But I thought everyone saved money in China?

Thursday, May 31, 2007 8:58

Following the post last week related to factoring in transportation stoppages, I realized that another post was needed to address a wider issue: Not everything should be made in China.

Over the last 2 years, we have worked with a number of firms: auto, construction tools, building materials, promotional items, mattresses, small electronics, motorcycles, and the list goes on… and in a number of cases things just have not worked out as the client would have liked.

With so much press surrounding China these days, it really isn’t surprising. Every time I return home, or go on vacation, people I meet will speak of china as if it were the dollar store… where everything is cheap, of poor quality, and ready for the taking.

But, reality is in fact quite different, and in a number of cases that we worked on…. China based sourcing was not always cheaper than U.S. based manufacturing.

Cost of goods sold (and we are going to keep this simple) is materials + overhead + labor … for some companies, it may also include transportation to the client…

Around the world, exchanges every day trade the basic materials: metals, oil, chemicals.. etc. If it is not a trading market defining the price, then it is the open market that does so through supply and demand, and unfortunately, there are few opportunities when dealing with raw materials to find a hidden cost…. sure, one can buy a Dow chemical product vs. a Chinese chemical product that achieves the same ends, but Dow chemicals have pricing structures around the world that prevent exploitable pricing gaps..

As such, it is really in the area of labor and overhead where the China advantage kicks in for many products, and for products that do not have a high percentage of either we often find that the reduction is just not enough for a customer to move their supply base.

In fact, we have found that a minimum 10% gain must be achieve before people move…. and that is after considering transportation.

A recent case where we were assisting on a light weight stamped metal fastener highlights this well. Initially, all was looking good. The tool was a fraction of the cost, and the supplier was willing to return that investment after a specified tonnage of raw material had been produced (Hint to everyone.. that is pretty standard). The cost savings was around 5%, which at a few hundred thousand units adds up, but the client found it hard to believe that was all the savings that could be found.

After all, everyone is saving money in China?? and they must be saving more than 5%
well.. the problem was that there was no labor to the piece at all. It wasn’t a piece that needed a lot of hands as the stamp was to do all the work….it required little more than being thrown into a container …. and it is because no hands were needed that there was only a 10% gain, which came from the savings in overhead .

As a heavy item, this piece “weighted out” a 20′ container, and that meant that the container was not fully utilized and that the transportation per piece was high… and in the end the net savings was about 5% (their hurdle was at best guess 15-20%)

Had they been more effectively utilizing the space by mixing the container with a low density item, the rates would have been cut in half, and an extra 3-4 points would have been gained.

At the same time, we looked at one of their more difficult pieces, also a fastener, that required not only multiple pieces to be stamped, but also these pieces to be put together. BINGO… a savings of more than 15%.. on a million pieces.

When looking at China, remember to take into account that (within reason) the raw material prices are the same everywhere, and any piece with only a few hands touching it will probably not result in much savings. China is not a magical place where once you enter, the price of production drops. It is limited by a number of the same conditions that exist in other markets, and e = mc2 here too.

If working to reduce the costs of highly automated products, make sure and introduce high labor products at the same time so as to balance out the portfolio as a whole. The goal should not be to save on every single item, but to develop a system that provides savings over all… or employ a mixed solution that leverages U.S. and Chinese production to result in a best case scenario (keep in mind the additional management of such a program will add costs back)

Understanding the contribution of raw materials, labor, and overhead will go a long way to determining which products you select to outsource vs. those left at home.. and in the end, it will increase your success rate and reduce your failure rate….

Stay tune for my next post on ways to plan for and mitigate raw material pricing shifts…

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One Response to “But I thought everyone saved money in China?”

  1. mablog says:

    June 1st, 2007 at 3:33 am

    Very Interesting Blog. I read your article of the Halfpat and found it extremely accurate. I will come back here!