – Many firms fail to understand their costs fully, nor how to maximize their options. These real options can make or save companies a lot of money, but often they are not exercised. Transportation is one of those areas that companies fail to understand enough. While those of us on the ground in China can see how a VAT reduction is going to impact the supply chain in 3 weeks, the point may be lost on executives who are more often looking at spreadsheets than containers.

Reviewing one’s options is something that should be done frequently with internal and external… Conversations with freight forwards, line managers, port officials, customers, and of course consultants can go a long way to improve the overall efficiency of a supply chain in China.. and around the world.

China can be a best shore option for many companies, but for others it is not. Transportation costs are just one of the costs that we consider when we are determining what is the best shore to produce on, and others include raw material costs, availability of Chinese produced substitute materials (and their cost), and labor.

There are a number of other hidden costs, but by taking the time to map out the supply chain in its entirety, many of those costs will be uncovered.

For those of you with containers hitting the LBC in 2 weeks (like me), let’s just hope that they are prepared for the tsunami of 40′ HC containers that are coming their way. We sent off another last night, and it was a close call… truck lines were very long last night and Shanghai port actually closed today because they were FULL.

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5 Responses to “BCG Report: Surviving China’s Rip Tide”

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  2. Adron says:

    June 28th, 2007 at 9:58 am

    Where I diverge in my thinking is that this market dynamic will force buyers to reestablish U.S. relationships for goods rather than pay the higher prices to receive them from China.

    I actually agree whole heartedly in this. As price points start to sync, I do see things rolling back this way. Already China has drastically increased some commodity buying from us (such as Steal, they’ve effectively, along with India, halted the collapse of our Steal industry in the last 6-8 years).

    I hope to follow up the oft pinged entry with some more of my 2 cents about the current trading situation. I just need a bit of time slotted one weekend to go through some of my collected materials.

  3. Rich says:

    July 6th, 2007 at 2:58 am

    Hi Adron,

    With regards to prices syncing, I am eagerly awaiting to see what effect the VAT rebate reduction has. For goods that are 100% being sourced in China, my feeling is the market will absorb the extra, and pass along in the U.S.

    But, if it is a product that has say 50% in China, 25% in U.S., and 25% in other places… Chinese share will reduce for sure as the prices in the U.S. will look much more attractive.

    Have a good weekend, and looking forward to future posts.

    Rich

  4. Josh says:

    January 3rd, 2008 at 9:34 am

    I found this report a good read also. Coming from a UK based distributor, I recognise that CEE suppliers are just as potentially important as China but I have to say that a lot of former communist bloc countries are still suffering from their Soviet hangover; the infrastructure can be truly awful and can be as hard to depend on as shipping from China.

  5. Rich says:

    January 3rd, 2008 at 12:02 pm

    Josh,

    Thanks for bringing the CEE perspective. You should also take a look at the report I posted a month of so ago that linked the importance of logistics and investment.

    Hope all is well and happy 2008

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