Once Again, Its Time to Follow the Leader

Sunday, November 26, 2006 19:06
Comments Off on Once Again, Its Time to Follow the Leader

For many companies, moving to China is an opportunity to reduce costs within their supply chain. Savings come typically come right away when manufacturers set up shop and they see costs savings in land and PPM… and over time, direct costs of labor and raw materials have traditionally been long term benefits.

For those earliest to China, these savings were significant at times as labor rates were still very low, and with only a few multinationals in the area, there was a lot of affordable real estate. Of course, at the time these companies were trailblazing a bit as the quality of labor had yet to reach the international standard and a lot of investment (time & money) went into everything. but, for their efforts, these leaders were rewarded.

In the last 2-3 years though, the scale by which companies have rushed to set up in China has created conditions whereby this savings gap has diminished significantly; labor rates in the gateway cities, land prices, and costs of transportation have all gone up; the availability of labor and land have decreased; and the general environment of the gateway cities towards foreign investment has changed.

These are all trends that have been reported in the popular press around the world, and one would think that the changing conditions would lead the larger companies to scale back in China.

Wrong!

The reality is that the same companies who were the leaders 10 years ago are still in the lead, and rather than scale down operations in “China”, they are increasing their China presence.

While it is true that macroeconomic trends in the gateway cities on the east coast are going up, leaders have begun to expand in two ways to mitigate and actually take advantage of this trend:

1) Move to the Hinterlands: Going to the NE, Central, or Southwest
As we have been discussing for a while now (see these reports), there is a move by many companies from the gateway cities to the hinterlands.Typically in support of a larger China-wide distribution strategy, many companies are finding that relocating large portions of staff to cities like Chengdu, Xi’an, and Wuhan offer the same cost savings cities like Shanghai, Beijing, and Tianjin offered 10 years ago.

Labor and land costs are significantly below those on the coast, and for companies that have a domestic China strategy, a move to the hinterlands is becoming a more and more popular model as these areas are rolling out the red carpets. Fortune 500 companies like Intel, IBM, Boeing, Unilever, and others have all set up shops in these hinterland cities, and many have announced expansion plans following their initial forays into the hinterlands.

For FMCG companies, moving operations into these cities will be important as the costs of transporting goods from the east coast are just not sustainable, and with cities like Xi’an and Wuhan being hubs for China’s highway network, they will definitely begin to see more FMCG company investment.

Like 10 years before though, companies going to these areas will have to invest time and energy into building a stable platform. That will mean dealing with a lower quality labor pool than is found on the east coast, who have had less experience with international companies (and their clients), and at times understanding that the pace by which things occurs in Chengdu is slower than that of Shanghai.

2) Moving to a Regional Support City of Coastal Gateway City:
For companies whom are manufacturing for export, moving cities to the hinterlands of China is not an option. Besides the costs associated with transporting goods from the hinterlands to the coast, these firms need to operate in an area where labor pools are already well trained, and be in a location that has access to ports, customs officials, and customers.

However, growing in line with Shanghai, Beijing, and Guangzhou are a number of support cities that have developed to the point where they are able to offer strong options for firms who need the perks of Shanghai, but at a lower cost.

With regard to these cities, there are two options: (1) within an hour and (2) Within a day.

Within an hour (in good traffic) from Shanghai are Minhang, Songjiang, Qingpu, Jinqiao, Wuxi, and other cities that have all become locations where companies are now able to easily establish operations. The zones in these areas have spent a lot of time and money on building attractive parks for companies, and are beginning to fill their spaces with large and small manufacturers who are looking to reduce their rental and labor costs while staying within a quick hop of Shanghai (i.e. civilization) and the Shanghai port.

A bit further out are the cities of Nanjing, Suzhou, Hangzhou, Jiazhou, Changzhou, and others who are between 3-6 hours by drive from Shanghai. Governments are rolling out the red carpet and bending over backwards in many cases as they are now in a great position to dramatically improve the conditions of their cities through investment, and these cities offer another option for companies who are looking for savings and for a larger labor pool (note: labor in this city does require more training than those in gateway cities, but not as much as those found in hinterlands).

For the largest of companies (GE, Unilever, Microsoft, and Novartis), these cities have recently become popular sites to locate large campuses.

Wrap-up:
Playing follow the leader is often much safer than being the trail blazer, but letting others do all the work comes at a cost. For those companies just entering the China market the costs are much higher now than they were 10 years ago in the gateway cities, and these costs come in direct terms (labor, land, etc) as well as indirect (lack of labor and land).

With the trend inland beginning, there are still excellent opportunities to get in early, and unlike 10 years ago, these opportunities are not reserved only for the largest firms… the SMEs can get in too!

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