China’s role in the global supply chain is changing faster than ever. Companies that procure goods from China must keep up with the country’s evolving challenges to take full advantage of the opportunities.

In recent years, as opportunities have increased for manufacturers sourcing from China, so too have risks and pitfalls.

Last year’s well-publicized product recalls involved only a narrow segment of Chinese imports. Nonetheless, and despite the country’s immediate assurance that it would take the issues seriously and tackle them immediately, the loss of consumer confidence in all China-made goods served as a wake-up call to every company sourcing from China.

If sourcing teams arm themselves with the correct information on what’s really going on in the process of sourcing with China, they are that much more empowered to seize the opportunity to maintain or even increase their competitiveness.

Rethinking Operational Structure
A recent study from Booz Allen Hamilton and the American Chamber of Commerce (AmCHAM) Shanghai, entitled China Manufacturing Competitiveness 2007-2008, deemed the following as the key to successfully getting the most out of procurement and operations efforts in China:

Companies that pursue China as both a growth market and a market for lower-cost labor and sources, and integrate these operationally, enjoy significantly higher profits than companies pursuing just one of those objectives.

Specifically, the study found those that “employ dual sourcing and sales strategies report an average profitability rate two-thirds higher than those focused on just one of those objectives (29.6 percent compared with 17.8 percent).”

The study also determined that many companies remain poorly prepared when it comes to operations management (both technology and process): Three out of four companies surveyed were found to lack fundamental best practices in their China operations, including integrating the dual functions of export platforms and domestic market penetration.

A 2007 report from the Boston Consulting Group (BCG), entitled Sourcing from China: Lessons from the Leaders, revealed that companies with the greatest success at China sourcing share some common best practices:

• Defining a clear sourcing strategy with specific targets and plans;

• Integrating China suppliers and research and development (R&D) into design, leveraging Chinese suppliers’ capabilities by integrating the suppliers and China technology centers into product design;

• Gaining 100 percent transparency into sourcing volumes and savings, developing country-specific scorecards and data collection systems that provide clear transparency; and

• Addressing real and perceived risks, including exchange rate fluctuations, changes in costs of labor and materials, power outages, quality problems and transportation delays.

Increasing Costs
Sourcing from China has become a lot more expensive, and this year will likely show little in terms of slowdown. The “doubly whammy” of increased export trade tariffs and the reduction/elimination of Chinese value-added tax (VAT) rebates seems to have caught some buyers, suppliers and U.S. importers off guard.

The change in VAT rebates is one of the main reasons for price increases sourcing from China will be more expensive this year. It is also one of the most overlooked (not to mention confusing) issues when purchasing from China. VAT is basically a sales tax. Historically, the Chinese government allowed for generous VAT refunds if the final manufactured product was for export.

As of July 2007, however, China has changed its refund formula, reducing VAT rebates for thousands of product types with little to no notice. The move was part of the government’s plan to promote higher-value products and to reduce the export economy’s reliance on industries that pollute the environment and pay the lowest wages. If the materials are used to make a final good for export, then the Chinese government will issue a rebate — which can be as high as 25 percent on some items — of this tax. As such, overlooking or not understanding the impact of VAT on your China importing project can lead to major complications and a heavy financial burden.

Moreover, China has been trying to stem an ever-growing trade surplus, manage domestic inflation, move development from coastal areas to inland areas and decrease its pollutant output. Many firms are facing steep increases in the cost of raw materials, labor, transportation and logistics — basically, higher costs at all stops along the supply chain.

Add skyrocketing petroleum prices, the weak dollar, new labor policies in China and increased competition for workers in various regions, and many industries are facing a new pricing paradigm that is pinching the bottom lines of many companies and possibly steep retail price increases for consumers.

Many observers have said that as costs continue to rise in China, smaller companies will be more heavily impacted than larger firms, which have more advanced manufacturing capabilities and diversified production.

Sourcing Shifts
For some U.S. companies, the changes are squeezing margins, forcing price hikes and leading many to scramble to find new ways to cut costs or locate new sourcing regions. Purchasers are advised to look both globally and regionally for suppliers.

To some extent, the Booz Allen/AmCham study seems to echo this perspective, pointing out that companies that are invested in China for the long term are those both with the brightest prospects and achieving the best returns — but that many others are seriously considering different options.

Not long ago, a global product executive for the logistics product suite with the Global Trade Services Group at JPMorgan wrote at Supply & Demand-Chain Executive:

While opportunities still exist in Asia, Mexico will become an increasingly popular source for manufactured goods as companies compete on time-to-market strategies, seek financial advantages found in Mexico’s multiple free trade agreement and capitalize on Mexico’s investment incentives, streamlined customs processes and abundant English-speaking workforce.

“The U.S. is getting over its love affair with Asian and China sourcing in particular, especially as it pertains to looking at the region just from an export perspective,” Jason Busch proposed at Spend Matters recently.

A Whole New Role
China built an empire on being the world’s “bargain basement” factory, but that is changing. Rather than serve as the industrial provider of low-value commodities or reduce its presence as the first-choice supplier of the manufacturing world, the country is deliberately and strategically repositioning itself toward the higher-value markets where the West has traditionally felt more secure.

“The era of China as a low-cost, manufacturing-for-export market has come to an end,” Booz Allen said in a statement.

China’s role may be changing on the global supply stage, but it is here to stay.

And contrary to what many of the critics would have us believe, purchasing from China does not mean compromising quality. Sourcing teams can take action to prepare for changes in the sourcing and purchasing spaces by better understanding their options.

Earlier:

China Declares War on Dangerous Products

Superpower Tug-of-War

Resources

Surviving China’s Rapidly Changing Sourcing Tides
MFG.com July 13, 2007

China Manufacturing Competitiveness 2007-2008
Booze Allen Hamilton, March 4, 2008

Sourcing from China: Lessons from the Leaders
The Boston Consulting Group, July 2007

China Tax: Understanding the China VAT Rebate
by Mike Bellamy
Global Sources, Feb. 13, 2008

The Cost Crisis
by Wayne Niemi
Footwear News, April 21, 2008

2008 Global Trade and Supply Chain Predictions
by Bernie Hart
Supply & Demand-Chain Executive

China: Think Localization, Not Just Global Sourcing
Spend Matters, March 20, 2008

4 Reasons Sourcing from China will be More Expensive in 2008
SourceJuice, Jan. 9, 2008

Additional

10 Tips to Smart Supplier Engagement in China
by Brad Kenney
IndustryWeek.com, April 1, 2008

How To Work with China and PYA — Protect Your Assets
by David Hale
IndustryWeek.com, April 2, 2008