China’s Manufacturing Appeal – Past, Present, and Future

by From the Top on 2012-07-24 01:23:54


Doug Gish China’s appeal for manufacturers is at a tipping point, causing forward-thinking executives to reexamine their global supply chain and manufacturing location decisions

Just 20 years ago, China was an aspiring nation with promising growth potential.  Driven by a seemingly endless supply of low cost labor and rapidly advancing manufacturing capabilities, China was climbing the list of global manufacturing players.  Other factors contributed to China’s allure, including preferential tax policies for foreign investors, and for some forward thinking companies, the domestic market potential of China’s consumer base.  But it was the abundant supply of skilled and low cost labor that rapidly propelled China to “factory of the world” status.

Yet, years of double-digit wage inflation (see chart below) have eroded China’s once decisive labor cost arbitrage.  Land prices have also increased dramatically, to the point where land in one Yangtze River Delta investment zone, which sold for $5 per square meter as recently as 2005 now carries a mandated minimum price of $62 per square meter.  In addition, preferential tax policies for most foreign-owned companies have disappeared or been trimmed significantly.  Most notably, the 15% tax rate which once applied to virtually all foreign investors, and included a 5-year holiday (two-year 100 percent exemption, followed by a three-year 50 percent rate reduction) has been replaced with a 25% corporate income tax rate from year one unless the operation qualifies for special tax incentives.



Source: Shanghai Statistical Yearbook, 2011.

While cost escalation within China has been dramatic, several external factors are similarly eroding China’s value proposition to export-oriented manufacturers.  These include:

Currency appreciation: Between 2005 and Q1 2012, the Chinese renmimbi (RMB) appreciated by about 40% (cumulative) against the US Dollari , thereby decreasing purchasing power for US consumers of Chinese goods.

Supply chain risk awareness:  As many companies become increasingly cognizant of global supply chain risks, they are focusing more on regional versus global production models.

Increased competition:  Other low-cost manufacturing destinations both in the Asia Pacific region (e.g. Vietnam, Indonesia, India, Bangladesh) and globally (e.g. Latin America, Central/Eastern Europe, and increasingly, Africa) are enhancing their infrastructure, talent pools, and in some cases, incentives, to better compete against China for foreign direct investments.

Protectionist policies:  China has been one of the main contributors, along with the European Union, to a global rise in economic protectionism since 2008ii.  

ChiJosh Timberlake na has reached a tipping point within the global manufacturing network as it transitions from an “export play” to a “market play”.  The days of companies pouring investments into China to serve as a low-cost export platform to the rest of the world appear to be in decline.  Implications on global supply chains are profound, as many western companies look to transition or expand production not only to other low cost countries, but increasingly in their regional marketsiii.

Despite the impending decline in export-oriented production, China will likely remain a dominant player on the global manufacturing scene, and is expected to continue to attract large-scale foreign direct investment.  But for the next 20 years, these investments will likely focus increasingly on serving China’s domestic market -- over 1.3 billion potential customers with insatiable demand and, increasingly, the spending power to match.  Disposable incomes in China’s urban areas essentially tripled from 2001-2010 (see chart below).  And while consumer spending is projected to grow at 11% annually, forecasts for luxury good spending are even more dramatic at 25% per year.iv


Source: China Statistical Yearbook, 2011.

Ironically, many of the same factors which impede China’s appeal for cost cutting exporters (e.g. desire to shorten supply chains, increases in labor costs and standard of living) boost its attractiveness for manufacturers focused on the Chinese domestic market.  Industry-specific drivers can also encourage companies to localize manufacturing in China, including rapid product design/development responsiveness in consumer products; just-in-time supply chains in automotive or industrial products; or healthcare reimbursement requirements for pharmaceutical and medical device producers.  

In response to these dynamics, many manufacturers are reevaluating their production networks in China and the region to better align their manufacturing capacity with local market needs.   Manufacturers are re-sourcing products that are not sold locally to other geographies in order to free up capacity for products that are being sold into China.  Increasingly this trend is moving beyond “infrastructure” related products such as construction and heavy industrial equipment to more consumer related goods.  To support this realignment of manufacturing in China, many global companies are simultaneously re-evaluating their regional supply networks to support the new mix of products and demand levels.  As companies increasingly turn to a “China for China” or “China for Asia” strategy, versus the prevailing “China for the world” approach, large-scale supply chain shifts appear to be on the horizon over the next 15-20 years -- not only for China, but for the world.

About the authors
Doug Gish is a principal in the manufacturing strategy and operations practice, and Josh Timberlake is a senior manager in the real estate and location strategy practice, of Deloitte Consulting LLP.

Photos: Doug Gish and Josh Timberlake of Deloitte Consulting LLP

i The Wall Street Journal, MarketWatch Inc., April 16, 2012.
ii World Economic Forum in Collaboration with Deloitte Touche Tohmatsu LTD: The Future of Manufacturing – Opportunities to Drive Economic Growth, April 2012.
iii Fortune.com; Made (again) in the USA: The Return of American Manufacturing, June 29, 2011.
iv Forbes.com, Consumer Spending In China: To Buy Or Not To Buy, June 15, 2012.


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