I recently came across a report from business network CNBC that had the eye-gripping title; Why US Manufacturers are Nixing the US for China. The premise of this report was that the combination of applied robotics and the devalued yuan are now lowering manufacturing costs for the global manufacturing hub. This was not the only report we have seen that suddenly trumps the new attractiveness for sourcing in China. However, industry sourcing teams need to be cautious and thorough in their positioning and weighting of manufacturing sourcing decisions.
The argument seems compelling. Chinese factories are cutting prices because their costs are going down as a result of devaluation of China’s currency, not to mention that the current downswing impacting China’s economy has motivated many manufacturers to become more aggressive in preserving existing business or seeking additional customers.
The other compelling force noted was the offset of raising direct labor costs by the shift to more automated manufacturing enabled by robotics. However, a recent posting by China Tech provides a different picture or reality, with the headline: The manufacturing boom in Guangdong is over’: Industrial robot makers the latest to get swallowed up by China’s economic slowdown. A senior salesperson of a leading Chinese robotics firm predicts that only 5 percent of current robotics producers will survive in the next two years because manufacturers do not have the available capital to invest in automation. Apparently many Chinese robotic manufacturers set overly aggressive sales targets and did not factor an economic downturn. Declaring that the export-led boom in coastal region Guangdong is over, exports continue to decline every month.
The specific geography of Guangdong is a key since this was the former lower cost direct labor manufacturing region for apparel, footwear, toys and electronics that can benefit from the application of robotics and automation. Instead, manufacturing has shifted to more interior regions of China, seeking lower direct labor costs.
A separate recent article states that the world’s largest contract manufacturer Foxconn, has throttled back its robotics targets to target 30 percent automation in its factories by 2020. Previous reports had cited a 70 percent target. This report indicates that Foxconn’s Chinese factories, including those in Shenzhen, have 50,000 fully functional robots currently operating. Replicating human tasks in high volumes is not as easy as it seems.
While both outlined factors, the devaluation of Chinese currency and the promise of increased automation to offset increasing direct labor costs would appear to be a compelling argument to once again consider China for manufacturing sourcing, we advise caution for manufacturers and retailers.
The primary lesson learned from the initial wave of strategic sourcing decisions that favored China so many years ago was the one-dimensional view that weighted so many industry sourcing decisions. That sole weighting was the attractive cost of direct labor.
Industries have since learned that intellectual property protection, added logistics and transportation costs and the risks inherent within China and across global distribution networks are all added factors. The same holds true for current decisions, but the assumptions have somewhat changed.
More and more manufacturing has moved to the interior regions of China, requiring added logistics and transportation factors. The global transportation industry has its own set of problems. Ocean container carriers are in a race of survival of the fittest, those with the biggest ships, lowest costs and highest revenue potential. Air freight capacity has been dramatically reduced, and existing air service comes with a premium. Last year’s massive disruption involving U.S. West Coast ports provided a lesson in overburdened port infrastructure and increased transportation risks. Supply chain teams must now balance their transportation risks among both U.S. East and West Coast port entries. For Europe based firms, a massive overcapacity of ocean container vessels on the China to Europe segment has yet to shake out as to which multi-carrier network will garner the most leverage in shipping rates.
China’s leaders are desperately trying to move the economy to one of consumption-based vs. the prior export led, and that will drive capital availability. A consumption-based economy places the priority on China’s own manufacturers and service providers to fuel job growth and compete for business within China. The government has identified strategic industries that will fuel China’s economic growth over the next five years and they will have access to advanced research and needed capital. If you happen to compete in these industries, your business risks are magnified, especially if you source within China. Consider the recent challenges of Western brands competing within China, as their supply chains came under attack for poor quality or sub-standard practices.
Technology is a new imperative, particularly in gaining end-to-end and multi-tiered supply chain visibility across global supply networks.
The takeaway of our commentary is to not be swayed by a singular trend or singular factors. Sourcing decisions continue to require a holistic analysis that not only includes the cost of manufacturing, but the various other factors related to landed costs, inventory investment, security of information and added supply chain risks.
A given in today’s increasingly competitive global economy is that change is a constant, and assumptions prevalent today will be different in the not too distant future.
Industry supply chain teams have hopefully learned that strategic sourcing decisions need to stand the test of landed costs, market access, supply chain resiliency and risk mitigation. While China will remain an important and meaningful source of manufacturing and value-chain capability, industry supply chain teams will require a balanced global approach in sourcing, one that spans cost, technology capabilities, IP protection and risk mitigation.
As a follow-up to our prior Supply Chain Matters posting reflecting on high tech executives meeting with the leaders of China and India last week, came the announcement from Boeing of a significant order for new commercial aircraft along with the pending opening of a Boeing manufacturing facility within China itself.
Boeing indicated that it would sell 300 of its new model 737 jets to China. Of far more concern, this deal includes a plan calling for Boeing to team-up with state-controlled Commercial Aircraft Corp. (Comac) in building and operating a single aisle aircraft completion center in China. This announcement came as President Xi Jinping of China visited Boeing’s facilities near Seattle.
While Boeing indicates that the timing of the completion center has not been finalized, Boeing’s labor unions and certain politicians were quick to weigh-in on this announcement. While Boeing stresses that it will not reduce employment on the 737 program in the state of Washington, the current global hub of 737 manufacturing, the announcement did not garner favor with the likes of U.S. Presidential candidate Donald Trump, State Representative June Robinson and the head of Boeing’s labor union representing aerospace workers.
Readers might recall that in 2011, Boeing reached a labor contract settlement with the labor union representing the company’s production workers at production facilities in the state of Washington. Among other tenets in the ratified agreement, Boeing agreed to source the production of its new 737 MAX aircraft, the newest version, within the union facilities in Renton Washington. The union pressed for such a tenet because Boeing had already had plans to ramp-up model 787 aircraft production at the Charleston South Carolina final assembly facility.
In its reporting, The Wall Street Journal indicates that last month, Boeing increased its forecast for commercial aircraft demand emanating from China to 6330 new aircraft over the next 20 years, 70 percent of which are noted as market growth vs, replacement of older aircraft. That figure represents an average annual volume of upwards of 300 aircraft on an annual basis and that is the friction associated with the announcement of Boeing’s first foreign-based final assembly manufacturing site.
Added to these concerns is that state-owned Comac has been developing the C919 to compete with the 737 and the Airbus A320. That aircraft has thus far garnered orders for 500 jets. Airbus operates an assembly plant in Tianjin to produce aircraft destined for China and Asia based carriers.
Boeing indicates that the new facility will paint the fuselage and install seats and in-flight entertainment systems, but yet one wonders whether China’s leaders will accept such lighter areas of manufacturing as a legitimate presence. One might speculate that value-added composition will be an area for ongoing negotiations related to the China based facility. While in-country value-add is often a tenet of large aircraft deals, coexistence with a declared competitor along with general concerns for intellectual property protection and information security compound a decision related to China in the current environment.
Similar to the themes of the high tech sector, Boeing needs access to China’s growing commercial aircraft market, and in order to gain such access, the company must add a China based production presence to its global supply chain flows, regardless of the expected fallout.
Supply Chain Matters provides a follow-up to our prior commentary: high tech supply chains- increased risks associated with global access. In that commentary, we posed the question of balancing the need of high tech firms for increased market access to China’s market with the added risks of intellectual property protection. Leading up to the visit by Chinese President Xi Jinping to the United States last week, prominent high tech firms elected to seek favor and seek new deals with Chinese partners.
The U.S.-China summit managed to yield some significant deals. On Friday, both countries agreed not to direct or support cyber-attacks that steal corporate information for economic benefit. The countries further agreed to cooperate more closely on the investigation of cybercrimes along with the creation of a high-level working group to combat such attacks. However, beyond the agreement are the actions and will of enforcement. President Obama declared: “We (United States) will be watching carefully as to make an assessment as to whether progress has been made in this area.” President Xi declared that the proper approach was to strengthen cooperation to avoid confrontation and politicization of the issue.
Prior to his summit meeting with President Obama, President Xi Jinping hosted an Internet Industry Forum meeting of prominent corporate high tech executives at the Seattle campus of Microsoft. In its reporting, The Seattle Times features a photo of the prominent high tech CEO’s invited to attend. The optics are stark. The CEO of Alibaba, Amazon, Apple, Cisco, Facebook, IBM, Lenovo, among others are shown as participants. U.S. and China based alike. The Times notes: “Based on the attendance for what was essentially a photo-op in Redmond, that tech industry is betting that their future relies on China.”
In conjunction with the Seattle and Washington meetings, Cisco Systems announced a partnership with China based Inspur Group Co. In June, Cisco indicated that it was prepared to invest more than $10 billion in China over the next several years. The irony of the current announcement was that Cisco was the key supplier to help build China’s internal Internet and was later accused of spying on Chinese citizens. Now its CEO declares: “There are certain geopolitical dynamics that we have to navigate.”
As we along with business media has noted, Chinese authorities have informed state-owned companies and agencies to buy more locally owned and produced high tech equipment and that has accelerated the strategic importance of domestic technology. Foreign based high tech companies now have to pick their partners in order to continue to expand revenues in China.
Surely not as a coincidence, India’s Prime Minister Narendra Modi visited Silicon Valley last week and made time to speak with prominent high tech and consumer electronics executives about investments in the country.
Market and technology access along with job-growth needs are all interwoven in moving parts with implications to global product innovation and value-chain strategies. There are no easy answers and thus are the risks, perils and strategy implications that continue to unwind within today’s globally based and far more competitive supply chains.
Earlier this week, The Wall Street Journal reported what Supply Chain Matters believes to be a troubling trend, namely that some U.S. hi-tech firms are electing to transfer more intellectual property as well as value-chain activity among China’s state-owned tech firms. (paid subscription required) The trend among China’s internal high-tech sector would appear as though companies are no longer content to replicate innovations from foreign firms but rather lead markets with new innovation.
The principal catalyst was this week’s announcement by Dell indicating that it is significantly expanding its investments in China, including collaborating more closely with Chinese companies in sectors that the country deems crucial to national security. Dell plans to invest $125 billion, no small sum, within China over the next five years as part of what is termed as: “In China, for China” strategy. According to the report, the investment figure includes the cost of procuring additional value-chain components for the manufacturing of PC’s and servers in the country.
Dell further announced partnerships with software and cloud-based technology firms Kingsoft Corp. and state-owned China Electronics Corp., whose subsidiary, China Standard Software, provides a market alternative to the Microsoft Windows operating system. Dell’s partnership with China Standard Software began last year as the high tech manufacturer became what was termed by a China Standard executive as the first Western brand to produce PC’s utilizing that firm’s NeoKylin operating system. Another partnership involves Tsinghua Tongfang Co., where the two companies are collaborating to develop was it is described as: ”high-performance computing products.” According to the WSJ report, Tongfang produces security equipment for the government of China including metal detectors and embedded chips within national ID cards. The report indicates that Apple, Microsoft and Cisco are also meeting with Chinese officials in advance of Chinese President Xi Jinping’s first state visit to the United States later this month.
There are two important concerns related to these developments. One is that intellectual property protection (IPP) has always been a major concern around sourcing activities within China. That risk extends to the early days of foreign firms investing within China. This latest shift in strategy among certain U.S. firms like Dell could expose more technology to such risks. Then again, some in the high tech sector would argue that these types of risks are ongoing and are part of the cost for added access to China’s vast and growing market.
Another risk is related to the ongoing Trans Pacific Partnership agreement, a proposed trade agreement among 12 nations including several Pacific Rim countries and the United States that remains in ongoing negotiation stages. This agreement, if adopted, does not include China.
As noted in our previous commentary, the stated goals of the TPP are to “enhance trade and investment among the TPP partner countries, to promote innovation, economic growth and development, and to support the creation and retention of jobs.” As many in business media have observed, the TPP is all about lowering existing market barriers along with tolerances for supply and value-chain sourcing arrangements for many years to come. Some high tech companies have initiated ongoing political lobbying to insure any TPP agreement does not impose a competitive or cost disadvantage for their products, along with protecting access to a huge market such as China. And that reflects the conflict and our concern. Are we about to witness different IP and technology transfer strategies, one predicated on access to China’s market with IP and value-chain sourced primarily internally, and one on TPP with market access, IP and sourcing spread among member TPP nations? And, the larger what-if question focuses on whether China’s industry or government leaders elect to later block foreign based firms from future opportunities for China’s business.
In essence, market access, political, technology access and job-growth needs are all interwoven in moving parts with implications to global product innovation and value-chain strategies.
There are no easy answers and thus are the risks, perils and strategy implications that continue to unwind within today’s globally based and more globally competitive supply chains.
Over the past month, business and general media has been reporting on leaked and other types of information stemming from the ongoing Trans Pacific Partnership (TPP) talks currently underway concerning a proposed trade agreement among 12 nations including several Pacific Rim countries and the United States. The stated goals of the TPP are to “enhance trade and investment among the TPP partner countries, to promote innovation, economic growth and development, and to support the creation and retention of jobs.” The latter portion of job creation is the most political and most impactful to industry global sourcing strategy.
The latest round of negotiations that occurred in Hawaii at the end of August ended without any sense of major agreement and the ongoing process remains politically charged among potential partner countries. What has been capturing the interest of Supply Chain Matters is the consideration and weighting that has been placed on global supply sourcing for certain key industries.
Automotive Supply Chain Impacts
Much of traditional business media reporting has been concentrated on the implications to the automotive industry. Major automotive OEM’s do not want this agreement to upend existing global sourcing strategies for component supply. Both Bloomberg Businessweek and The Wall Street Journal have recently reported that Mexico’s primary automotive industry group, which has been booming from continued new sourcing of production announcements from various global auto producers, has thrown a wrench into the current talks.
Mexico overtook Japan to become the second-largest exporter of vehicles to the U.S., primarily because existing free-trade agreements have attracted new plant investments from various global brands. In essence, the country wants to protect its interests in the definition of “rules of origin” and what would be classified as duty-free imports to the U.S. Under the North America Free Trade Agreement (NAFTA), 62.5 percent of component sourcing must come from within the NAFTA free-trade area to qualify as duty-free. Bloomberg reports that Washington tentatively agreed that Japan based automotive producers should be allowed to ship vehicles duty-free to the U.S., even if upwards of 50 percent of component sourcing comes from non-TPP countries. Component suppliers from both Mexico and Canada are reportedly lobbying for negotiators to stand pat with NAFTA guidelines. Meanwhile, autoworkers in all three NAFTA countries are voicing the need for fairer standards, and not allowing Asia-Pac car companies to game the system in favor of more job creation among lower cost manufacturing regions.
U.S. based automotive OEM’s have been similarly vocal as well, declaring that they rely on global supply chains to be able to competitively manufacture vehicles in the U.S. Nations such as Malaysia and Vietnam anticipate that the TPP will provide an incentive for each of these countries to increase their presence in supply of automotive supply chains, but Thailand is now an important component sourcing hub for Japan based OEM’s.
Dairy Industry Exports
Another area of dispute is that of dairy based imports, which are the basis of supply for other food related producers. New Zealand’s economy is dependent on exports of dairy products, which is prompting that country to lobby for broader access to markets of TPP member countries including Canada. Dairy imports into Canada currently invoke a tariff in excess of 200 percent, and that country’s politicians fear a backlash in the upcoming federal elections in October if they dare agree to cutback current tariffs that protect Canadian dairy farmers. New Zealand reportedly is holding firm that the country will not sign any new trade agreement that does not open new dairy related markets.
Apparel and Textile Sourcing
For the apparel and textile industry, only clothing that is wholly sourced and produced within TPP nations qualify for duty-free sales. A recent report from Time points out that Vietnam, currently the second-largest exporter of apparel to the United States, is only able to produce a fifth of the fabric it needs to supply finished apparel to global markets. Vietnam currently imports nearly $5 billion of fabric from China, a non-TPP country, and that scale of fabric sourcing must shift. However, current U.S. tariffs of Vietnam sourced apparel which are currently 32 percent would be eliminated, perhaps adding some impetus for finding new TPP-centric sources of fabric.
High Tech Sourcing
Similarly, high tech and consumer electronics producers have a current high sourcing content dependency on China and Taiwan, and to some extent, the Philippines and Thailand for component supply. Some high tech companies have initiated their own political lobbying to insure any TPP agreement does not impose a competitive or cost disadvantage for their products. Consider how much of the value-chain components of an iPhone or iPad are sourced from non TPP regions.
Clock is Ticking
The clock is ticking on whether a final agreement on TPP can be reached soon. The U.S. Presidential sweepstakes is well underway, and member nations have their own political events that will hold legislators to task. In the end, it would appear that any TPP agreement will have some direct and probably indirect impacts on global component sourcing strategies for multiple industries.
In October of 2014 we alerted Supply Chain Matters readers to a noteworthy milestone development, namely Chinese designed and branded railway cars appearing in a U.S. subway system. Much of U.S. media did not cover this development at the time.
The headline back then was that the State of Massachusetts Department of Transportation selected China’s state-owned CNR Corp. for the replacement and delivery of 284 modern subway cars for the Massachusetts Bay Transportation Authority (MBTA), also locally known as the “T’. This was the first Chinese manufacturer to win a U.S. based major transit system equipment replacement contract. The further significance of this development was twofold. First, the awarded contract cost, namely $566 million, was a rather affordable sum for this amount of modern rail equipment. A further significance was that the contract called for the railcars to be assembled at a new final assembly manufacturing facility at a former closed Westinghouse factory site located in Springfield, a central city in Massachusetts. Assembly operations would therefore be U.S. based, with the expectation that other U.S. equipment supply contracts could follow.
At the time of bidding, there were actually two China state-owned railway firms, CNR and CSR, as bidders along with other prominent global based producers. While CNR eventually won the contract, CSR was eliminated because of deficiencies.
In our 2014 commentary, we cited a Bloomberg published report indicating that the contract awarded price was a little more than half that of Bombardier and other bidders including Hyundai Rotem Co. of South Korea and Kawasaki Rail Car of Japan. Earlier this year, at the request of China’s government, both state-owned rail companies were combined, primarily because both were bidding against each other for the same business opportunities.
Yesterday, a ground-breaking ceremony was held at the site of this new $95 million assembly plant. Massachusetts Governor Charlie Baker was present along with officials of The China Railway Rolling Stock Corporation, the newly formed entity. This new production facility is expected to be completed by the end of 2017 and employ upwards of 150 local factory workers. Rail car production operations are expected to begin in the spring of 2018 with first deliveries of rail cars beginning in early 2019.
A published report from yesterday’s New York Times reiterates that this deal represents China’s biggest push into the U.S. rail market and is part of the Chinese government’s policy to encourage its tech companies to export expertise to foreign markets. It further notes that the contract may be an impetus for other U.S. states and cities to consider modernization of their transit and railway systems.
The Times cites an independent rail economist as indicating that the Massachusetts contract might have been a price-loss leader as a means to establish a presence in the U.S. The publication cites CRRC’s vice-president of international business as indicating that his company was eager to apply the lessons learned in building transit and high speed rail systems in China. This same executive was the former chairmen of Tangshan Railway Vehicle, and oversaw the design and manufacture of one of the fastest high-speed trains in the world. The manufacturer has previously produced subway cars for many systems including three separate lines within Beijing’s subway network. (pictured).
The contract calls for the design, manufacturing and replacement of 152 Orange Line and 132 Red Line subway cars, along with an additional option for the delivery of 58 additional Red Line cars. Existing decades older Orange Line cars have racked up in excess of 1.5 million miles of service per vehicle while some Red Line cars have logged even longer service.
Last winter, the city of Boston and its surrounding metropolis experienced its most severe winter that included in excess of 100 inches of snowfall and subsequently crippled its subway system. Its aged equipment just could not overcome the accumulation of snow and ice and many cars were forced out of service. That situation has placed enormous ridership pressure on the MBTA to replace the aging fleet as soon as possible. Thus it is rather crucial that China Railway Rolling Stock meet its production and delivery milestones.
From a supply chain perspective, the initial plans call for many of the major train components to be produced in China and shipped to the U.S. for final assembly at the Springfield Massachusetts facility. However, there have been some indications that some U.S. service and production suppliers may be considered. Another open question is the recruitment of an adequately skilled U.S. workforce that can adapt to Chinese work methods.
This remains an important development to observe over the coming months as China’s railway experts continue in their efforts to make a more sustained presence within the U.S. We at Supply Chain Matters will continue to provide updates and perhaps a plant visit at some point.